Over the past decade, I’ve been advocating what I call the “musical chairs model” of the business cycle. This is from a 2013 blog post: You don’t need DSGE models to understand business cycles, it’s basically just a game of musical chairs.  Nominal wages are very sticky and NGDP is very volatile. So when NGDP falls there is less money to pay workers, and rather than taking nominal wage cuts you get lots of workers sitting on the floor—unemployment. Notice that the emphasis is on cash flows and the pay of existing workers, not the marginal cost of new hires.  Tyler Cowen recent praised a new NBER paper by Benjamin Schoefer with this abstract: I propose a financial channel of wage rigidity. In recessions, rather than propping up marginal (new hires’) costs of labor, rigid average wages squeeze cash flows, forcing firms to cut hiring due to financial constraints. Indeed, empirical cash flows and profits would turn acyclical if wages were only moderately more procyclical. I study this channel in a search and matching model with financial constraints and rigid wages among incumbent workers, while new hires’ wages are flexible. Individually, each feature generates no amplification. By contrast, their interaction can account for much of the empirical labor market fluctuations—breaking the neutrality of incumbents’ wages for hiring, and showing that financial amplification of business cycles requires wage rigidity. The paper (p. 34) also contained this interesting observation: A testable prediction is that financially constrained firms’ labor demand elasticities are higher due to the cash flow effect, and that encompassing wage changes, for all workers, have larger effects than marginal wage changes. Saez, Schoefer, and Seim (2019) provide some evidence for this prediction, studying net-of-payroll-tax wage changes from a payroll tax change that targeted young workers (but ended up boosting employment for all, even ineligible, worker groups, especially in financially constrained firms). When nominal GDP falls sharply, firms receive less revenue.  Even if new hires are willing to take pay cuts, the sticky wages of existing workers cause firms to reduce employment, often closing down money-losing units within the firm, such as factories.  A mixture of labor market norms and training costs prevent firms from immediately reopening these closed factories with new hires at a lower wage level. Nominal wage stickiness really does exist, and cannot be brushed aside.   (1 COMMENTS)

While I found Terence Kealey’s case for protectionism underwhelming, it definitely got me thinking.  Here are my further thoughts: 1. Early in his presentation, Kealey claimed that free trade is good for rich countries but bad for poor countries.  Yet later in his presentation, he blamed free trade for the post-1980 plight of non-college workers in the UK and US.  What gives?  He could have argued that free trade improved First World living standards overall, but were still a net negative for non-college workers.  But as far as I recall, he didn’t. 2. If Kealey really thought that free trade is good for rich countries but bad for subgroups, you would have expected him to favor a package of free trade and targeted redistribution, not trade barriers.  He didn’t do that. 3. Similarly, if a country’s goal is to encourage domestic innovation, why use a debatably effective technique like protectionism, instead of simply handing out large cash prizes for successful domestic innovation?  If you want X, don’t pay for Y and hope Y leads to X; pay directly for X. 4. If you really believe Kealey’s learning-by-doing story, it is unclear why even rich countries would ultimately benefit from free trade.  Just because your industries are currently the world’s leaders is hardly a reason to stop struggling to improve.  And on Kealey’s logic, allowing foreign competition automatically reduces native firms’ incentive to improve. 5. Kealey’s learning-by-doing mechanism ought to work in every industry, not just high-tech industries.  So what’s wrong with letting comparative advantage determine what each country specializes in, and then sit back and watch every country learn how to become even better at whatever they were initially comparative good at? 6. Kealey said relatively little about foreign investment, but on his logic, developing countries should love it.  Foreigners come in – and let natives learn by doing.  Even if the foreigners eventually leave, this skilled labor force now gives domestic investors a big head start.  Yet in practice, protectionism and hostility to foreign investment go hand in hand. 7. If Kealey were right, remote countries should be poorer in the short-run, but richer in the long-run.  Yet New Zealand remains one of the poorest countries in the Anglosphere.  Weird. 8. Kealey said virtually nothing about immigration, but almost all of the countries that allegedly “grew rich under protectionism” also “grew rich under open borders.” The US, Canada, Australia, and New Zealand all spent the 19th-century welcoming foreigners.  Is this strong evidence that open borders is crucial for growth?  Even I wouldn’t say so. 9. The United States and other immigrant societies owe a lot of their 19th-century progress to innovative immigrants.  If these immigrants had stayed in their home countries, some of this progress would have happened there.  But many immigrant innovators would simply died in obscurity in their home countries.  Since innovation is largely non-rival, the net effect of immigration for the world was great.  True, since innovation is still partially rival, the receiving countries may still have lost.  But even that is far from clear. 10. In the debate, Daniel Hannon pointed out that almost no one who claims that wages “stagnated” (or even fell) since the 1980s would actually want to go through a one-way time machine back to 1980.  The literature on CPI bias strongly backs him up.  Official statistics overstate inflation every single year (except 2020, where the opposite holds!), so every year official measures of our standard of living become more and more absurdly pessimistic. 11. There was one issue that both Kealey and Hannon got wrong: They both overstated the importance of international trade.  Even under complete free trade, the large majority of trade is internal.  Why?  Because transportation costs pull countries apart from each, and social networks bind each country together.  National productivity matters more for prosperity than free trade, so Hannon’s enthusiastic adjectives were over-the-top.  But this is still a minor error compared to Kealey’s hyperbolic pessimism. (0 COMMENTS)

