Russ Roberts

Roberts on Wealth, Growth, and Economics as a Science

EconTalk Episode with Russ Roberts
Hosted by Russ Roberts
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EconTalk host Russ Roberts talks with reporter Robert Pollie about the basics of wealth and growth. What happens when the stock market goes down or the price of housing? When wealth goes down, where does the wealth go? How do these changes affect our wealth? What is the relationship between wealth and inflation? Roberts explains the economic fundamentals of these changes. At the end of the conversation, Roberts discusses the implications of the current economic crisis for assessing the state of economics as a discipline.

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0:36Intro. Where did the wealth go when our houses became less valuable? What causes growth? How do price changes affect our measures of wealth?
1:18Robert Pollie: If wealth is based on the labor force and capital--factories and infrastructure--and knowledge, and money, currency, all those things have remained the same from before the recession till now. Yet supposedly aggregate wealth has shrunk. How can that be, and does that question even make sense? Mixing up things that should be kept separate. Wealth, in everyday use of the word, has wide range of meanings. Source of our well-being, an asset, but we don't usually think about measuring it. A lot of the above things are assets. Factories, natural resources, knowledge, system of rules and laws that help us make contracts, great culture. When people talk about our wealth being destroyed, they are typically talking about the dollar value of our assets. Those have gone down in dollar terms. Confusion particularly comes into play in the stock market, which is currently half its peak. So, are we half as wealthy? Confusing because stock market is a funny place; we don't think about it much. What it is, is an attempt to predict what the future will be. If the future is predicted to be less rosy, stock market goes down; real. Are we poorer? Could have cashed out at that higher rate, but if it was artificially rosy, it's not so horrible that it readjusts downward. What's horrible is that it readjusted this far downward. We overstated how much our house was worth; if you bought it some years ago, it's come down some; we've given back some of the gains. If you bought a house last year, different perspective. Those who bought a while ago have seen the value rise, but we still may be ahead of where we started. Lost paper profits. Amateur observation about the stock market: guess on the value of the economy; or guess on the behavior of other investors, whether other people will be getting out or into certain stocks. Stock market is really a bell-weather of the future of the corporate profits, not the economy itself. A lot of the economy is not traded on the stock market. The goal of life is not to make as much money as possible, but to enjoy life to its fullest. Includes making money in stock market, but includes sometimes corporate America not doing well because that's the right policy. Speculative element in the stock market. Think of it with housing: If I think housing will go up because housing is more valuable, then housing is a good investment. But it can be a good investment even if it's not more valuable, just everybody else thinks it's more valuable. Animal spirits, herd mentality. Hard in the long run, though. Stock market in 2000 and 2001, lots of stocks racing up, possibly because of speculative motive. Also possible because no one was quite sure which stocks would be successful, which internet companies would thrive. Speculative bubble vs. no complete information ever. New times, lots of uncertainty. Eventually comes down. Can't ride out the speculative bubble and keep it going. In the short run, at any one point of time, can be over- or under-confidence, over- or under-pessimism about the actual value of the stock market. Over time those tend to wash out and the stock market tends to accurately reflect the fundamentals. If market is purely speculative without underlying fundamentals, can't stay high. When market is skittish and each piece of news can send people into or out of the market, seems mostly speculative. In the reverse time now, go-go stock market and go-go housing market, falsely inflated or policy mistakes; but now other end of it, world where market seems artificially low. Great time to buy, then! But scared. Everybody is uncertain if the current level of stock prices is reflecting reality. Maybe the future profitability over the next few years for corporate America is actually pretty dismal--financial markets messed up, policy initiatives and some fail, borrow a few trillion dollars. Or maybe people are just scared. Can't distinguish. Would like to be reassured, but reality is no one knows.
12:38Wealth: valuation of our assets at market prices. Sounds good, but notion of value is slippery and relative. If all values go down, couldn't relative values remain unchanged? Value is relative. A dollar buys this or ten dollars buys this, doesn't matter if the amount of cash changes accordingly. What's important: worried that we are going to have inflation in next few years. Federal Reserve has injected billions into the banking system; banking system is sitting on it because they are skittish, earning low rate of interest by holding Treasury Bills. As people get more confident, they will lend that money out and it will come into the hands of investors and consumers. Dollar prices will go up. If we have 100% inflation, your used car might appreciate dramatically in dollar terms, but you are not any wealthier. Put in real terms by using a price index. Dollar value of wealth can increase but what it can purchase can go down; poorer, not wealthier. Theater ticket sales: by dollar box office sales, The Titanic is the most popular movie of all times, but when you correct for inflation, Gone With the Wind. Been out longer; but important to recognize that a dollar yesterday differs from a dollar tomorrow. If your real wealth goes up--stock market, house value, knowledge go up--by more than prices increase, then you are wealthier. Purchasing power is a measure of whatever liquid assets you have relative to the price of things. If everything went up or down proportionally, things would remain the same; but in the wealth-creation scenario, some things get more valuable relative to other things, things we want to buy. Why does the price of things not adjust accordingly? Not out of whack. Broader time period: today versus a century ago. Son says, "My salary is really high today." Grandfather says "When I was a boy, you could get a soda for a penny!" Mixed bag. Higher salary but expensive Coke. Want to correct correctly for the average level of prices or level of prices of stuff you enjoy. Over 100 years, quality of things changes; put that aside. Our incomes in America are dramatically higher today, but when you correct for higher prices, it's not a wash. What an hour of a laborer's time can buy today is much higher than 100 years ago. If wages are higher, don't I want to put that into the price index? No. When incomes or wages go up by a factor of 10 but prices go up by a factor of 5, that's a real difference--you can buy more than you could before. Want to keep that separate. True, it's a price, but you don't want to weight that in to the higher prices of goods you enjoy.
