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Review of Philip Tetlock’s “Superforecasting” – Article by Adam Alonzi

Review of Philip Tetlock’s “Superforecasting” – Article by Adam Alonzi

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The New Renaissance Hat
Adam Alonzi
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Alexander Consulting the Oracle of Apollo, Louis Jean Francois Lagrenée. 1789, Oil on Canvas.

“All who drink of this treatment recover in a short time, except those whom it does not help, who all die. It is obvious, therefore, that it fails only in incurable cases.”

-Galen

Before the advent of evidence-based medicine, most physicians took an attitude like Galen’s toward their prescriptions. If their remedies did not work, surely the fault was with their patient. For centuries scores of revered doctors did not consider putting bloodletting or trepanation to the test. Randomized trials to evaluate the efficacy of a treatment were not common practice. Doctors like Archie Cochrane, who fought to make them part of standard protocol, were met with fierce resistance. Philip Tetlock, author of Superforecasting: The Art and Science of Prediction (2015), contends that the state of forecasting in the 21st century is strikingly similar to medicine in the 19th. Initiatives like the Good Judgement Project (GJP), a website that allows anyone to make predictions about world events, have shown that even a discipline that is largely at the mercy of chance can be put on a scientific footing.

More than once the author reminds us that the key to success in this endeavor is not what you think or what you know, but how you think. For Tetlock pundits like Thomas Friedman are the “exasperatingly evasive” Galens of the modern era. In the footnotes he lets the reader know he chose Friedman as target strictly because of his prominence. There are many like him. Tetlock’s academic work comparing random selections with those of professionals led media outlets to publish, and a portion of their readers to conclude, that expert opinion is no more accurate than a dart-throwing chimpanzee. What the undiscerning did not consider, however, is not all of the experts who participated failed to do better than chance.

Daniel Kahneman hypothesized that “attentive readers of the New York Times…may be only slightly worse” than these experts corporations and governments so handsomely recompense. This turned out to be a conservative guess. The participants in the Good Judgement Project outperformed all control groups, including one composed of professional intelligence analysts with access to classified information. This hodgepodge of retired bird watchers, unemployed programmers, and news junkies did 30% better than the “pros.” More importantly, at least to readers who want to gain a useful skillset as well as general knowledge, the managers of the GJP have identified qualities and ways of thinking that separate “superforecasters” from the rest of us. Fortunately they are qualities we can all cultivate.

While the merits of his macroeconomic theories can be debated, John Maynard Keynes was an extremely successful investor during one of the bleakest periods in international finance. This was no doubt due in part to his willingness to make allowance for new information and his grasp of probability. Participants in the GJP display open-mindedness, an ability and willingness to repeatedly update their forecasts, a talent to neither under- nor over-react to new information by putting it into a broader context,  and a predilection for mathematical thinking (though those interviewed admitted they rarely used an explicit equation to calculate their answer). The figures they give also tend to be more precise than their less successful peers. This “granularity” may seem ridiculous at first. I must confess that when I first saw estimates on the GJP of 34% or 59%, I would chuckle a bit. How, I asked myself, is a single percentage point meaningful? Aren’t we just dealing with rough approximations? Apparently not.

Tetlock reminds us that the GJP does not deal with nebulous questions like “Who will be president in 2027?” or “Will a level 9 earthquake hit California two years from now?” However, there are questions that are not, in the absence of unforeseeable Black Swan events, completely inscrutable. Who will win the Mongolian presidency? Will Uruguay sign a trade agreement with Laos in the next six months? These are parts of highly complex systems, but they can be broken down into tractable subproblems.

Using numbers instead of words like “possibly”, “probably”, “unlikely”, etc., seems unnatural. It gives us wiggle room and plausible deniability. They also cannot be put on any sort of record to keep score of how well we’re doing. Still, to some it may seem silly, pedantic, or presumptuous. If Joint Chiefs of Staff had given the exact figure they had in mind (3 to 1) instead of the “fair chance” given to Kennedy, the Bay of Pigs debacle may have never transpired. Because they represent ranges of values instead of single numbers, words can be retroactively stretched or shrunk to make blunders seem a little less avoidable. This is good for advisors looking to cover their hides by hedging their bets, but not so great for everyone else.

If American intelligence agencies had presented the formidable but vincible figure of 70% instead of a “slam dunk” to Congress, a disastrous invasion and costly occupation would have been prevented. At this point it is hard not to see the invasion as anything as a mistake, but even amidst these emotions we must be wary of hindsight. Still, a 70% chance of being right means there is a 30% chance of being wrong. It is hardly a “slam dunk.” No one would feel completely if an oncologist told them they are 70% sure the growth is not malignant. There are enormous consequences to sloppy communications. However, those with vested interests are more than content with this approach if it agrees with them, even if it ends up harming them.

When Nate Silver put the odds of the 2008 election in Obama’s favor, he was panned by Republicans as a pawn of the liberal media. He was quickly reviled by Democrats when he foresaw a Republican takeover of the Senate. It is hard to be a wizard when the king, his court, and all the merry peasants sweeping the stables would not know a confirmation bias from their right foot. To make matters worse, confidence is widely equated with capability. This seems to be doubly true of groups of people, particularly when they are choosing a leader. A mutual-fund manager who tells his clients they will see great returns on a company is viewed as stronger than a Poindexter prattling on about Bayesian inference and risk management.

The GJP’s approach has not spread far — yet. At this time most pundits, consultants, and self-proclaimed sages do not explicitly quantify their success rates, but this does not stop corporations, NGOs, and institutions at all levels of government from paying handsomely for the wisdom of untested soothsayers. Perhaps they have a few diplomas, but most cannot provide compelling evidence for expertise in haruspicy (sans the sheep’s liver). Given the criticality of accurate analyses to saving time and money, it would seem as though a demand for methods to improve and assess the quality of foresight would arise. Yet for the most part individuals and institutions continue to happily grope in the dark, unaware of the necessity for feedback when they misstep — afraid of having their predictions scrutinized or having to take the pains to scrutinize their predictions.

