Against Intellectual Property

I have long suspected that there was something fishy about the economic defense for property rights in knowledge. My first attempt at questioning the wisdom of such a policy at a conference at NYU in 1994 was met with harsh criticism (especially from the late great Fisher Black, bless his libetarian soul). I was never able to fully recover from that experience, and so I meekly let that research program die.

But I am now very pleased to see that Michele Boldrin and David Levine have taken up the cause. Levine was kind enough to visit SFU on March 20, 2009 where he delivered a public lecture entitled "Against Intellectual Property." The lecture, if you are interested, is now available online here.

There is much food for thought here. The logic of his argument and the evidence he provides is quite persuasive, in my view. But if you see any holes in his arguments that have escaped me, please let me know.

Believing in Fiscal Stimulus 2

In part 1, I asked the question: Why do some people believe that fiscal stimulus "works" in the sense that it leads to a desirable increase in aggregate output and employment?

I have yet to see what I would consider to be a persuasive argument in favor of this belief.

Bruce Wilder (see his response to my earlier post) suggests that most economists do not believe that this is true universally; but that it is true only under "special" circumstances like a large negative "aggregate demand" shock. According to Bruce:

The case for fiscal stimulus rests on the belief that macroeconomic circumstances are such that the economy is not near, and is not headed in the near-term toward, a full-employment equilibrium, and that the price matrix is seriously out-of-whack.

I think that his view reflects accurately how many economists feel about why a massive fiscal stimulus is currently needed. The question I have for non-believers is the following: Do you find Bruce's argument persuasive?

Personally, I do not. He makes no attempt to justify his belief that the price-system is seriously out-of-whack. And even if it is out-of-whack, he makes no attempt to explain to us why this is the product of market malfunctioning, rather than government regulation. Moreover, he does not tell us what "the full-employment" level of employment is in the U.S. Nor does he identify other episodes in economic history where the policy has worked under similar "special" circumstances. No...instead we are asked simply to believe. Indeed, the non-believers are asked to explain why they do not believe!

I have stated earlier that I believe that fiscal stimulus can "work" as a redistributive mechanism. The only semi-clear evidence I see where fiscal policy has "worked" to stimulate aggregate output and employment is in the U.S. during WW2. But this policy was also associated with a significant decline in private consumption. In short, people were willing to make sacrifices to support the war effort. A similar policy today would not likely be viewed as welfare-enhancing by a population not currently facing a large threat to national security.

Where else can we find examples of economies subject to Bruce's special "deflationary" shock? How about Japan? Why did Bruce not mention the "success" that Japan has had in overcoming its troubles with fiscal stimulus. Let me explain to you why. Because the evidence clearly does not support the hypothesis; see my earlier post here. (Actually, if memory serves, perhaps Bruce mentioned that the Japanese case simply shows that fiscal stimulus is "not enough." But even so, this is hardly a persuasive argument to make in favor of fiscal stimulus).

But then, there are a lot of really smart people out there that believe that it works. Take Brad DeLong for example in his debate with Michele Boldrin; see my post here. DeLong, being the economic historian that he is, even goes so far to give us examples that purport to show why fiscal stimulus will work. What are his three examples? Here they are:

[1] The 2003-2005 housing boom, facilitated by loose monetary policy;[2] The 1996-1998 internet boom;[3] The post 1982 boom following the easing of monetary policy, the Reagan tax-cuts, and increase in military expenditure.

Now are you persuaded?

Perhaps we should believe on the basis of what some econometricians report to be fiscal multipliers above one? No one will be persuaded; this "evidence" is simply not compelling. (Among other things, we know that based on the manner in which fiscal purchases are accounted for in NIPA, the "true" contributions to GDP are by definition overstated).

Where is the evidence? Somebody please tell me. I need something more than a thinly-veiled belief that the private sector is screwed up and that therefore "something" must be done by the government to correct this screw-up.

Let me repeat what I have said in earlier posts: if a case is to be made for fiscal stimulus, it should likely be framed in terms of its desired effects as a redistributive mechanism. Here, I think the evidence is much clearer and can be made much more persuasive. One may question why it is socially desirable to keep construction workers or auto workers employed when there is clearly too much product on the market, but at least it is clear how such a policy benefits these unfortunate workers.