20:31If wages go up more than prices go up, how did they go up without prices going up? Secret ingredient: productivity. Aren't wages an input into the production process? Productivity. Another way of saying our standard of living is higher. Thanks to knowledge, technology, and competition, which forces the creators of technology to share. Forced through competition to charge a lower price than you'd want to charge; and people who use the machines would like to capture productivity in the form of profit, but can't because of competition, which causes some of the gains to be shared by consumers. Compensation, as a portion of total output, is pretty rock-steady at about 70% for the last 60 years. When people say wages have been falling as a proportion of output, ignores benefits. Corporations unable to change that because of competition. Reverse scenario, when wealth declines, those three ingredients have not diminished. Important to remember that we are not much poorer today. Wealth vs. income: Wealth is a stock, put all your stuff in a pile, snapshot at a point in time. Income is how much you earn per time period, a flow. Our annual incomes and productivity have barely gone down; Gross Domestic Product (GDP), how much you produce per year has barely gone down, even though we are in a recession. Our wealth has gone down a lot. What's generating our income is our productivity, knowledge. It could go down: we are not at our full income-producing capacity. Wealth down because stock market has plummeted, dollar value down through process we talked about earlier. Situation where real wealth, purchasing power, goes up relative to the cost of things; when we talk about wealth going down, asset values have gone down in relation to the cost of things. What has caused this disjuncture? Why haven't costs gone down proportionally? Source of the wealth loss is reassessment of what the future will hold for the companies we are talking about, and the dollar values attached to our stock, mutual funds goes down; dollar paper value of our wealth goes down; prices of things we want to buy have gone down hardly at all. Why haven't the prices of things gone down with the lower demand? When things are not sold, sitting there as potential money. The asset valuation, the dollar valuation on stocks or mutual funds isn't what affects the prices of movie tickets, trips to the doctor. That is determined by how many pieces of paper, or credit floating around the economy. If the Federal Reserve puts more money into the system, we will have inflation and prices of goods will rise. What's happening now, is that the prices of one part of the economy, not similar to prices of shirts. Stocks not in price index.
30:45Something different: In this regime, demand has fallen, even food. Yet prices have remained stable, so loss of demand has not caused prices to fit. Psychology: something in us resists taking a pay cut, lowering prices. Plays a role, but let's disentangle. Demand for cars is down, so prices of cars have been down. People have not lowered their demands for everything. Concentrated on high ticket items. Out in real world, a lot of inventory for car makers. They can discount them to move them off the lot, and they do that. But if they lowered them enough, people would start buying; but they don't want to lose money on them. Food, restaurants, Starbucks probably struggling. After a while can't lower costs further or go out of business. The way the market responds to a decrease in demand is fewer restaurants. Luxuries and innovation and devices and gadgets harder and harder to sell, people turn to the basics. Kindle 2, maybe not Kindle 3. Six year or ten year slump. Back up to first principles: Why value of certain things remains higher as system as a whole is slowing down is because demand for certain things remain high or supply becomes limited. You notice the things where demand goes down but not where demand goes up. Rice might get more expensive because people turn to staples. Wal-Mart doing well; Nordstrom's has put things on sale. High end meals will go down but maybe McDonald's will do well, or people will eat home, increasing their demand for raw food. If Federal Reserve is still printing money, it will support the price of goods. Money supply tricky: all kinds of different measures. Fed has injected billions into banks, but it is not circulating. Also, velocity, the rate at which a dollar gets spent; now that we are more cautious about spending, might hold more in our wallet than in good times, spending less quickly. Political challenge for Fed. Paul Volker vs. Ben Bernanke. Money supply right now in terms of real turnover down? Turnover down, but money supply is up and we are still spending a great deal. Fed obsessed with avoiding deflation. In 2001, Alan Greenspan lowered Federal Funds rate to such a low level, different problem now.
39:35EconTalk, spirit of inquiry. January podcast, soul-searching on value and function of economics, what economics is good for, economics as a science. Empirical studies seem to seldom change the views of economists. Unfortunate truth, we should be honest about what we know. We are about to spend $787 billion financed by borrowing--strikes some as an error, but other economists think it should be bigger. Nobel Laureates on both sides! Maybe should be called Nobel Prize in Economic Art. Why no consensus? This is something we don't fully understand. Ability to tease out truth from statistical techniques something of a mirage. Ed Leamer: Faith-based economics, faith-based statistics, not real science. Do we want to be more like France or less like France? Disagreement, dispute--philosophical dispute. Is economics always underlain by ideological disposition? Glass three-quarters empty but not totally empty. Economists agree on many things, including the material in this podcast. There are policy issues economists agree on: no on price supports for agricultural products, yes on free trade, etc. Politicians, politics not what we are good at. On grasping the complexity of the world, we have a lot to contribute. Our predictive power is limited, but that's what people want from us. We should say "That's not my job." Can economics ever falsify a theory? Have you ever had your beliefs changed by evidence? Not really. Stimulus during Great Depression, WWII. Story: Yes, we came out of the Depression after 15 years, but that was where we finally got back to stability. We have a major depression once a century. Complexity. We learned a lot about the Great Depression; still a lot of debate among economists and citizens; but we made a lot of mistakes. We should at minimum not make those mistakes again. It was a mistake to pass the Smoot-Hawley Tariff of 1930. Mistake to contract the money supply without responding. In the 1930s we tried to cartelize big unions and gave more power, mistake. Most economists agree about those things being mistakes. "Pretty unique" situation. Housing bubble followed by financial collapse, not a lot of historical precedents. Cannot expect economics to know how to get out of it. Economics runs up against psychology; Freud. Economics has virtually nothing to say about investor confidence; neither to most psychologists--nothing to be ashamed of.