David Ferrucci is wary of the “guru model” to settling disputes. No doubt you’ve witnessed or participated in this kind of whimpering fracas: one person presents a Krugman op-ed to debunk a Niall Ferguson polemic, which is then countered with a Tommy Friedman book, which was recently excoriated  by the newest leader of the latest intellectual cult to come out of the Ivy League. In the end both sides leave frustrated. Krugman’s blunders regarding the economic prospects of the Internet, deflation, the “imminent” collapse of the euro (said repeatedly between 2010 and 2012) are legendary. Similarly, Ferguson, who strongly petitioned the Federal Reserve to reconsider quantitative easing, lest the United States suffer Weimar-like inflation, has not yet been vindicated. He and his colleagues responded in the same way as other embarrassed prophets: be patient, it has not happened, but it will! In his defense, more than one clever person has criticized the way governments calculate their inflation rates…

Paul Ehrlich, a darling of environmentalist movement, has screeched about the detonation of a “population bomb” for decades. Civilization was set to collapse between 15 and 30 years from 1970. During the interim 100 to 200 million would annually starve to death, by the year 2000 no crude oil would be left, the prices of raw materials would skyrocket, and the planet would be in the midst of a perpetual famine. Tetlock does not mention Ehrlich, but he is, particularly given his persisting influence on Greens, as or more deserving of a place in this hall of fame as anyone else. Larry Kudlow continued to assure the American people that the Bush tax breaks were producing massive economic growth. This continued well into 2008, when he repeatedly told journalists that America was not in a recession and the Bush boom was “alive and well.” For his stupendous commitment to his contention in the face of overwhelming evidence to the contrary, he was nearly awarded a seat in the Trump cabinet.

This is not to say a mistake should become the journalistic equivalent of a scarlet letter. Kudlow’s slavish adherence to his axioms is not unique. Ehrlich’s blindness to technological advances is not uncommon, even in an era dominated by technology. By failing to set a timeline or give detailed causal accounts, many believe they have predicted every crash since they learned how to say the word. This is likely because they begin each day with the same mantra: “the market will crash.”  Yet through an automatically executed routine of psychological somersaults, they do not see they were right only once and wrong dozens, hundreds, or thousands of times. This kind of person is much more deserving of scorn than a poker player who boasts about his victories, because he is (likely) also aware of how often he loses. At least he’s not fooling himself. The severity of Ehrlich’s misfires is a reminder of what happens when someone looks too far ahead while assuming all things will remain the same. Ceteris paribus exists only in laboratories and textbooks.

Axioms are fates accepted by different people as truth, but the belief in Fate (in the form of retroactive narrative construction) is a nearly ubiquitous stumbling block to clear thinking. We may be far removed from Sophocles, but the unconscious human drive to create sensible narratives is not peculiar to fifth-century B.C. Athens. A questionnaire given to students at Northwestern showed that most believed things had turned out for the best even if they had gotten into their first pick. From an outsider’s perspective this is probably not true. In our cocoons we like to think we are in the right place either through the hand of fate or through our own choices. Atheists are not immune to this Panglossian habit. Our brains are wired for stories, but the stories we tell ourselves about ourselves seldom come out without distortions. We can gain a better outside view, which allows us to see situations from perspectives other than our own, but only through regular practice with feedback. This is one of the reasons groups are valuable.

Francis Galton asked 787 villagers to guess the weight of an ox hanging in the market square. The average of their guesses (1,197 lbs) turned out to be remarkably close to its actual weight (1,198 lbs). Scott Page has said “diversity trumps ability.” This is a tad bold, since legions of very different imbeciles will never produce anything of value, but there is undoubtedly a benefit to having a group with more than one point of view. This was tested by the GJP. Teams performed better than lone wolves by a significant margin (23% to be exact). Partially as a result of encouraging one another and building a culture of excellence, and partially from the power of collective intelligence.

“No battle plan survives contact with the enemy.”

-Helmuth von Moltke

“Everyone has a plan ’till they get punched in the mouth.”

-Mike Tyson

When Archie Cochrane was told he had cancer by his surgeon, he prepared for death. Type 1 thinking grabbed hold of him and did not doubt the diagnosis. A pathologist later told him the surgeon was wrong. The best of us, under pressure, fall back on habitual modes of thinking. This is another reason why groups are useful (assuming all their members do not also panic). Organizations like the GJP and the Millennium Project are showing how well collective intelligence systems can perform. Helmuth von Moltke and Mike Tyson aside, a better motto, substantiated by a growing body of evidence, comes from Dwight  Eisenhower: “plans are useless, but planning is indispensable.”

Adam Alonzi is a writer, biotechnologist, documentary maker, futurist, inventor, programmer, and author of the novels A Plank in Reason and Praying for Death: A Zombie Apocalypse. He is an analyst for the Millennium Project, the Head Media Director for BioViva Sciences, and Editor-in-Chief of Radical Science News. Listen to his podcasts here. Read his blog here.

3 Kinds of Economic Ignorance – Article by Steven Horwitz

3 Kinds of Economic Ignorance – Article by Steven Horwitz

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The New Renaissance HatSteven Horwitz
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Do you know what you don’t know?

Nothing gets me going more than overt economic ignorance.

I know I’m not alone. Consider the justified roasting that Bernie Sanders got on social media for wondering why student loans come with interest rates of 6 or 8 or 10 percent while a mortgage can be taken out for only 3 percent. (The answer, of course, is that a mortgage has collateral in the form of a house, so it is a lower-risk loan to the lender than a student loan, which has no collateral and therefore requires a higher interest rate to cover the higher risk.)

When it comes to economic ignorance, libertarians are quick to repeat Murray Rothbard’s famous observation on the subject:

It is no crime to be ignorant of economics, which is, after all, a specialized discipline and one that most people consider to be a “dismal science.” But it is totally irresponsible to have a loud and vociferous opinion on economic subjects while remaining in this state of ignorance.