I suspect that this argument is not made for two reasons. The first is political; i.e., it is much more politically palatable to sell a fiscal stimulus package on the grounds that "everyone" will be made better off. The second has to do with the way most conventional macroeconomic models are structured; in particular, they are usually one-sector models so that economists trained in these models have not often thought about how, in practice, fiscal policy is usually directed to specific sectors. Who knows...this is largely conjecture on my part.

Believing in Fiscal Stimulus

My earlier post appears not to be having its desired effect. What I am really curious to know is why people believe that fiscal stimulus "works" in the conventional sense; i.e., leads to a desirable increase in aggregate output and employment.

Personally, I do not believe this; that is, I remain unconvinced by the arguments people typically employ to support this belief. This does not mean that I believe that the contrary is true; it simply means that I remain agnostic.

But most people appear not to be agnostic on the matter; they appear to believe very strongly that fiscal stimulus works. Of course, there are some that believe very strongly that the opposite is true. I am not sure what accounts for their belief either, but I choose to ignore them. The burden of the proof surely rests with those that believe. If you want me to make a big earthly investment in relation to your belief in Jesus Christ, then it is up to you to convince me (it is not up to me to disprove the existence of God).

When I was an undergrad, I believed that fiscal stimulus worked. Why did I believe this? Because this was what I was told; and at that young age, I had no reason not to believe what my professor told me. Moreover, he could show me the "logic" of the argument by way of a simple theory (at that time, the IS-LM model). He could even point to WW2 as empirical evidence in support of the theory. This theory was further corroborated in my mind by the fact that policymakers, newspaper columnists, and many other economists said exactly the same thing. The "truth" of this matter was (and still remains) conventional wisdom.

I also used to believe that Lemming populations were prone to commit mass suicide by jumping off cliffs. Why did I believe this? Because this is what I was told; in particular, this is what Walt Disney told me in his Academy Award winning 1958 documentary White Wilderness. You can see the footage here. How's this for empirical evidence?


Naturally, almost everyone who has ever heard of the phenomenon actually believes it. The image of lemmings running off a cliff has become a popular metaphor for following a crowd in an unthinking manner; see figure above.

It was only many years later that I discovered that this "fact" was a myth. Even worse, the "Norwegian" lemmings shot by Disney were imported from Hudson Bay to Calgary, where they did not jump off the cliff but were, in fact, launched off the cliff using a turntable.

I suppose that the point I am trying to make is that we are all to some extent "slaves of received wisdom." This is unavoidable. But it is not unavoidable that we should let this defect prevent us from questioning the conventional wisdom handed down to us by our predecessors (and repeated in rote-like fashion by true believers). I am wondering to what extent the widespread belief in fiscal stimulus is similar in any way to what many believe to be true of lemming populations?

As I mentioned in my earlier piece, many (certainly not all) people appear to believe in fiscal stimulus because they can see how it "works" at the microeconomic level. For example, here in my home province of British Columbia, we can measure quite directly the impact on gross employment stemming from the government's decision to build several state-of-the-art "fast ferries." The shipworkers benefited; as did a number of related trades. And the incomes earned by these people in this endeavor were no doubt spent in a manner that "stimulated" other economic activity.

But while the impact on gross employment is easy to measure, the impact on net employment is not. This particular fiscal stimulus program cost provincial taxpayers close to $500 million. This is 500 smackeroos that was no longer in the hands of the people who earned it. This loss of private sector purchasing power must have surely depressed the demand for all sorts of goods and services; and by implication, depressed the demand for labor in many sectors of the economy. Moreover, some of that income that would have been saved to ultimately finance other capital expenditures, now found its way to finance a fleet of fast ferries. In short, the aggregate impact of this policy--if measured correctly--is not likely to have been very large. (Unfortunately in this case, it did turn out to be large, but in the opposite direction; see fast ferry fiasco).

It would be more persuasive, in my view, if proponents of fiscal stimulus promoted their belief on the basis of its redistributive effects; not its aggregate effects. There may very well be a good reason to advocate fiscal stimulus with the view of supporting various sectors in dire need of help. But this is a very different argument than asserting that (almost) everyone will somehow benefit. This latter argument may even be true; but like I said, I have yet to be presented with convincing evidence.

Does Fiscal Spending "Work"?

I just returned from a visit to the Bank of Canada and had the opportunity to speak to a few high-level officials at the Bank along with several leading academics concerning a variety of issues relating to the current financial crisis.