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COMMENTS (30 to date)
Paul writes:

Love this podcast! I think I learn more from each episode than I do from any other podcast. However…

I find myself frustrated with the extent of Russ’s humility regarding the correctness of his economic views. For one thing, it strikes me a bit as unilateral disarmament, since I don’t expect to hear the same modesty from many Keynesians. But more than that, it creates a serious dissonance with what I’ve learned from Russ and others through the years…

Does Russ really think that the stimulus might be the right thing to do? That more government spending and borrowing may be just the ticket? While I appreciate the lack of arrogance, I’m surprised just how willing Russ seemed to be to leave these questions so open.

I think we all know that the Krugmans of the world are not going to match this modesty, and feel very comfortable stating their theories as if consensus, theory, and history are all behind them. Is this just because they have Keynesian priors and so all experience is adapted to that view? Or are there systemic forces at work that drive the attention and resources to those that say “more state power is needed”? My thinking is that a careful study of theory and history favor the free market view but nonetheless, systemic forces in our society tend to amplify the inferior Keynesian view.

I guess I find it hard to believe that Russ is really as ambivalent as he comes across on this, and I think that expressed ambivalence is dangerous because it can easily lead to resignation for those that are inclined to pursue a deeper understanding. Why bother with the difficult work of trying to sort this out if Russ is right and all sides can be equally well defended? Seems to me that the case for the free market may be difficult and complex to make, but I hope it can be made and that the effort is worth the trouble. And I hope that the complexity involved can be acknowledged and engaged without sacrificing modesty and without unilaterally disarming.

I would feel much better about a message that said “I’m pretty sure I’m right – it’s complicated, and I’m open to contrary evidence, but I’ve studied things carefully and I really do think I’m right”. As opposed to “Hey, you’re a Keynesian, I’m a Chicagoan, so we’re going to see things differently – there’s no way to really know who’s right – c’est la vie”.

Thanks!

Greg Ransom writes:

Why did wages go up compared to prices?

Why? Your answer -- productivity, cashed out as knowledge, technology & competition.

But this can't be right. Imagine a world where we have advances in knowledge, technology & competition -- but where we've consumed all of our production goods.

Without production goods -- capital -- the returns to labor as compared to other prices would go down, would be reduced in an enormous degree.

Even advances in knowledge & technology & competition depend to a remarkable degree on existing production goods, i.e. upon capital.