Economic ignorance comes in different forms, and some types of economic ignorance are less excusable than others. But the most important implication of Rothbard’s point is that the worst sort of economic ignorance is ignorance about your economic ignorance. There are varying degrees of blameworthiness for not knowing certain things about economics, but what is always unacceptable is not to recognize that you may not know enough to be speaking with authority, nor to understand the limits of economic knowledge.

Let’s explore three different types of economic ignorance before we return to the pervasive problem of not knowing what you don’t know.

1. What Isn’t Debated

Let’s start with the least excusable type of economic ignorance: not knowing agreed-upon theories or results in economics. There may not be a lot of these, but there are more than nonspecialists sometimes believe. Bernie Sanders’s inability to understand why uncollateralized loans have higher interest rates would fall into this category, as this is an agreed-upon claim in financial economics. Donald Trump’s bashing of free trade (and Sanders’s, too) would be another example, as the idea that free trade benefits the trading countries on the whole and over time is another strongly agreed-upon result in economics.

Trump and Sanders, and plenty of others, who make claims about economics, but who remain ignorant of basic teachings such as these, should be seen as highly blameworthy for that ignorance. But the deeper failing of many who make such errors is that they are ignorant of their ignorance. Often, they don’t even know that there are agreed-upon results in economics of which they are unaware.

2. Interpreting the Data

A second type of economic ignorance that is, in my view, less blameworthy is ignorance of economic data. As Rothbard observed, economics is a specialized discipline, and nonspecialists can’t be expected to know all the relevant theories and facts. There are a lot of economic data out there to be searched through, and often those data require careful statistical interpretation to be easily applied to questions of public policy. Economic data sources also require theoretical interpretation. Data do not speak for themselves — they must be integrated into a story of cause and effect through the framework of economic theory.

That said, in the world of the Internet, a lot of basic economic data are available and not that hard to find. The problem is that many people believe that certain empirical facts are true and don’t see the need to verify them by actually checking the data. For example, Bernie Sanders recently claimed that Americans are routinely working 50- and 60-hour workweeks. No doubt some Americans are, but the long-term direction of the average workweek is down, with the current average being about 34 hours per week. Longer lives and fewer working years between school and retirement have also meant a reduction in lifetime working hours and an increase in leisure time for the average American. These data are easily available at a variety of websites.

The problem of statistical interpretation can be seen with data on economic inequality, where people wrongly take static snapshots of the shares of national income held by the rich and poor to be evidence of the decline of the poor’s standard of living or their ability to move up and out of poverty.

People who wish to opine on such matters can, again, be forgiven for not knowing all the data in a specialized discipline, but if they choose to engage with the topic, they should be aware of their own limitations, including their ability to interpret the data they are discussing.

3. Different Schools of Thought

The third type of economic ignorance, and the least blameworthy, is ignorance of the multiple perspectives within the discipline of economics. There are multiple schools of thought in economics, and many empirical questions and historical facts have a variety of explanations. So a movie like The Big Short that clearly suggests that the financial crisis and Great Recession were caused by a lack of regulation might be persuasive to people who have never heard an alternative explanation that blames the combination of Federal Reserve policy and misguided government intervention in the housing market for the problems. One can make similar points about the Great Depression and the difference between Hayekian and Keynesian explanations of business cycles more generally.

These issues involving schools of thought are excellent examples of Rothbard’s point about the specialized nature of economics and what the nonspecialist can and cannot be expected to know. It is, in fact, unrealistic to expect nonexperts to know all of the arguments by the various schools of thought.

Combining Ignorance and Arrogance

What is missing from all of these types of economic ignorance — and what is often missing from knowledgeable economists themselves — is what we might call “epistemic humility,” or a willingness to admit how little we know. Noneconomists are often unable to recognize how little they know about economics, and economists are often unable to admit how little they know about the economy.

Real economic “expertise” is not just mastery of theories and facts. It is a deeper understanding of the variety of interpretations of those theories and facts and humility in the face of our limits in applying that knowledge in attempting to manage an economy. The smartest economists are the ones who know the limits of economic expertise.

Commentators with opinions on economic matters, whether presidential candidates or Facebook friends, could, at the very least, indicate that they may have biases or blind spots that lead to uses of data or interpretive frameworks with which experts might disagree.

The worst type of economic ignorance is the type of ignorance that is the worst in all fields: being ignorant of your own ignorance.

Steven Horwitz is the Charles A. Dana Professor of Economics at St. Lawrence University and the author of Hayek’s Modern Family: Classical Liberalism and the Evolution of Social Institutions. He is a member of the FEE Faculty Network.

This article was published by The Foundation for Economic Education and may be freely distributed, subject to a Creative Commons Attribution 4.0 International License, which requires that credit be given to the author.

Dispelling Popular Great Depression Myths: Robert Murphy’s “The Politically Incorrect Guide to the Great Depression and the New Deal” (2009) – Article by G. Stolyarov II

Dispelling Popular Great Depression Myths: Robert Murphy’s “The Politically Incorrect Guide to the Great Depression and the New Deal” (2009) – Article by G. Stolyarov II

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The New Renaissance Hat
G. Stolyarov II
Originally Published November 25, 2009
as Part of Issue CCXIX of The Rational Argumentator
Republished July 23, 2014
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Note from the Author: This essay was originally published as part of Issue CCXIX of The Rational Argumentator on November 25, 2009, using the Yahoo! Voices publishing platform. Because of the imminent closure of Yahoo! Voices, the essay is now being made directly available on The Rational Argumentator.
~ G. Stolyarov II, July 23, 2014
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Download a free audio recording of this essay here.

We live in times when fact and propaganda are all too easily – and often deliberately – conflated. I recall, a long time ago, sitting in my public high school’s Advanced Placement US History course, when the instructor explicitly mentioned “lack of government regulation” as one of the causes of the Great Depression. The odd aspect was that he prefaced this explanation with an explicit warning to me that I would not like what he was about to say.