Historian Bret Devereaux of the University of North Carolina talks with EconTalk host Russ Roberts about our understanding of the ancient Greeks and Romans. Devereaux highlights the gap between the reality of Greece and Rome and how they’re portrayed in popular culture. The conversation focuses on the diversity of ancient Rome and the military prowess of Sparta. (0 COMMENTS)

Historian Bret Devereaux of the University of North Carolina talks with EconTalk host Russ Roberts about our understanding of the ancient Greeks and Romans. Devereaux highlights the gap between the reality of Greece and Rome and how they’re portrayed in popular culture. The conversation focuses on the diversity of ancient Rome and the military prowess of […] The post Bret Devereaux on Ancient Greece and Rome appeared first on Econlib.

A recent NBC/YouGov opinion survey showed that nearly two-thirds of American adults agree with the pullout from Afghanistan (see question 4). Can we infer that the electorate prefers a pullout to maintaining a small military in Afghanistan or even to a “forever war”? Not at all, as the “Condorcet paradox” demonstrates. Here is an illustration. I am not taking sides on the substantive issues in the Afghan war, but only pointing out that the electorate does not know what “it” wants. In general, we can expect it to prefer both A and non-A; in this case, pullout and non-pullout. Imagine that the American voters are (or have been or will be) facing three alternatives: M: providing Moderate support to an Afghan government keeping the Taliban at bay F: waging a Forever war in Afghanistan R: Retreating or pulling out from, or never intervening in, Afghanistan Assume that the preferences of American voters among these three alternatives divide them into three equal groups: V1  group (1/3 of voters) where each voter prefers M to F and F to R. Being rational in the sense of having transitive preferences, each voter in this group also prefers M to R. (In the table below, this is symbolically represented by M >F >R, where “ >” only means “preferred to.”) V2  group (1/3 of voters) where each voter prefers F to R and R to M and, therefore, F to M. (In the table, this is symbolically represented by F >R >M.) V3 group (1/3 of voters) where each voter prefers R to M and M to F and, therefore, R to F. (In the table, this is symbolically represented by R >M >F.) Condorcet Paradox Illustrated V1 M >F >R V2 F >R >M V3 R >M >F Electorate M >F >R >M >F >R >M … Suppose the electorate is asked to choose between M and F. Members of V1 and V3, will vote for M, making it the winning alternative. If the voters are asked instead to choose between F and R, the result of the vote would be F because V1 and V2 vote for F; the winner is F. So the electorate prefers the moderate solution in Afghanistan (M) to a forever war (F) and a forever war (F) to a retreat (R). If the electorate is rational, it must prefer a moderate solution (M) to a retreat (R). Now, if the same voters are asked, perhaps at a later election (or opinion poll), to choose between R and M, the majority, V2 and V3, votes for R. Without any voter changing his mind, the majority that preferred a moderate solution (M) to a retreat (R) also prefers the contrary: a retreat (R) to a moderate solution (M). The last line of the table describes the electorate’s intransitive and cycling preferences. This does not mean that majority votes are never useful, only that we can’t count on the electorate to be rational even if no voter changes his mind. The aggregation of voters’ preferences may give inconsistent results and will generally do so as the number of voters or issues increases. For a more thorough discussion of the irrationality of voting and its political implications, see my review of a classic book by William Riker, “Populist Choices Are Meaningless,” Regulation 44:1 (Spring 2021), pp. 54-57; and my article on “The Impossibility of Populism,” The Independent Review 26:1 (Summer 2021), pp. 15-25. Teaser: the equivalent of the Condorcet paradox affects any voting system respecting some basic axioms related to rationality. (0 COMMENTS)