And, yes, I'm fully aware of the "new" economics of growth, Romer and all that.

The traditional answer of economics is that wage rates go up because of the maintainance and accumulation of production goods (see the work of F. A. Hayek). Technological progress is vital to the degree of income growth, but dependent in the first instance on the existence and continued maintanance and accumulation of production goods.

Once again, the theory of capitalism abstracted from the existence of capital, i.e. production goods, is pretty silly stuff.

Greg Ransom writes:

"Falsifiability" is not the criterion of science -- by this criterion Darwinian biology and many other complex sciences would not be counted science.


This is what Hayek forced Karl Popper to admit -- it was Popper who invented the falsifiability criterion. See Hayek's papers, "Degrees of Explanation" and "The Theory of Complex Phenomena" and also Karl Popper's intellectual autobiography, where he says "uncle" and admits that Hayek is right and Darwinian biology is a science, although it doesn't offer falsifiable predictions.


Kuhn's debate with Popper also established the emptiness of Popper's falsifiability criterion of "science".

Economics offers powerful causal explanations for undesigned order in our experience -- just like biology. This makes economics a science.

See my paper on Hayek and the nature of economic explanation, which you can find on the "Taking Hayek Seriously" blog.

Mads Lindstrøm writes:

To Paul (and Russ)

Maybe Russ is more willing to acknowledge the economic professions lack of certainty, because it leads to the policies he believes in? And Keynesians is less willing as it leads to the policies they are do not believe in.

Imagine you told the general population that we really do not know, if the too-high-to-fathom stimulus package would really make a difference. Imagine if you told the general population that we really do not know, if bank-aids would do any good for the country. Do you think average Joe would then think it was a good idea to pay the banks and do the stimulus package?

Also and different, I would guess that media is more willing to interview the economist who come with a clear message, than the economist with a vague message.


Regards,

Mads Lindstrøm

david writes:

A couple of days ago, I had an emergency appendectomy. I was laying quietly on the couch this afternoon recovering and listening to Russ talk about wealth, monetary policy, inflation, etc. Somewhere, about 45 minutes into the podcast, I sat up suddenly, wincing at the sudden jab on the right side of my stomach. "What caused such a sudden stir?", one might ask. To which I reply -- I was bowled over by the eloquence of Russ' comments during the last ten minutes or so of the podcast.

I have always enjoyed the intellectual give-and-take of Econtalk. Russ' willingness to critique and question not just those views with which he disagrees -- but also those he holds dear -- is refreshing. Today, however, what he said and how he said it, struck a cord. Not to be too effusive, but he sounded like Atticus Finch, George Bailey, or somebody else along those lines. Russ' honest, humble assessment of economics and its differing schools of thought, reminded me why it is so fun to learn. The value of learning lies not in reaching a destination or learning how to better defend a preconceived view, but in the journey -- in getting to that place where you can be assured of only one (maybe two, depending how you count) thing(s). That is that you don't have all the answers and, as it turns out, the things you once thought were indisputable either aren't true or are highly debatable. Bringing back fond memories of some of my favorite professors and teachers, Russ' comments reminded me of these truths.

I disagree with those who criticize Russ' academic modesty. Genuine humility, that is acknowledging that you don't know all the answers and making it a practice to honestly appraise other points of view, is not to admit rhetorical weakness; nor does it risk confusing Econtalk listeners. To the contrary, save perhaps the dullest listener, recognition of other viewpoints avoids the risk of insulting the audience's intelligence by refusing to recognize points which should, in all candor, be recognized. That aside, I don't think anyone who listens to Econtalk regularly holds much doubt as to Russ' viewpoints.

Pietro Poggi-Corradini writes:

Why do objects fall? Because of gravity. What is gravity? Well, there are many competing theories.

Likewise, economics is 'scientific' in the sense that it provides theories that try to explain how the world works. But good science doesn't necessarily have to rely on heavy statistical analysis. Mostly it gives logical frameworks that help and facilitate the discovery of new insights, i.e. new theories.

Lee Kelly writes:

Greg,

Have you actually read Popper? I ask because Hayek did not "force Popper to admit" anything.

Read The Logic of Scientific Discovery; it seems to me that few people have. When I began to research criticism of Popper's falsifiability criterion, I was disgusted: it betrays an appalling lack of comprehension and study. Eventually I returned to LoSC to ensure that I was not going crazy, but highlighted dozens of passages where Popper explicitly addressed what later critics would offer. And here you are doing it again. It's like a bad joke.

Kuhn was among the worst offenders--to say he completely missed the point is an understatement. The underlying problem was that Popper and Kuhn were dealing with different problems, seeking different goals. Popper's falsifiability criterion did not satisfy Kuhn, not because of any logical or methodological error on Popper's part, but because Kuhn wanted more (as do most philosophers).