It was as if he knew that he was presenting an ideologically charged position as fact – and he did it anyway, because, in his mind, no other interpretation of the Great Depression was possible. He and millions like him would benefit immensely from reading Robert P. Murphy’s The Politically Incorrect Guide to the Great Depression and the New Deal.

The myth of the Great Depression being caused by laissez-faire capitalism – and being solved by either the New Deal, World War II, or both – is so prevalent that in popular-opinion surveys, Franklin Delano Roosevelt routinely appears in the top five of all US presidents, while the name of Herbert Hoover has become synonymous with government inaction during an economic crisis. Hundreds of books, essays, and even works of fiction have been published to challenge these notions – but somehow the fallacies have prevailed; and they have been eagerly exploited by the would-be FDRs of the past seven decades.

For millions of Americans who have not studied Austrian economics and the Mises/Hayek theory of the business cycle, or read the brilliant critiques of the New Deal by H.L. Mencken, Isabel Paterson, Albert Jay Nock, Garet Garrett, and John T. Flynn, the commonplace myth of laissez-faire as ruinous and FDR as savior appears true, self-evident, and incontestable. Unfortunately, many of these same people vote for politicians and policies that promise a “New New Deal.” Such a plan would further exacerbate the current economic crisis, which is fueled by hyperregulation, Federal Reserve manipulation of the money supply, and the unforeseen consequences of prior interventions, including the original New Deal.

Murphy’s work seeks to correct popular misunderstandings of the Great Depression by attacking them directly. Virtually every single commonly encountered assertion – that the Depression was caused by the excesses of capitalism, that Hoover exacerbated the Depression by “doing nothing,” that the New Deal revitalized economic activity and mitigated unemployment, and that World War II energized the United States into recovery – is refuted at length. In the course of this debunking, the reader is treated to concise, elegant explanations of the Austrian theory of the business cycle, the economics of tax reduction, the virtues of the gold standard and the dangers of fiat currencies, and to discussions of the errors both in Keynesian prescriptions for deficit spending and in the Chicago School’s suggestion that the Federal Reserve triggered the Great Depression by failing to inflate sufficiently.

To add flavor to the book and enable readers to identify with more concrete aspects of the policies it criticizes, Murphy discusses many of the follies and corruptions of the New Deal: FDR’s use of “lucky numbers” to set the price of gold, the persecution of the Schechter brothers for defying the National Recovery Administration’s restrictions on poultry production, FDR’s attempt to pack the Supreme Court with his supporters after the court ruled in favor of the Schechter brothers, the confiscation of private citizens’ gold holdings, and the New Dealers’ pervasive use of government funding to bribe and intimidate constituencies into supporting FDR’s policies.

Murphy skillfully reminds us that the politicians who seek to suppress our economic and political liberties in favor of a central plan are neither omniscient nor benevolent; they quite frequently pull policy prescriptions out of thin air and they are anything but evenhanded, tolerant, or concerned for objective human wellbeing. Behind the lofty rhetoric and faux amiability of men like FDR stands the harsh, impatient, implacable, and often indiscriminate enforcer, in the mold of those thugs who broke into peaceful men’s homes to ensure that they were not violating the National Industrial Recovery Act by sewing clothes at night.

If there is any hope for an intellectual rejection of New Deal ideology in the United States, Murphy’s book will be one of the crucial elements motivating it. Murphy bridges the gulf between high theory and the concerns accessible to the majority of readers. While it is unfortunate that, given the state of education in our time, most Americans would not be able to immunize themselves against common economic fallacies by directly reading Menger, Mises, Hayek, and Rothbard, Murphy helps bring some of the key ideas of these thinkers into a format more accessible to a layman with no formal economic training.

Murphy also incorporates the work of such historians as Burton Folsom and Paul Johnson, and he draws on biographical information to shed light on the lives, motivations, and personalities of Calvin Coolidge, Herbert Hoover, and other key figures of the 1920s and 1930s. Murphy does for the popular understanding of the Great Depression in the early 21st century what Frederic Bastiat did for free trade in the mid-19th and what Leonard Read and Henry Hazlitt did for basic economic principles in the 20th.

I am a former student of Murphy, and I can credit his instruction for enabling me to advance from a basic understanding of Austrian economics to the publication of a paper in the Quarterly Journal of Austrian Economics. From personal experience, I know him to be well-read, cosmopolitan, sophisticated, and capable of articulating the arguments – and recognizing the strengths and weaknesses – of an immense variety of theories and worldviews. At the same time, he possesses a talent for communicating complex and challenging ideas, connecting them to concrete phenomena, and even joking about them.

As such, he is eminently suited to bringing some of the most important economic and historical insights of the 20th century to a mass audience. Indeed, it might reasonably be hoped that thousands of readers of this book will use it as a gateway to discovering the works of the many free-market thinkers cited therein. The lists of suggested readings (“Books You’re Not Supposed to Read”) peppered throughout the text make it a worthwhile purchase by themselves.

Perhaps someday my old US history teacher, and men like him, will use The Politically Incorrect Guide to the Great Depression in their courses to balance the many explicitly pro-New Deal and prointerventionist texts and presentations that dominate public-school curricula today. If this is too much to hope for, then at least this book has the potential to appeal to many young students and be sought out by them on their own initiative – as an antidote to the fallacies they encounter from “mainstream” sources.

Read other articles in The Rational Argumentator’s Issue CCXIX.

When Zero’s Too High: Time Preference versus Central Bankers – Article by Douglas French

When Zero’s Too High: Time Preference versus Central Bankers – Article by Douglas French

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The New Renaissance Hat
Douglas French
July 20, 2014
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Central banking has taken interest rate reduction to its absurd conclusion. If observers thought the European Central Bank (ECB) had run out of room by holding its deposit rate at zero, Mario Draghi proved he is creative, cutting the ECB’s deposit rate to minus 0.10 percent, making it the first major central bank to institute a negative rate.

Can a central-bank edict force present goods to no longer have a premium over future goods?

