Kenneth Arrow on Markets

Here is an excerpt from an interview with Kenneth Arrow, one of the most prominent economists, available from the Federal Reserve Bank of Minneapolis:

Region: In 1978, you wrote an article for Dissent titled ‘A Cautious Case for Socialism.’ Given the recent changes in the Soviet Republic, would you now make a ‘cautious case for capitalism’?

Arrow: I should start by saying that, as usual with magazines, the title is not written by the author. It was actually more of an autobiographical account of my early concerns with socialism. Let me say that the ideals that were sought for there, I still firmly accept. I think the idea that a society has to be responsible for all of its citizens, those who do well and those who do not, is really a precondition of a good society. Let me say that from the time I first understood economic principles, I was always concerned also that any system be operated on an efficient basis, which meant decentralization because knowledge is not concentrated anywhere. It’s based on motivation, and so these are the advantages of, say, the cautious case for capitalism, that the market system is efficient.

On the other hand, markets are not, in my opinion, a full solution to any problem. The obvious problem they don’t meet is the concerns of the welfare of individuals who may get lost in the operation of the system–the distributional question. We’ve seen this growing as we go further and further toward a market ideology in the United States and the United Kingdom. We’ve seen a decline in the welfare of the working poor, leaving aside any other pathologies, just the working poor, a very distinct increase at the very top levels.

This is not universally true by the way. It’s not true of those European countries that have maintained social welfare institutions to a much greater extent than we have–Germany, France and, of course, the Scandinavian countries; and they are not doing worse than the United States on an overall basis. The fact is that the United States in the last 12 to 13 years has shown a remarkably modest rate of growth per capita. So it’s not that we’re unleashing tremendous productive forces.

The switch to the market in Eastern Europe, of course, has not exactly been one of the greatest advertisements for the market. There’s no question the socialist system–and I hate to use the word ‘socialist,’ but I suppose some description of a system in which the state is in control–was breaking down, really collapsing. In these countries, most markedly in Russia itself and in a number of the others, it obviously was based on a tyranny, which is unacceptable even if it were producing good economic results, which it was not. But the fact is the conversion to a price system, which according to all our theories should have resulted in an immediate boost of productivity, has done nothing of the sort. Some people say Russia is running at 50 percent of its gross domestic product under that during the Communist period. In fact, none of the countries seems to have recovered the level that they had under communism, although the other countries in Eastern Europe are doing better than Russia and particularly the Czech Republic seems to be doing modestly well. East Germany I can’t count because they have a rich uncle. You have economic benefits which have nothing to do with the workings of the system. While I do believe that these countries will sooner or later find an equilibrium and start a satisfactory rate of progress, they’re going for quite a long period through a tremendous drop.

I think on the efficiency level, not only the distribution level, capitalism is a flawed system. It probably has the same virtues as Churchill attributed to democracy: It’s the worst system except for any other. And I think that’s right, but it cannot be thought that some unmitigated belief in free markets is a cure even from the efficiency point of view. As I say, the United States is not showing that now. The British probably could be getting better, but they’re not remarkable either. The fact is the heyday of intervention, as in the 1960s, was our golden era, in retrospect, from the point of view of growth. Admittedly, the reasons for the growth may have nothing to do with the system at all, but with unexploited opportunities due to the war and the Great Depression.

Classic economic theories recognize public goods aspects of one kind or another–the need for economic intervention in, obviously, the supply of infrastructure and, particularly in this case, of education. We’re not supplying that infrastructure at an appropriate rate today. I don’t doubt it isn’t just money; it’s organization and goals and so forth. The intrinsic social structure, the family structure and so forth, is certainly in a very bad state. And I think that this is showing up in productivity. I think part of the reason, and I can’t prove this, we’re seeing a decline in some places is the breakup of the family, which is partly the result of an extreme form of individualism.

It is Capitalism

It is Capitalism that has forced a moral feud and a commercial competition between the sexes; that has destroyed the influence of the parent in favour of the influence of the employer; that has driven men from their homes to look for jobs; that has forced them to live near their factories or their firms instead of near their families; and, above all, that has encouraged for commercial reasons, a parade of publicity and garish novelty which is in its nature the death of all that was called dignity and modesty by our mothers and fathers. It is not the Bolshevist but the Boss, the publicity man, the salesman and the commercial advertiser who have, like a rush and a riot of barbarians, thrown down and trampled under foot the ancient Roman statue of Verecundia.

G.K. Chesterton, “The Three Foes of the Family” in The Common Man

Two American Families

Bill Moyers has a great interview on the Colbert Report this week, regarding his new documentary that follows 2 middle class families since the 1990s. He quotes Jim Hightower:

The real question is not why do people fall through the cracks, the real question is why are there so many cracks?

The Retirement Gamble

PBS Frontline has an excellent program “The Retirement Gamble” about how complicated financial instruments are used to confuse and take advantage of people who are trying to save for their retirement through 401(k)’s. It is also just another example of where the limitations of our brains to process information allows corporations to take advantage of unsuspecting consumers.

The episode features  interviews with Teresa Ghilarducci, a former faculty member in Notre Dame’s department of economics. She is now at the New School, and I enjoyed reading her bio and remembered what kind of economist Notre Dame used to attract:

Economist Teresa Ghilarducci sees The New School as “an enterprise to design systems that help people live and work better in society.” In her recent book When I’m Sixty-Four: The Plot against Pensions and the Plan to Save Them, Ghilarducci discusses developing systems to guarantee all working people a dignified and secure retirement. Perhaps because she grew up in a low-income family, Ghilarducci developed a desire to improve society through economic and social policy. As a 21-year-old, she consulted with unionized workers at Stanford University about their benefits and helped them choose pension plans. This experience started her on the path to a career in labor economics, which has now spanned more than two decades and a variety of roles in different organizations.