And besides, Darwinian evolution is not unfalsifiable. Seriously, do you have any clue what you're talking about? I really do not think so. You might as well be claiming that 2 + 3 = 4, because that's how wrong you are.

Lee Kelly writes:

Greg,

By the way, it does not really concern me how anyone defines the word "science". The falsifiability criterion doesn't have to demarcate between "science" and "non-science" if it pleases you. It is merely a proposal to adopt a convention, not a metaphysical assetion about the essential nature of some theory or activity. Since "science" is primarily associated with experimentatal testing, there is some sense to calling only those theories which can potentially fail such a test "scientific".

But whether you care for this terminology or not, there is an important distinction here i.e. some theories can be tested by empirical work and others cannot. If the dermarcation between "science" and "non-science" is not drawn here, then I am just not that interested whether something is "science".

Lee Kelly writes:

My problem with Dr. Roberts's humility is that it is quite close to fence-sitting. I am an absolute sceptic, but take a position on almost every issue.

Nobody ever stumbled upon the truth by sitting on a fence. Be bold with your hypotheses, don't hesitate to guess, but just don't get attached-- expect to be wrong and be ready to admit it.

What you don't know might save your life, since you don't have to know it for it to be true.

Tom writes:

I liked this podcast, but I thought one part was incorrect. The Kindle 2 will soon be under $300, and the Kindle 3 will be inexpensive as well. So there is every reason to believe these low end, popular products will sell strongly even if the recession kept going.

The Japan comparison was a little funny. Japan had no growth at all in 1991-1993, then started fits of growth to average 1% to 1.5% GDP/capita during the lost decade. During that time, cellphones became a huge sensation, the internet took off in 1997/98 and Starbucks expanded rapidly. Not surprisingly, new auto sales were hit during the bad years.

Greg Ransom writes:

Yes Lee, I've read a lot of Popper.

Lee asks:

"Have you actually read Popper?"

Did Popper ever read the later work of Wittgenstein? I've found no evidence that he did.

It's a fact that Popper changed his mind about the scientific status of Darwinian biology, and that he references Hayek on the issue of the non-falsifiabilty by "testing" of sciences where explanations come in the form of "explanations of the principle".

Greg Ransom writes:

I should add in reply to Lee that I don't think the things at issue between Kuhn & Popper, or between Hayek and Popper can be addressed in philosophical detail in the comments section of a blog post.

It's a fact that Popper declared Darwinian biology not a science because it failed to fit his demarcation criterion for "science". And its a fact that Hayek convinced Popper to change his mind about this.

Greg Ransom writes:

Lee writes:

"Darwinian evolution is not unfalsifiable"

What matters is that Darwinian biology is doesn't fit Popper's model of falsifiability or any crude "physics" model of falsifiability.

One immediately moves to inference to the best explanation, hard cores verse stuff outside the hard core, etc.

This whole model of thinking about what is science and what isn't science falls apart -- and doesn't help us think about what science is.

Greg Ransom writes:

Lee is begging the whole question here about what is demanded in the"testing" of an explanatory framework and what isn't, because it looks like he's assuming a model of "testing" that doesn't stand up to examination when one looks to real explanatory choice in science, and one that doesn't apply to all sorts of examinations and evaluations of expanatory rivals.

Lee writes:

"there is an important distinction here i.e. some theories can be tested by empirical work and others cannot."

Greg Ransom writes:

The bottom line of Popper is that Popper's model of "testing" -- and that of most people with a simple minded "physics" model in their head -- does even closely fit all sorts of different uses of evidence in science to evaluate explanatory rivals.

Adam writes:

No Greg, the bottom line is that this isn't really the place to be discussing the merits or demerits of what Popper may or may not have believed. If you don't have anything to say about the podcast maybe you should take it somewhere else.

It was nice to see a return to "first principle" as the reporter put it. Very enjoyable interview, and a nice change of pace.

Greg Ransom writes:

Adam -- both Russ and his guest in this podcast used the "falsifiability" criterion to reject the notion that economics is a science, and both seemed to think that crude and simple minded physics like "testing" is the very substance of "science" and anything else is not "science". This kind of thinking is at the core of much of the worst of modern economics over the last 70 years, as Bruce Caldwell talks about in his FEE podcast discussing his book "Hayek's Challenge".

wbond writes:

Splendid interview.

And I, for one, find it endearing and remarkable that a somewhat mean-spirited philosophy of science debate can break out in the comments section of an economics podcast.

(I'm trying to locate the Kissinger quote about academics).