Armed with high-powered math and models dancing in their heads, modern central bankers believe they are only limited by their imaginations. In a 2009 article for The New York Times, Harvard economist and former adviser to President George W. Bush, N. Gregory Mankiw, wrote, “Early mathematicians thought that the idea of negative numbers was absurd. Today, these numbers are commonplace.”

While this sounds clever, Ludwig von Mises undid Mankiw’s analogy long ago. “If he were not to prefer satisfaction in a nearer period of the future to that in a remote period,” Mises wrote of the individual, “he would never consume and enjoy.”

Carl Menger explained that it is “deeply imbedded in human nature” to have present desires satisfied over future desires. And long before Menger, A. R. J. Turgot wrote of the premium of present money over future money, “Is not this difference well known, and is not the commonplace proverb, ‘a bird in the hand is better than two in the bush,’ a simple expression of this notoriety?”

Central bankers can set a certain interest rate, but human nature cannot be eased away, quantitatively or otherwise. But the godfather of all central bankers, John Maynard Keynes, ignored time preference and focused on liquidity preference. He believed it was investments that yielded returns, and wrote, “Why should anyone outside a lunatic asylum wish to use money as a store of wealth?”

If liquidity preference determined the rate of interest, rates would be lowest during a recovery, and at the peak of booms, with confidence high, everyone would be seeking to trade their liquidity for investments in things. “But it is precisely in a recovery and at the peak of a boom that short-term interest rates are highest,” Henry Hazlitt explained.

Keynes believed that those who held cash for the speculative motive were wicked and central bankers must stop this evil. However, as Hazlitt explained in The Failure of the “New Economics,” holding cash balances “is usually most indulged in after a boom has cracked. The best way to prevent it is not to have a Monetary Authority so manipulate things as to force the purchase of investments or of goods, but to prevent an inflationary boom in the first place.”

Keynesian central bankers leave time out of their calculus. While they think they are lending money, they are really lending time. Borrowers purchase the use of time. Hazlitt reminds us that the old word for interest was usury, “etymologically more descriptive than its modern substitute.”

And as Mises explained above, time can’t have a negative value, which is what a negative interest rate implies.

Borrowers pay interest in order to buy present assets. Most importantly, this ratio is outside the reach of the monetary authorities. It is determined subjectively by the actions of millions of market participants.

Deep down, Mankiw must recognize this, writing, “The problem with negative interest rates, however, is quickly apparent: nobody would lend on those terms. Rather than giving your money to a borrower who promises a negative return, it would be better to stick the cash in your mattress. Because holding money promises a return of exactly zero, lenders cannot offer less.”

But still, he approvingly cites German economist Silvio Gesell’s argument for a tax on holding money, an idea Keynes himself approved of.

Keynesian central bankers are now central planners maintaining the unshakable belief that low interest rates put people back to work and solve every economic woe. “But in reality,” writes Robert Murphy, “interest rates coordinate production and consumption decisions over time. They do a lot more than simply regulate how much people spend in the present.”

Murphy points out that low rates stimulate some sectors more than others. Lower rates generally boost housing and car sales, for instance, while not doing much for consumer goods.

More than half a decade of zero interest rates has not lifted anyone from poverty or created any jobs—it has simply caused more malinvestment. It is impossible for the monetary authorities to dictate the proper interest rate, because interest rates determined by command and control bear no relation to the collective time preference of economic actors. The result of central bank intervention can only be distortions and chaos.

Draghi and Mankiw don’t seem to understand what interest is or how the rate of interest is determined. While it’s bad when academics promote their thought experiments, the foolish turns tragic when policymakers use the power of government to act on these experiments.

Douglas E. French is senior editor of the Laissez Faire Club and the author of Early Speculative Bubbles and Increases in the Supply of Money, written under the direction of Murray Rothbard at UNLV, and The Failure of Common Knowledge, which takes on many common economic fallacies.

This article was originally published by The Foundation for Economic Education.

Heterogeneity: A Capital Idea! – Article by Sanford Ikeda

Heterogeneity: A Capital Idea! – Article by Sanford Ikeda

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The New Renaissance Hat
Sanford Ikeda
June 26, 2014
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When Thomas Piketty’s Capital in the 21st Century was released in English earlier this year it sparked vigorous debate on the issue of wealth inequality. Despite the prominence of the word in the title, however, capital has not itself become a hot topic. Apparently none of his defenders have taken the opportunity to explore capital theory, and, with a few exceptions, neither have his critics.

To prepare to read Mr. Piketty’s book I’ve been studying Ludwig Lachmann’s Capital and Its Structure, which, along with Israel M. Kirzner’s Essay on Capital, is among the clearest expositions of Austrian capital theory around. A hundred years ago the “Austrian economists”—i.e. scholars such as Eugen von Böhm-Bawerk who worked in the tradition of Carl Menger—were renowned for their contributions to the theory of capital. Today capital theory is still an essential part of modern Austrian economics, but few others delve into its complexities. Why bother?

Capital is Heterogeneous

 

Among the Austrians, Böhm-Bawerk viewed capital as “produced means of production” and for Ludwig von Mises “capital goods are intermediary steps on the way toward a definite goal.” (Israel Kirzner uses the metaphor of a “half-baked cake.”)  Lachmann then places capital goods in the context of a person’s plan: “production plans are the primary object of the theory of capital.” You can combine capital goods in only a limited number of ways within a particular plan. Capital goods then aren’t perfect substitutes for one another. Capital is heterogeneous.

Now, mainstream economics treats capital as a homogenous glob. For instance, both micro- and macroeconomists typically assume Output (Q) is a mathematical function of several factor inputs, e.g. Labor (L) and Capital (K) or

Q = f(L,K).

In this function, not only is output homogenous (whether we’re talking about ball-bearings produced by one firm or all the goods produced by all firms in an economy) but so are all labor inputs and all capital inputs used to produce them. In particular, any capital good can substitute perfectly for any other capital good in a firm or across all firms. A hammer can perfectly replace, say, a helicopter or even a harbor.

On the other hand, capital heterogeneity implies several things.