In some of my conversations, I brought up the subject of fiscal spending; in particular, the desirability of many of the so-called "fiscal stimulus" packages that are currently being proposed. I am not sure why I was surprised, but almost everyone I spoke to thought that there was clear merit in the idea of "fiscal stimulus;" especially in the form of infrastructure investment.

Once their view was made known, I asked the question "why?" What evidence can be brought to bear in support of their view? What was it that convinced them of their belief on this matter?

Judging by the delay in the responses I received, I got the impression that many were not used to being asked such a question. They had to pause, after the initial shock I suppose, of having to collect their thoughts on the matter. The responses I received were not entirely convincing.

The responses could be divided into one of three categories:

[1] There is econometric evidence which suggests that the government spending multiplier is greater than one;
[2] The big jump in U.S. fiscal spending during WW2 and corresponding increase in GDP constitutes clear evidence of the efficacy of fiscal stimulus; and
[3] These are unusual times; the market is screwed up and *something* of this sort must be tried.

Personally, I am skeptical of having one's belief on the matter so firmly rooted on the basis of [1]. But perhaps one of you might persuade me otherwise.

The second world war is one data point that most people like to point to for confirming evidence. But is it wise to base one's beliefs on this one data point? The war experience was rather unusual. True, there was a massive buildup in military hardware (and hence, measured GDP), much of which was destined for destruction. But there was also a sharp drop in personal consumption expenditures (e.g., foodstuffs and material were rationed to the population). And while employment surged, much of this was by taking women out of the home sector and into the production of war materials. I can see why a population might want to make such sacrifices during a period of war; but would they be willing to do so today? And if so, would such a diversion of resources make society better off in any meaningful sense? I am not sure.

I found [3] the least convincing. My own view is that if we do not have convincing evidence that a particular policy will "work," then how do we know that doing "something" might not leave things even worse off than doing "nothing" at all? Since doing "something" involves the mass appropriation of resources from private citizens, would it not be better to err on the side of doing "nothing?" (Evidently not).

Of course, there may be better answers to the questions I asked, but these were the answers I received. My surprise, I suppose, was not in the answers themselves; but rather, how firmly people seemed to believe in the value of fiscal stimulus on the basis of their reported answers. Is this some sort of new religion? Perhaps they might have provided more convincing answers if they had a little more time to think about it, but I am not sure.

My own view is that people believe that fiscal stimulus works because there is no question that it does work at the microeconomic level. That is, when the government commissions a large number of workers to build something, one can actually see it being built, and one can actually see workers being employed in the act of construction.

But of course, what appears to work at the microeconomic level does not necessarily mean that it "works" at the macroeconomic level. It is harder to "see" the general equilibrium effects. It is harder to estimate net employment creation (rather than gross). What would these workers have been doing absent the government project? Would they have sat at home "idle;" or would they have been employed in some other sector (or perhaps engaged in retraining?). And how does the tax bill levied on the population at large affect their desired spending? If government spending is so successful in one area, then why not have the government coordinate all production activities in the economy? What is the optimal level of government spending? How does one calculate it? These are much harder questions to answer; and so, I suppose it is easier if they are not asked.

I leave you with a couple of articles on Japan's fiscal experience:
Bloated Bureaucracy Exposed (Japan Times)
Japan's Big-Works Stimulus is a Lesson (NY Times)

For the time-being, I remain agnostic on the subject (although, I confess that the evidence from Japan leans me more in one direction than the other). If someone can provide me with clear evidence one way or the other, I'd really appreciate it!

King Solomon's Dilemma and Behavioral Economics

When the tale of King Solomon's dilemma was first told to me as a kid, I was (like most people, no doubt) left marvelling at Solomon's brilliant solution to a rather difficult predicament.

But then I grew up and made the unfortunate choice of pursuing a graduate degree in economics. My mind was left rotted to the point where I could no longer appreciate what most other people continued to believe was the self-evident wisdom of Solomon.

The problem with Solomon's "solution" is that it adopts what in modern parlance would be labeled a "behavioral approach." In other words, the solution relies heavily on the assumption that people are "irrational" in a particular sense. It turns out to be easy to be a wise philosopher king when one assumes that everyone else is irrational. Perhaps this is why so many aspiring philosopher kings today want to replace conventional economic theory with what they call "behavioral economics."