Mark Selden writes:

Paul,

When it comes to expressing opinions, passion is the casualty of humility.

But I don’t think Russ’ moderated passion comes across as ambivalent; just credible. I hope that he continues his journey without any change in direction; one where he continues to articulate well the story of free-markets, but that he also advances the cause for humility. It’s a tightrope that he walks extremely well.

John writes:

Something seems wrong with these links. When I go save as it only downloads a 1kb file.

[Thanks for your patience. We had some technical problems this morning, Apr. 24, 2009. They are resolved now. We apologize for the inconvenience.--Lauren, Econlib Editor]

Paul Downs writes:

Regarding falling prices: Russ, every now and then you need to talk to an actual business person, not just an academic. You would quickly find out that a large part of the price of things is determined by costs which are locked in over long terms. I, for instance, am a small manufacturer. My costs for rent, electricity, health insurance, taxes, etc. do not respond to short term changes in the economy. They are locked in over relatively long time periods. I am doing everytyhing I can to cut my prices by cutting costs, but I am quite constrained as to what can be cut.

I think you should do a show in which you ask business people how your theories of how the economy work play out in real life - similar to your show on buying cars, which was fascinating. The parade of ivory tower guys is good, but more real life topics would be illuminating.

Paul Downs

Adam writes:

Paul Downs,

To quote Edmund Burke (in 4.4.41):

"When any commodity is carried to market, it is not the necessity of the vender, but the necessity of the purchaser that raises the price. The extreme want of the seller has rather (by the nature of things with which we shall in vain contend) the direct contrary operation. If the goods at market are beyond the demand, they fall in their value; if below it, they rise. The impossibility of the subsistence of a man, who carries his labour to a market, is totally beside the question in this way of viewing it. The only question is, what is it worth to the buyer?"

The costs that businessmen and suppliers generally have to deal with is a matter of indifference to buyers. No matter what your costs are, long-term or otherwise, you will not sell your product if you charge a price higher than buyers are willing to pay.

If your costs are too high for the market to bear, you will simply go out of business. Thus costs effect the price of a good only in as much as they drive out suppliers until those who are left are able to charge a price that enough buyers are willing to pay to make their business profitable.

Business people certainly have a valuable, on-the-ground perspective. But the ground level view is rarely as good at seeing the big picture as the bird's eye view.

Lee Kelly writes:

Greg,

I apologise for my rude comments before.

But moving on. First, whether or not a piece of evidence falsifies a theory depends upon its interpretation, and an interpretation depends upon other assumptions e.g. initial conditions. Rather than being 'T -> P', where T is a theory and P is a prediction, it is 'T + I -> P', where I is some set of other necessary assumptions. This, of course, means that every falsification is ambiguous, that is, T or I or both might be false. We just have to guess, and, if necessary, keep testing.

I heard Arnold Kling mention the other day that historical events are not like controlled experiments. Well, he's right, but his response to that "insight" was wrong. The problem is that the I, the interpretation, is less agreed upon in economics and biology. In other words, that which must be assumed in order to elicit a falsification is much greater and more difficult to test. But in principle there is no difference; the logic is just the same in both instances.

Popper knew this, he must have, because he discussed the same thing in a slightly different context, namely "conventionalist strategems". It tends to be much more difficult in economics and biology to monitor, test, and agree upon the I, that is, the set of assumptions which are necessary to elicit a falsification. But the same logical situation exists in physics and chemistry; it is only a problem for those people who like the evidence or data to decide for them what they should think.

Second, I never beg the question, ever. It's just not possible, because I know already that my arguments are circular. Not just one, but all of them. Since I know this, I do not expect my premises, implicit or explicit, to justify, support, or convince anyone of anything, so I never beg any question. What people should be convinced is that the argument makes good sense, or solves some problem. The premises can't support anything, since in any valid (i.e. truth-preserving) argument, the conclusion is just unpacking something that is already implicit or explicit in the premises. That's why its truth-preserving in the first places, because it repeats itself either in part or whole.

But anyway, why do you think "explanation in principle" should automatically be unfalsifiable? And why, if the "explanation in principle" is not scientific, do you care? I mean, if everyone redefined the word "science" tomorrow to include astrology, would it suddenly be better than before. Good economics is good economics: whether we call it "science" or not isn't going to change anything.

Paul Downs writes:

"Business people certainly have a valuable, on-the-ground perspective. But the ground level view is rarely as good at seeing the big picture as the bird's eye view."

I'm not a bird, and find that the elevated viewpoint is often of little use to ground dwellers. If one accepts that the duty of the bird is to understand what they are looking at, wouldn't a visit to earth now and then be recommended?