First, according to Mises, heterogeneity means that, “All capital goods have a more or less specific character.” A capital good can’t be used for just any purpose:  A hammer generally can’t be used as a harbor. Second, to make a capital good productive a person needs to combine it with other capital goods in ways that are complementary within her plan: Hammers and harbors could be used together to help repair a boat. And third, heterogeneity means that capital goods have no common unit of measurement, which poses a problem if you want to add up how much capital you have:  One tractor plus two computers plus three nails doesn’t give you “six units” of capital.

Isn’t “money capital” homogeneous? The monetary equivalent of one’s stock of capital, say $50,000, may be useful for accounting purposes, but that sum isn’t itself a combination of capital goods in a production process. If you want to buy $50,000 worth of capital you don’t go to the store and order “Six units of capital please!” Instead, you buy specific units of capital according to your business plan.

At first blush it might seem that labor is also heterogeneous. After all, you can’t substitute a chemical engineer for a pediatrician, can you? But in economics we differentiate between pure “labor” from the specific skills and know-how a person possesses. Take those away—what we call “human capital”—and then indeed one unit of labor could substitute for any other. The same goes for other inputs such as land. What prevents an input from substituting for another, other than distance in time and space, is precisely its capital character.

One more thing. We’re talking about the subjective not the objective properties of a capital good. That is, what makes an object a hammer and not something else is the use to which you put it. That means that physical heterogeneity is not the point, but rather heterogeneity in use. As Lachmann puts it, “Even in a building which consisted of stones completely alike these stones would have different functions.” Some stones serve as wall elements, others as foundation, etc. By the same token, physically dissimilar capital goods might be substitutes for each other. A chair might sometimes also make a good stepladder.

But, again, what practical difference does it make whether we treat capital as heterogeneous or homogenous? Here, briefly, are a few consequences.

Investment Capital and Income Flows

 

When economists talk about “returns to capital” they often do so as if income “flows” automatically from an investment in capital goods. As Lachmann says:

In most of the theories currently in fashion economic progress is apparently regarded as the automatic outcome of capital investment, “autonomous” or otherwise. Perhaps we should not be surprised at this fact: mechanistic theories are bound to produce results that look automatic.

But if capital goods are heterogeneous, then whether or not you earn an income from them depends crucially on what kinds of capital goods you buy and exactly how you combine them, and in turn how that combination has to complement the combinations that others have put together. You build an office-cleaning business in the hopes that someone else has built an office to clean.

There’s nothing automatic about it; error is always a possibility. Which brings up another implication.

Entrepreneurship

 

Lachmann:

We are living in a world of unexpected change; hence capital combinations, and with them the capital structure, will be ever changing, will be dissolved and re-formed. In this activity we find the real function of the entrepreneur.

We don’t invest blindly. We combine capital goods using, among other things, the prices of inputs and outputs that we note from the past and the prices of those things we expect to see in the future. Again, it’s not automatic. It takes entrepreneurship, including awareness and vision. But in the real world—a world very different from the models of too many economists—unexpected change happens. And when it happens the entrepreneur has to adjust appropriately, otherwise the usefulness of her capital combinations evaporates. But that’s the strength of the market process.

A progressive economy is not an economy in which no capital is ever lost, but an economy which can afford to lose capital because the productive opportunities revealed by the loss are vigorously exploited.

In a dynamic economy, entrepreneurs are able to recombine capital goods to create value faster than it disappears.

Stimulus Spending

 

As the economist Roger Garrison notes, Keynes’s macroeconomics is based on labor, not capital. And when capital does enter his analysis Keynes regarded it the same way as mainstream economics: as a homogeneous glob.

Thus modern Keynesians, such as Paul Krugman, want to cure recessions by government “stimulus” spending, without much or any regard to what it is spent on, whether hammers or harbors. (Here is just one example.)  But the solution to a recession is not to indiscriminately increase overall spending. The solution is to enable people to use their local knowledge to invest in capital goods that complement existing capital combinations, within what Lachmann calls the capital structure, in a way that will satisfy actual demand. (That is why economist Robert Higgs emphasizes “real net private business investment” as an important indicator of economic activity.)  The government doesn’t know what those combinations are, only local entrepreneurs know, but its spending patterns certainly can and do prevent the right capital structures from emerging.

Finally, no one can usefully analyze the real world without abstracting from it. It’s a necessary tradeoff. For some purposes smoothing the heterogeneity out of capital may be helpful. Too often though the cost is just too high.

Sanford Ikeda is an associate professor of economics at Purchase College, SUNY, and the author of The Dynamics of the Mixed Economy: Toward a Theory of Interventionism.
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This article was originally published by The Foundation for Economic Education.
Mainstream Economists Prove Krugman Wrong About Hayek and Mises – Article by John P. Cochran

Mainstream Economists Prove Krugman Wrong About Hayek and Mises – Article by John P. Cochran

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The New Renaissance Hat
John P. Cochran
September 13, 2013
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Paul Krugman has recently been critical of Friedman (and Phelps), the Phillips curve, and the Natural Unemployment Rate (NUR) theory in the process of arguing that due to the recent Great Recession, the accompanying financial crisis, and Bush-Obama-Fed Great Stagnation, Friedman has vanished from the policy front. Krugman makes this claim despite the fact there is an on-going vigorous debate on rules versus discretion with at least some attention to Friedman’s plucking model. While maligning Friedman’s contributions, Krugman manages a slap at Austrians and claims a renewed practical relevance for Keynes:

What I think is really interesting is the way Friedman has virtually vanished from policy discourse. Keynes is very much back, even if that fact drives some economists crazy; Hayek is back in some sense, even if one has the suspicion that many self-proclaimed Austrians bring little to the table but the notion that fiat money is the root of all evil — a deeply anti-Friedmanian position. But Friedman is pretty much absent.