David Friedman has an interesting post that leads off with this quote from novelist Robert Heinlein: A human being should be able to change a diaper, plan an invasion, butcher a hog, conn a ship, design a building, write a sonnet, balance accounts, build a wall, set a bone, comfort the dying, take orders, give orders, cooperate, act alone, solve equations, analyse a new problem, pitch manure, program a computer, cook a tasty meal, fight efficiently, die gallantly. Specialization is for insects. David goes on to mention a lot of skills he has that are like some of the above or that are simply general skills that he finds useful. Here’s how I rate on the above. Change a diaper.  Been there, done that many times. The startup cost to learn it again would be very low. Plan an invasion. I don’t know if I could; I’ve never tried. I’ve planned a few “political invasions,” that is, using very limited resources to conduct and, in most cases, win on a ballot initiative. Butcher a hog. No; I think I would do a bad job. Conn a ship. Does running a pontoon boat count? Design a building. Design? Maybe. Would it be any good? I don’t know. Write a sonnet. Yes. Balance accounts: Absolutely. I used to do it to the penny. Build a wall. If it were made of stone, then I can say that my brother and I did it when I was about 12. Set a bone. I don’t know. Comfort the dying. Yes, I’ve done it. Take orders. Yes. Give orders. Yes. Cooperate. Yes. Act alone. Yes. Solve equations. Oh yes. Analyse a new problem. Yes. Pitch manure. If pitching human manure (I dug out all the crap under our outdoor toilet at my cottage when I was 14) counts, then yes. Program a computer. Sadly, no. Although I think I did some basic stuff on a Compaq back in 1985. Cook a tasty meal. Absolutely. Fight efficiently. I know the principles. Would I put them into action if push came to shove? (Pun intended.) Maybe time will tell (but hopefully time won’t tell.) Die gallantly. Yes. When I was on a flight that I was pretty sure would crash in Monterey in about 1995, I calmly took out my credit card, stuck it in the slit, called home, told my daughter to get her mother on the phone, and prepared to say goodbye to both of them and remind Rena where the life insurance documents were filed. Then the captain thought better of it and turned around to go back to San Fran. I was amazed at how calm I was. (0 COMMENTS)

This tweet raises an interesting question: I believe that it’s a big mistake to use monetary policy to target employment (as we saw in the 1960s and 1970s).  The counterargument is that Congress gave the Fed a mandate that included “maximum employment” and thus the Fed is sort of forced to set a target for maximum employment. But that Fed mandate does not force the Fed to precisely define maximum employment for the simple reason that the Fed cannot precisely define maximum employment, nor can anyone else.  No one knows how many jobs can be created through monetary stimulus without threatening the other part of the dual mandate, which is price stability (defined as 2% inflation, but that’s another issue.) That doesn’t mean the Fed should ignore the maximum employment mandate, rather the implication is that the Fed needs a model as to how best to address the dual mandate.  And one basic model that the Fed has been working with in recent decades is the Natural Rate Hypothesis, which is the idea that you cannot permanently push employment above its natural rate with expansionary monetary and fiscal policies. Philosophers tell us that the best way to be happy is to directly aim for some goal other than happiness—perhaps devotion to a cause.  Similarly, the best way to promote maximum employment is to aim for some other policy target, such as steady growth in NGDP at a rate that is broadly consistent with expectations of the public.  Whatever level of employment results from that policy (in the long run) can be inferred to be the “natural rate of employment”.  That doesn’t mean that other policy reforms cannot boost employment further, just that you cannot use monetary policy to produce consistently higher employment than what you’d get with a steady rate of NGDP growth of say 4% or 5%. In my view, the Fed will define “maximum employment” as the actual rate of employment when two things have occurred: 1.  NGDP growth has been pretty stable for an extended period. 2.  The actual unemployment rate has stopped falling, and has leveled off for a period of years. As far as I know, that’s never happened in all of US history (but did happen in the UK from 2001-07).  If not for Covid, I believe this would have happened here in the early 2020s.  Now I wonder if I’ll live long enough to see a “soft landing”, i.e. whether I’ll live long enough to see a sustained period of steady and low unemployment and steady NGDP growth. PS.  Even if the Fed does eventually figure out the definition of maximum employment, it will be a pyrrhic victory, as this elusive figure continually changes over time. (0 COMMENTS)