Paul Downs


Peter Wogan writes:

David, Well put and very moving--thank you. Just one thing: While Russ can take pride in the Atticus comparison, he might not have appreciated the comparison to George Bailey. I'm thinking of the podcast where Russ said--and this made me sit up--that there are no positive representations of businesspeople in popular culture, only mean Mr. Potters.

Lee and Paul, I would just point out that Russ didn't equivocate one bit when he repeatedly set the reporter straight, telling him without hesitation how the economy works. But you're probably referring to the final few minutes, the discussion of econ as "science," and, again, I have to agree with David. I thought Russ judiciously sorted out this vexing empiricism vs. ideology problem, showing what economics can and can't do and never backing down on his core principles.

Adam writes:

Paul Downs,

I wasn't really all that interested in dueling metaphors. What is your response to the specific point I made, that the costs of the supplier are completely irrelevant if consumers are unwilling to pay the price they're asking.

If you are locked into a long-term obligation that imposes more costs than the market will bear, the result is unlikely to be that prices will fail to fall--rather, the result will be that you will go out of business unless you find a way to cut costs somewhere.

Do you disagree?

Paul Downs writes:

Adam - you are looking at prices from the perspective of a theoretical purchaser who considers only price in choosing comparable goods. I was pointing out that prices are set by sellers and are subject to constraints not apparent at the market place, and that the market itself is very complicated. Can you explain why goods are available at a range of prices, even if their function is comparable? Why do we have both Mercedes and Hyundais? Both get you from A to B.

"... if consumers are unwilling to pay the price they're asking."

I haven't seen that happen much. I don't disagree that costs of the supplier can be irrelevant to the consumer, but on the other hand the consumer is frequently willing to pay a higher price in order to allow a producer with higher costs to continue in business - "Buy American" campaigns, or "green" electricity being two examples.

I also am hard pressed to think of a situation where demand for a useful product drops to zero at some arbitrary price point. Most goods are offered at a variety of quality and price levels, so demand can migrate up or down to different offerings. Most items have some floor price (for new goods) which never gets reduced, and customers use that as a basis for comparison for other offerings. If you can provide an answer for the question "How much would a cheap new car cost" then you know what I'm talking about.

In my own business, custom conference tables, I expected demand to migrate to lower price points during a recession, and it did. My reaction was not to simply shut the doors, but rather to re-engineer my product so that we could offer a lower priced item without having to beggar my workers. Lo and behold, sales are still happening. I presume that my more expensive competitors are being hurt worse than I am, but what's really interesting is that demand for the high end table hasn't disappeared, even though there is no compelling reason for anyone to buy one.

Long term obligations are part of our costs, but not all of them. So it is possible to lower costs by cutting wages and benefits. However, as a human being, I would prefer not to do that to my employees. So our reaction has been to reengineer the product, to simplify the designs, to enhance the marketing, to squeeze the suppliers, to provide better service to the customer - an arsenal of actions that keep our revenues up even though we are cutting prices.

The point I was trying to make in my original post is that theory is nice, but the ground game is far more complex. I was inviting Russ to spend some time discussing this. After all, a theory isn't worth much if it can't be applied in real life.

Paul Downs

Adam writes:

Can you explain why goods are available at a range of prices, even if their function is comparable?

There could be any number of reasons; you pay for more than just the good itself after all. If I could get a DVD for five dollars less elsewhere, but the only place offering that lower price is twenty miles away, then I (personally) will prefer to pay more in money to avoid paying in time and gas. There is a price that I am willing to pay for that good, but that price is expressed both in money and in other costs I have to bear.

the consumer is frequently willing to pay a higher price in order to allow a producer with higher costs to continue in business - "Buy American" campaigns, or "green" electricity being two examples.

And how are American cars doing these days?

I also am hard pressed to think of a situation where demand for a useful product drops to zero at some arbitrary price point.

It doesn't need to drop to zero.

Do you accept that, in general, increasing the price of something will reduce the number of people willing to buy it?

So if you face rising costs, and increase the price you charge, you will be reducing the number of potential buyers at the same time that your costs are rising.

Now, if the amount that you lose by that decrease is less than the amount that you gain by selling at the higher price, or if they offset each other, then you could still be OK. But that just begs the question, why did you wait for your costs to rise before you increased the price, if you could get away with it? Why not take the higher profit even when your costs are lower?

However, as a human being, I would prefer not to do that to my employees. So our reaction has been to reengineer the product, to simplify the designs, to enhance the marketing, to squeeze the suppliers, to provide better service to the customer - an arsenal of actions that keep our revenues up even though we are cutting prices.