The Friedman-Phelps hypothesis was the heart of the policy effectiveness debate of the 1970s and early 80s. The empirical evidence developed during the debate over the policy implications of the NUR model, at least temporally, discredited active Keynesian discretionary policy as an effective tool to reduce unemployment in the long run. One result of the debate: monetary policy appeared to improve, especially compared to the Fed’s dismal record in the late 1920s and 1930s and the mid 1960s to the late 1970s. Central banks, à la Friedman, focused on rules-based policy and inflation targeting resulting in what many, following John B. Taylor, call the Great Moderation of the early 1980s to the early 2000s.

Krugman does recognize the “stagflation (of the 1970s) led to a major rethinking of macroeconomics, all across the board; even staunch Keynesians conceded that Friedman/Phelps had been right (indeed, they may have conceded too much [emphasis added]), and the vertical long-run Phillips curve became part of every textbook.”

My early work on Hayek and Keynes (see here and here) argued that this development was important, but misleading. The then current business cycle research and its newer variants could benefit from re-examining the issues at the heart of the Hayek-Keynes debate.

Money, banking, finance, and capital structure were, and still are, for the most part ignored in much of the new (post-Friedman-Phelps) macroeconomics including the new–Keynesian approaches. In this regard, Hayek (and Mises) had then, and has now, more to offer than Keynes.

Recent papers by respected mainstream economists are beginning to recognize that attention to Hayek and Mises can be useful. Guillermo Calvo of Columbia University, in a recent paper [PDF], has even gone so far as to argue, “the Austrian school of the trade cycle was on the right track” and that the Austrian School offered valuable insights and noting that:

There is a growing empirical literature purporting to show that financial crises are preceded by credit booms including Mendoza and Terrones (2008), Schularik and Taylor (2012), Agosin and Huaita (2012), and Borio (2012).

Calvo adds “[t]his was a central theme in the Austrian School of Economics.”

Claudio Borio highlights what Austrians have long argued is a key flaw in inflation-targeting or stable-money policy regimes such as many central banks either adopted or emulated during the 1980-2008 period. This flaw contributed to back-to-back boom-busts of the late 1990s and 2000s:

A monetary policy regime narrowly focused on controlling near-term inflation removes the need to tighten policy when financial booms take hold against the backdrop of low and stable inflation. And major positive supply-side developments, such as those associated with the globalisation of the real side of the economy, provide plenty of fuel for financial booms.

Borio thus recognizes that a time to mitigate a bust is (contra-Keynes) during the boom:

In the case of monetary policy, it is necessary to adopt strategies that allow central banks to tighten so as to lean against the build-up of financial imbalances even if near-term inflation remains subdued.

William R. White, another economist who has worked at the Bank of International Settlements (BIS) and has been influenced by Hayek, has come to similar conclusions as does Calvo, who argues “Hayek’s theory is very subtle and shows that even a central bank that follows a stable monetary policy may not be able to prevent business cycles and, occasionally, major boom-bust episodes.”

In the current environment, many, including Krugman, have argued for a higher inflation target or a higher nominal GDP target to jump start the current sluggish recovery.

Austrian business cycle theory on the other hand, as recognized by Borio and Calvo, provides analysis on why such a policy may be ineffective and if temporarily effective in the short run, harmful if not destructive, in the long run. (See here and here for more.)

An easy money and credit policy impedes necessary re-structuring of the economy and new credit creation begins a new round of misdirection of production leading to an “unfinished recession.” Calvo expounds:

Whatever one thinks of the power of the Hayek/Mises mix as a positive theory of the business cycle, an insight from the theory is that once credit over-expansion hits the real sector, rolling back credit is unlikely to be able to put “Humpty-Dumpty together again.”

It is too bad it took back-to-back harmful boom-bust cycles for the profession at large to begin to again examine Austrian insights, but it does illustrate how foolish Krugman is when he argues Austrians have nothing to bring to the table.

John P. Cochran is emeritus dean of the Business School and emeritus professor of economics at Metropolitan State University of Denver and coauthor with Fred R. Glahe of The Hayek-Keynes Debate: Lessons for Current Business Cycle Research. He is also a senior scholar for the Mises Institute and serves on the editorial board of the Quarterly Journal of Austrian Economics. Send him mail. See John P. Cochran’s article archives.

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This article was originally published by the Ludwig von Mises Institute. Permission to reprint in whole or in part is hereby granted, provided full credit is given.

Review of Gary Wolfram’s “A Capitalist Manifesto” – Article by G. Stolyarov II

Review of Gary Wolfram’s “A Capitalist Manifesto” – Article by G. Stolyarov II

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The New Renaissance Hat
G. Stolyarov II
January 5, 2013
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While Dr. Gary Wolfram’s A Capitalist Manifesto is more an introduction to economics and economic history than a manifesto, it communicates economic concepts in a clear and entertaining manner and does so from a market-friendly point of view. Wolfram’s strengths as an educator stand out in this book, which could serve as an excellent text for teaching basic microeconomics and political economy to all audiences. Wolfram is a professor of economics at Hillsdale College, whose course in public-choice economics I attended. The book’s narration greatly resembles my experience of Wolfram’s classroom teaching, which focuses on the essence of an idea and its real-world relevance and applications, often utilizing entertaining concrete examples.

The book begins with several chapters on introductory microeconomics – marginal analysis, supply, demand, market equilibrium, opportunity cost, and the effects of policies that artificially prevent markets from clearing. The middle of the book focuses on economic history and political economy – commenting on the development of Western markets from the autarkic, manorial system of the feudal Middle Ages, through the rise of commerce during the Early Modern period, the Industrial Revolution, the emergence of corporations, and the rise in the 20th century of economic regimentation by national governments. One of the strengths of this book is its treatment of the benefits of free trade, from its role in progress throughout history to the theoretical groundwork of Ricardian comparative advantage. Enlightening discussions of constitutionalism and the classical idea of negative liberty are also provided. Wolfram introduces the insights of Ludwig von Mises regarding the infeasibility of central planning in solving the problem of economic calculation, as well as Friedrich Hayek’s famous “knowledge problem” – the dispersion of information among all the individuals in an economy and the impossibility of a central planner assembling all the information needed to make appropriate decisions. Wolfram further articulates the key insights of Frederic Bastiat: the seen versus the unseen in economic policy, the perils of coercive redistribution of wealth, the immorality of using the law to commit acts which would have been unacceptable if done by private individuals acting alone, and the perverse incentives created by a system where the government is able to dispense special privileges to a select few.