Let's think about this. The "mechanism" (game) designed by Solomon proposes to split the baby in two (sounds "fair" at least). One women screams out "No! Let the other have the whole baby instead." The other woman coldly agrees to the solution. The real mother is revealed in the obvious manner. What is not so obvious is why the false mother could not have anticipated this outcome; a more clever woman would have simply mimicked the behavior of the true mother. Instead, the false mother fails to make this calculation (and instead adopts a simple "behavioral" strategy; which is just a fancy label for irrational behavior).

Now, perhaps there really are "irrational" people like the false mother. But would you be willing to stake a baby's life on this assumption? Even if this mechanism worked out one time, could we reasonably expect it to work in the future (would people not learn from the outcome and tailor their strategies accordingly?). If you believe that people are fundamentally irrational in this sense, then you will make a fine behavioral economist (and a poor philosopher king).

So what is the solution to Solomon's dilemma?

One approach might be to adopt the Coase theorem, which states that if transaction costs are zero, then an arbitrary assignment of property rights will lead to the efficient solution. That is, Solomon could just have assigned the baby at random to one or the other woman. If it fell into the hands of the false mother, the true mother (who presumably values the baby more) could then purchase the baby (from the one who values it less). In other words, if there are gains to trade (as would obviously exist in this case), then these gains will be realized--if transaction costs are zero.

The problem with this approach is that transaction costs are obviously not zero (these costs could arise, for example, if the true value of the baby by both women is private information). Moreover, this "solution" violates what most people would consider to be a principle of "fairness" (why should the true mother pay for her own baby?). The Coase theorem is a fascinating theorem, but it should not be applied as a solution to the problem at hand; the theorem simply states what one could expect to happen IF transaction costs are zero. In fact, the Coase theorem should be interpreted as explaining precisely why various institutions emerge to handle the problem of resource allocation in a world where transaction costs are not zero.

One such solution was offered by Solomon. But I have already highlighted the problem with his proposed institution (or mechanism). Another possible solution was offered by William Vickery: a sealed-bid second-price auction (or a Vickery auction). Assume, as seems reasonable in this case, that only the two mothers know the true value they attach to the baby. A Vickery auction would have both mothers submitting sealed bids for the baby. The woman with the highest bid would then win the auction, but pay the second-highest bid.

This solution is clever because the amount that either woman expects to pay is independent of their actual bid. Accordingly, neither one of them have an incentive to misrepresent how much they really value the baby. If the true mother values the baby more, she will win the auction (it would not be rational for the false mother to bid more than what the baby is worth to her).

Clever indeed. But there is still a problem associated with this solution. In particular, it requires that the true mother actually pay for her baby. Leaving issues of "fairness" aside, a more relevant problem may be that this mother does not have the resources to make the requisite payment. (It is absolutely critical that the payment be forthcoming; if Solomon could not credibly commit to collecting the payment, then rational players will understand this limitation and alter their strategies accordingly).

One solution might be to let the women offer themselves as indentured servants. This sounds feasible and has the desirable property that the true mother gets her baby (she would presumably be happy to offer herself as Solomon's servant, if it means getting her baby). While this solution has its drawbacks, it seems to dominate Solomon's solution--something that risks having the baby split in two.

But is it possible to design a mechanism that "does the right thing" without any cost to the true mother? Several solutions have been proposed in the literature; but each with its own peculiar drawbacks. But I recently came across one proposed solution that seems quite clever; see Bid and Guess: A Nested Solution to King Solomon's Dilemma, by Cheng-Zhong Qin of UC Santa Barbara.

The idea as presented in Qin's paper seems a little more complicated than it needs to be (but I could be wrong). The basic idea, as I see it, is to have the women play a "participation game" just before playing a standard Vickery auction. We could set up the mechanism as follows.

First, Solomon informs the women of the Vickery auction that will be used to allocate the baby. Second, he informs each woman that the price of participating in the Vickery auction will be a half-life of servitude in some miserable occupation. The women are then asked to submit envelopes with ballots that are marked "yes" or "no" (yes, I am willing to participate; no I am not). If both women submit "yes," then the Vickery auction is played. If only one woman submits "yes," then the baby is allocated to her for free (the auction is not played). If neither woman submits "yes," then the baby is disposed of in some manner (perhaps in the King's service).

Now, put yourself in the place of first, the true mother and second, the false mother. How would you play the game? Would you say "yes" or "no?"