Pathologies of Power

In the Forward to Paul Farmer’s Pathologies of Power, Amartya Sen writes on the importance of  power in the developing world,

For example, if inequality of power, in different forms, is central to deprivation and destitution, then little sense can be made of the frequently aired and increasingly popular slogan, “I am against poverty, but I am really not bothered by inequality.”  xvi.

Recognizing that power determines who will struggle to find adequate health, education, and dignity requires realizing that inequality matters. Inequality is of utmost importance to issues of development. Yet astonishingly, development economists ignore inequality. The recent hit popular econ book Poor Economics by Esther Duflo and Banerjee contains no chapter on inequality, which is truly baffling. Some argue that the entire field of development economics is implicitly about inequality, but this is only falling prey to exactly the kind of ignorance that Sen warns about in the quotation above.

Worrying about increasing wages and educational and health outcomes for those in extreme poverty is necessary, of course; but it is NOT the same thing as inequality. Duflo and Banerjee’s  interventions could be successful, and meanwhile the income distribution in India could be increasing, decreasing, or staying the same – depending on whether the rest of the society gains at a faster or slower rate than those at the bottom. The analysis of success or failure of the intervention program is completely independent to changes inequality. And until economists heed Sen’s warning that fighting poverty while ignoring inequality does not make sense, the field of development economics will be vastly limited in its effectiveness.

A Non-Euclidean World

The classical theorists resemble Euclidean geometers in a non-Euclidean world who, discovering that in experience straight lines apparently parallel often meet, rebuke the lines for not keeping straight – as the only remedy for the unfortunate collisions which are occurring. Yet, in truth, there is no remedy except to throw over the axiom of parallels and to work out a non-Euclidean geometry. Something similar is required to-day in economics.

John Maynard Keynes, The General Theory (1936)

But their beauty can be blinding

Mathematician David Orrell writes in a new book that scientific truths may not always be “beautiful” and “elegant” theories:

It is easier to claim a theory is beautiful than to show that it actually works, or makes sense.

As further described by Christopher Shea in the article:

He [Orrell] points to modern physics, in particular, as especially prone to develop ever-more-elaborate models whose goals have more to do with elegance or beauty for beauty’s sake than anything else.

“Historically, there was this give and take between mathematical beauty and scientific productivity,” Orrell said in a recent interview. But in physics, “if you look in recent decades, it’s as if the aesthetics has taken over. Theory hasn’t had the input from data to put it on the right path.”

If even modern physics suffers from this “perfect-model syndrome” of forsaking truth and usefulness in the quest for beauty, what hope do we have for modern economics?

 

ND Expert on the SOTU

One of Notre Dame’s most hyped economics hires offers some critical opinions on Obama’s the State of the Union, though his remarks really sound more like something one would hear on a conservative talk show aiming to bolster the narrative about the need to shrink government:

As for fiscal solvency, the current budgetary policy is simply not sustainable, primarily because of the rapid growth in entitlement spending. If something is unsustainable, we know that it is going to stop. What is unclear is how it will stop…

Everyone knows that there must be significant budgetary changes to ensure long-run solvency, but the unwillingness to deal with this leads to heightened uncertainty. It may even be the case that this policy uncertainty is one reason that job growth has been so anemic.

The other gem is regarding establishing a living wage:

“It is contrary to all economic logic to suggest that higher minimum wages will lead to increased employment,” according to Fuerst.

Research on minimum wages and employment remain inconclusive, but anyway this quip really misses the point from the speech: many Americans feel that it is not right for employers to hire workers and pay less than a living wage. Though true that in competitive markets employers may not be free to pay a living wage, that is exactly the role of the legal intervention requiring it. The inability of some economists to admit that free markets do not always work well is really astounding.

What a wonderful new economics department that Notre Dame has constructed!

Ideas over Interests

Dani Rodrik on the economists’ role in bringing about the most recent financial crisis:

In the aftermath of the financial crisis, it became fashionable for economists to decry the power of big banks. It is because politicians are in the pockets of financial interests, they said, that the regulatory environment allowed those interests to reap huge rewards at great social expense. But this argument conveniently overlooks the legitimizing role played by economists themselves. It was economists and their ideas that made it respectable for policymakers and regulators to believe that what is good for Wall Street is good for Main Street.

Economists love theories that place organized special interests at the root of all political evil. In the real world, they cannot wriggle so easily out of responsibility for the bad ideas that they have so often spawned. With influence must come accountability.

Peter Edelman on Changing the Poverty Landscape

This essay in the NYT lays out the poverty situation in America eloquently:

Low-wage jobs bedevil tens of millions of people. At the other end of the low-income spectrum we have a different problem. The safety net for single mothers and their children has developed a gaping hole over the past dozen years.

And he rightfully point to politics, not policy, as the solution:

A surefire politics of change would necessarily involve getting people in the middle — from the 30th to the 70th percentile — to see their own economic self-interest…

 

I have seen days of promise and days of darkness, and I’ve seen them more than once. All history is like that. The people have the power if they will use it, but they have to see that it is in their interest to do so.

Edelman speaks like a community organizer here- change is not about “empowering,” but organizing the power that already exists- which is easier said than done.