You don’t hear people discuss the 3rd Amendment to the US Constitution as often as some of the other amendments: No Soldier shall, in time of peace be quartered in any house, without the consent of the Owner, nor in time of war, but in a manner to be prescribed by law. Obviously, the intent was to prevent the government from requiring property owners to house people that they don’t wish to provide shelter to.  In those days, no one could have envisioned governments forcing people to house ordinary citizens; the problem was the forcible quartering of soldiers. (BTW, the British government didn’t typically force their soldiers to be housed in occupied homes; rather they forced property owners to house soldiers in commercial property, barns, inns, etc.) The Supreme Court recently invalidated an eviction moratorium that effectively forced homeowners to provide housing to people that were not paying rent.  (Some of those people were presumably soldiers.) Jacob Sullum at Reason points out that the reasoning behind the CDC’s regulation would have allowed for an almost unlimited control over our lives: If the CDC’s understanding of its powers were correct, it would have the authority to make any of its frequently contentious COVID-19 recommendations, including its advice on mask wearing by K–12 students and the general public, mandatory. Rather than focus on people who move because they are evicted, it could simply decree that no one is allowed to change residences. It could require every American to be vaccinated against COVID-19. It could unilaterally impose nationwide shutdowns of businesses and order every American to stay home except for “essential” purposes. It could prescribe fines and jail sentences for people who defy those requirements, as it has with the eviction moratorium. And it could do any of these things not just in response to COVID-19 but also to control the spread of any communicable disease, including the seasonal flu and the common cold. Where does the CDC think it gets this limitless discretion? The Public Health Service Act, which Congress approved in 1944, says “the Surgeon General, with the approval of the Secretary [of health and human services], is authorized to make and enforce such regulations as in his judgment are necessary to prevent the introduction, transmission, or spread of communicable diseases from foreign countries into the States or possessions, or from one State or possession into any other State or possession.” This is one reason why the Constitution is so important.  Congress is not authorized to pass regulations that violate the Constitution.  Of course it’s not enough to have a constitution, you also need to be willing to enforce the protections it provides.  New Zealand’s Bill of Rights (they don’t have a formal constitution like ours) provides for freedom of assembly, but the government recently suspended that right: New Zealand police said officers were on Queen Street on Friday after hearing a protest was being planned, but only one person arrived with the intention of protesting, Newshub reported. “Police have been in the area and have spoken to one person who arrived intending to attend the protest. Police spoke to the individual who was encouraged to comply with alert level four restrictions and chose to leave,” a spokesman said. (1 COMMENTS)