Theory suggests that the true mother will say "yes" to the participation game (she knows that she will get the baby if the auction is played; she will pay one half-life of servitude for participation, and the other half-life in payment for the baby). Likewise, the false mother will say "no." Why submit to a half-life of servitude when she knows that she will inevitably lose the subsequent auction? The false mother will rationally bow out of the bidding; she will choose not to participate. And the baby is allocated for free to the true mother.

Of course, this assumes that the people playing this game are "rational" in the sense that they understand the rules of the game and in the sense that they can anticipate how others are likely to play it. One of the great strengths of assuming rationality in this form is that the assumption can be applied as a general condition that prevails in any resource allocation problem. Its weakness is that people may not always possess this assumed degree of rationality.

But the alternative--the "behavioral approach"--suffers from an even greater problem. In particular, the policymaker must be aware of precisely how people are irrational in each and every given circumstance (a great loss in generality). There are an infinite number of ways in which people might be irrational; and the behavioral theorist is forced to choose among an infinite number of "behavioral rules" that he or she believes captures this irrationality in a plausible manner. The only hope that a behavioral theorist has for developing a general theory is in discovering that people are irrational in some systematic manner. But if the theorist can identify this systematic pattern of irrationality, it seems hard to know why people cannot discover it for themselves too. But then, it seems clearly in the interest of aspiring philosopher kings prefer to think of themselves as being systematically more rational than the subjects they study.

South Park on the Financial Crisis

Am winding down a two-week visit at the department of economics at Nanterre (Paris X). Paris is lovely, even at this time of year. And naturally, I have fallen in love...with the bakery next to my flat (a sure sign of old age, when one prefers to oggle a fresh baguette in a shop window, rather than the pretty Parisiennes walking down the street).

During my idle time (digestive phase), I surf the net for amusing/interesting pieces. Most of my searches have turned up idiotic musings by the likes of Buiter, DeLong, and comrade Anatole. But here now, I have finally found the jewel among the rot: an episode from South Park that draws on Monty Python's "The Life of Brian."

This is absolutely brilliant; a short clip is available here.

I wonder whether all the finger-pointers might recognize themselves? (I doubt it).

Goodbye, Homo Economicus

Here we have Anatole Kaletsky, giving us his version of the Buiter rant: Goodbye, Homo Economicus.

Who is Anatole Kaletsky? Evidently, he is an "economist." Well, more like a journalist-economist-consultant-forecaster. That is, he is a snake-oil salesman; which is to say, he is richer than you or I.

In this fine piece, Kaletsky argues that economists must take the blame for the current financial crisis. Well, not all economists, of course. Not economists like Kaletsky, for example. Not the "talking head" economists, or the economists who like to forecast things. The blame lies with academic economists...like me. Well, I am sorry. I am truly sorry for causing the crisis.

The fault lies with academics who plant crazy ideas into the minds of people (adults who cannot possibly be held responsible for what they learn). Crazy ideas like efficient markets, the glory of capitalism, blah, blah, blah. One can certainly see how these crazy ideas have manifested themselves as unbridled capitalism run amok (it is inconvenient here to observe that the financial sector is by far the most heavily regulated sector in any "well-developed" economy).

To flash his eruditeness, Kaletsky offers us the following quote from Keynes:

Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back.

I like this quote and agree with it. Kaletsky evidently believes that the economist is to blame for this; rather than the madmen who adopt their ideas. Evidently, Kaletsky must have skipped some classes at Cambridge. I see that Keynes (1923) also said:

The theory of economics does not furnish a body of settled conclusions immediately applicable to policy. It is a method rather than a doctrine, an apparatus of the mind, a technique of thinking which helps its possessor to draw correct conclusions.

This is something that Kaletsky evidently does not understand. He certainly shows none of the humility that academic economists demonstrate when it comes to understanding the world around them. For example, take a look at Kaletsky's bold predictions for the economy (made January 2008), Goodbye to all that: the worst is over for the global credit crunch.

His predictions are as follows:

[1] The global credit crisis is now almost over;
[2] There will be no U.S. recession;
[3] Stock markets around the world will rise in 2008;
[4] There will be a "decoupling" between the U.S. and Asia;
[5] The sterling will fall against every other major currency

Incredibly, every single one of his predictions failed to materialize. This takes an incredible amount of skill (generally, bullshit forecasts can expect to be correct 50% of the time). But I suppose that the fault here again lies with academic economists. Shame on all of you!