The latter third of the book focuses on such areas as money, inflation, and macroeconomics – including an exposition of the Keynesian model and its assumptions. Wolfram is able to explain Keynesian economics in a more coherent and understandable manner than most Keynesians; he thoroughly understands the theories he critiques, and he presents them with fairness and objectivity. I do, however, wish that the book had delved more thoroughly into a critique of Keynesianism. The discussion therein of the Keynesian model’s questionable assumptions is a good start, and perhaps a gateway to more comprehensive critiques, such as those of Murray Rothbard and Robert Murphy. A layperson reading A Capitalist Manifesto would be able to come out with a fundamental understanding of Keynes’s central idea and its assumptions – but he would not, solely as a result of this book, necessarily be able to refute the arguments of Keynes’s contemporary followers, such as Joseph Stiglitz and Paul Krugman. Wolfram mentions critiques of Keynesianism by Milton Friedman and the monetarist school, the concept of rational expectations precipitating a move away from Keynesianism in the late 1970s, and the “supply-side” interpretations of the Keynesian model from the 1980s. However, those viewpoints are not discussed in the same level of detail as the basic Keynesian model.

More generally, my only significant critique of A Capitalist Manifesto is that it is too brief in certain respects. It offers promising introductions to a variety of economic ideas, but leaves some significant questions arising from those areas unanswered. Wolfram introduces the history and function of the corporation but does not discuss the principal-agent problem in large, publicly traded firms with highly dispersed ownership. To anticipate and answer (and perhaps partially acknowledge the validity of) criticisms of the contemporary corporate form of organization, commentary on how this problem might be overcome is essential. Wolfram explains the components and computation of Gross Domestic Product and the Consumer Price Index but devotes only a small discussion to critiques of these measures – critiques that are particularly relevant in an electronic age, when an increasing proportion of valuable content – from art to music to writing to games – is delivered online at no monetary cost to the final consumer. How can economic output and inflation be measured and meaningfully interpreted in an economy characterized partially by traditional money-for-goods/services transactions and partially by the “free” content model that is funded through external sources (e.g., donations or the creators’ independent income and wealth)? Moreover, does Wolfram’s statement that the absence of profit (sufficient to cover the opportunity cost) would result in the eventual decline of an enterprise need to be qualified to account for new models of delivering content? For instance, if an individual or firm uses one income stream to support a different activity that is not itself revenue- or profit-generating, there is a possibility for this arrangement to be sustainable in the long term if it is also justified by perceived non-monetary value.

Wolfram’s discussion of inflation is correct and forms a strong link between inflation and the quantity of money (government-issued fiat money these days) – but I would have wished to see a more thorough focus on Ludwig von Mises’s insight that new money does not enter the economy to equally raise everybody’s incomes simultaneously; rather, the distortion due to inflation comes precisely from the fact that some (the politically favored) receive the new money and can benefit from using it while prices have not yet fully adjusted. (This can be logically inferred from Wolfram’s discussion of some of the “tools” of the Federal Reserve, which directly affect the incomes of politically connected banks – but I wish the connection to Mises’s insight had been made more explicit.) Wolfram does mention that inflation can be a convenient tool for national governments to reduce their debt burdens, and he also discusses the inflationary role of fractional-reserve banking and “tools” available to central banks such as the Federal Reserve. However, Wolfram’s proposed solutions to the problems of inflation remain unclear from the text. Does he support Milton Friedman’s proposal for a fixed rate of growth in the fiat-money supply, or does he advocate a return to a classical gold standard – or perhaps to a system of market-originated competing currencies, as proposed by Hayek? It would also have been interesting to read Wolfram’s thoughts on the prospects and viability of peer-to-peer and digital currencies, such as Bitcoin, and whether these could mitigate some of the deleterious effects of central-bank-generated inflation.

Wolfram does discuss in some detail the sometimes non-meritocratic outcomes of markets – stating, for instance, that “boxers may make millions of dollars while poets make very little.” Indeed, it is possible to produce far more extreme comparisons of this sort – e.g., a popular “star” with no talent or sense earning millions of dollars for recording-studio-hackneyed “music” while genuinely talented classical musicians and composers might earn relatively little, or even have their own work remain a personal hobby pursued for enjoyment alone. To some critics of markets, this may well be the reason to oppose them and seek some manner of non-market compensation for people of merit. For a defender of the unhampered market economy, a crucial endeavor should be to demonstrate that truly free markets (unlike the heavily politicized markets of our time) can tend toward meritocracy in the long run, or at least offer people of merit a much greater range of possibilities for success than exists under any other system. Another possible avenue of exploration might be the manner in which a highly regimented political system (especially in the areas of education) might result in a “dumbed-down” culture which neglects and sometimes outright opposes intellectual and esthetic sophistication and the ethic of personal productivity which is indispensable to a culture that prizes merit. Furthermore, defenders of markets should continually seek out ways to make the existing society more meritocratic, even in the face of systemic distortions of outcomes. Technology and competition – both of which Wolfram correctly praises – should be utilized by liberty-friendly entrepreneurs to provide more opportunities for talented individuals to demonstrate their value and be rewarded thereby.

Wolfram’s engaging style and many valid and enlightening insights led me to desire more along the same lines from him. Perhaps A Capitalist Manifesto will inspire other readers to ask similar questions and seek more market-friendly answers. Wolfram provides a glossary of common economic terms and famous historical figures, as well as some helpful references to economic classics within the endnotes of each chapter.  A Capitalist Manifesto will have its most powerful impact if readers see it as the beginning of their intellectual journey and utilize the gateways it offers to other writings in economics and political economy.

Disclosure: I received a free copy of the book for the purposes of creating a review.