On the surface, Milton Friedman and Paul Samuelson have a lot in common. They each did pathbreaking work in economics; both won Nobel prizes. Each had a column in Newsweek on alternating weeks for eighteen years. And they were, by their own admission, each other’s greatest rivals- Samuelson, the “High Priest of Keynesianism, and Friedman, the practical free market ideologue. In this episode, EconTalk host Russ Roberts welcomed author Nicholas Wapshott to talk about his new book, Samuelson Friedman: The Battle Over the Free Market. Wapshott tells a story of friendly rivalry, professional ambition, and lasting legacies. One wonders who could fill the shoes of either Samuelson or Friedman today. Let’s hear what you took from this episode. Use the prompts below to start a conversation here in the comment, or with your fav friend (or frenemy?) offline. As always, we love to hear from you.   1- How does Wapshott characterize the respective academic contributions of Samuelson and Friedman? How does he compare the motivations of each relative to their success? What does he imply in describing Friedman as “seductive” and Samuelson as “patrician?” What were the greatest sorts of disagreements between the two on economic issues?   2- Samuelson was probably most famous for his textbook. What does Roberts mean when he says that despite not having a textbook of his own, Friedman was continually “percolating” through Samuelson’s textbook revisions?   3- Roberts described Friedman’s influence on monetary policy as immortal. What was the substance of Friedman’s influence in this area? How does Wapshott characterize Friedman’s influence here differently? Who do you think better characterizes Friedman’s legacy here, and why?   4- Wapshott and Roberts agree that of the two, Friedman was more directly engaged in policy. How does each evaluate Friedman’s successes and failure with regard to his policy proposals? What do you think has been Friedman’s greatest policy success? His greatest failure?   5- Roberts suggests that ultimately, Hayek has been more influential in the policy sphere than Friedman. To what extent do you agree? Who do you think has had a more lasting influence on economic policy between Friedman and Samuelson? And more broadly, what do you think the role of economists should be with regard to public policy?   6- Roberts and Wapshott spend a good bit of time discussing the Hoover Institution toward the end of the conversation, and both seem to suggest they find something “missing” in its atmosphere today, as compared to when Friedman and George Shultz were in residence. What do you think they’re missing, and how might any institution recover what they feel has been lost? (0 COMMENTS)

If you kindly allow me, just once, to personify society, I would say that the featured image of this post represents how America should feel when seeing itself in the Chinese mirror. The Economist tells us that Chinese president Xi Jinping and his Communist Party “pressed high-income enterprises to ‘return more to society.’” (“Business This Week,” August 28, 2021. See also the accompanying article, “Xi Jinping’s talk of ‘common prosperity’ spooks the prosperous.”) He is using a Western platitude that is actually nonsense in anything resembling a free society. A free business benefits consumers by benefiting its owners and employees; there is nobody else to whom it should be forced to “return” anything. In an exploitative regime like in China, on the contrary, the state and its crony corporations should return everything, including Mr. Xi’s remuneration and perks, to the taxpayers who have been forced to pay for it. Look at the phenomenon in another, more general, way. The legendary Martian, not very philosophically astute, landing on Earth might think that the Chinese state is rapidly converging to the Western world’s freedom. The Chinese state is doing things like boosting its antitrust laws, expanding regulation, and attacking high-tech companies, all of that in the name of competition. It even adopted what is said to be one of the world’s strictest data-privacy laws. It would appear to our Martian that Western-style laws and regulations are being introduced in China. This illusion is very misleading. Chinese rulers and apparatchiks do not use the concept of “law” or “constitution” in the theoretical sense it has here or at least in the ideal sense it had in the Western classical-liberal tradition. Legal concepts were closely related to the “rule of law,” a system of general and abstract rules that allowed individuals to interact, trade, and arrange their own affairs without ad hoc bans or orders from the government. The power of government was equally bound by the rule of law. Two classic treatments of these issues, at the frontier of law and economics, are due to Friedrich Hayek: Law, Legislation and Liberty, especially vol. 1: Rules and Order (University of Chicago Press, 1973); and his The Constitution of Liberty (University of Chicago Press, 1960). On the contrary, what they mean by “law” in China is just the form in which the government issues its arbitrary orders and bans. When the Chinese political authorities imitate Western governments’ interventions, they imitate precisely what has, over a century or so, most undermined the rule of law: antitrust laws, attacks on industries that the state doesn’t like (or whose executives it doesn’t like), mercantilism, investment and trade controls, government surveillance, etc. The Chinese privacy laws are meant to constrain independent businesses, not government agencies. China has become a deforming mirror of the West, where the state is using corrupted Western ideals to become a worse Leviathan. It remains to be seen whether the US government and other Western governments, as well as the public, will be repulsed by what they see in the Chinese mirror and will rediscover classical-liberal values, or whether they will be led to look more and more like the deformed image they see in the mirror. Thus far, the latter seems to be happening. Just consider that the US government and other governments in the West are expanding industrial policy, which has long been proved inefficient and been gradually (if only formally) abandoned, but is now rekindled for the illusory goal of competing with a planned economy under a tyrannical state. (0 COMMENTS)