I mean that's great--obviously in a perfect world all we'd do is continually reduce our costs rather than every laying anyone off. But you did that out of necessity, and not everyone is capable of doing that. Just because you set it as your goal does not mean you will be able to accomplish it--and those who can't will have to cut costs somewhere or they will risk going belly up.

The point I was trying to make in my original post is that theory is nice, but the ground game is far more complex.

Absolutely the truth. But every attempt to interpret that complex reality that you have given has relied on some theory you were putting forward (people will buy American, you can just re-engineer your costs rather than lay off workers, etc.). In short, you have been no less abstract than Professor Roberts or I or any economist.

No one just looks at reality and recognizes a manifest truth. We look at it through a lens which first filters out everything but that which we think is worth observing in the first place, and then interprets those things we do observe based on some notion of how the world works.

Often that leaves us with questions, but we can't even ask questions unless we have some framework to do so. "Why is there a range of prices" is only a meaningful question if you have a notion of what a price is, and some underlying assumption of why it would be surprising that a set of things would sell for different prices.

So I agree that reality is complex and that those who indulge in pure theory without making any observations are unlikely to be very successful at providing accurate explanations.

But in the end any discussion of reality is going to be theoretical in nature.

Paul Downs writes:

Adam - I'll start with a question: what do you do for a living? Have you ever run a business? Do you sell anything?

Then, rather than address all of your questions, I'll comment on this one:

"But that just begs the question, why did you wait for your costs to rise before you increased the price, if you could get away with it? Why not take the higher profit even when your costs are lower?"

We make our tables to order. Each one is a combination of custom design and features. The client doesn't know the price going into the transaction. I can quote them whatever I want, once I have figured out my break even point (which is never a precise calculation in custom fabrication). Obviously, I can quote high, and sometimes I'll get the job and the excess profits. Or I can quote lower and have a greater likelihood of getting the job. If the shop is already booked then I quote high. If not, then low. I could quote two very different prices for the same item to two clients on the same day, if one buys before the other and books the shop. In that context, what does the price mean? The client thinks they are buying a table, they are really buying time in my shop. There might be another shop down the street that would quote higher, or lower, depending on how busy they are. The client may or may not be aware of that fact, or may or may not care, as they don't want to spend time shopping. Many of my clients aren't spending their own money - that changes the deal entirely. Who is the customer in that case?

The classic idea of the market place with sellers lined up offering comparable goods at a publicly stated price doesn't begin to describe how my transactions work. There are a relatively low number of transactions, of greatly varying size, and you never know when the next client will call. You also don't know how much the client is willing to pay for a given item (although I always ask, and frequently get an answer - inexplicable to an economist.) It's important to close every possible sale. Just to make this a little harder, these transactions happen over the phone and via email, rarely face to face. Would you buy a car over the phone, that you couldn't touch or test drive, one that didn't even exist yet? I can sell you that car and get you to love it even before it shows up.

In the real world sales, and by extension pricing, has a psychological component which is very hard to quantify. And even though American cars may not be selling, I have had a large percentage of my clients tell me that they buy from me because the product is American. Go figure! Many of them are in the military, and most of the rest from Midwest. You might not approve, but it doesn't bother me in the least. I know my product is good, if others put extra value on its place of origin it is fine with me.

If you feel the need to respond to each of these point in order to demonstrate that you are smarter or better educated than me, have at it. I'm done now.

Paul Downs

Adam writes:

what do you do for a living? Have you ever run a business? Do you sell anything?

I work in a startup that I do not run. The closest I've been to the sales side was when I got stuck at the register when I worked at Borders.

The scenario you describe is entirely in line with economic theory. I was particularly struck when you said: "The client thinks they are buying a table, they are really buying time in my shop." Economists emphasize that cost is not measured just by how much producers spend in terms of money, but in terms of the full opportunity cost of what they have to give up in order to produce what they produce. In the case of a custom job, obviously the opportunity cost to making a single item is very high vs what it would be if we were just talking about the cost of making mass produced items.

The classic idea of the market place with sellers lined up offering comparable goods at a publicly stated price doesn't begin to describe how my transactions work.

This is a stereotype and a strawman. I may not run a business, Paul, but have you ever taken the time to study economic theory? Because this is a pretty lame representation of it.

Honestly it is such a flimsy strawman I'm not even sure how to respond to it. Economists are well aware that the extent to which goods are substitutes is variable, often in more than one direction depending on how many uses there are for those goods. They understand that individuals (be they buyers or sellers) face problems of uncertainty, imperfect information, that they often are willing to pay more to save time, etc, etc.

If you feel the need to respond to each of these point in order to demonstrate that you are smarter or better educated than me, have at it. I'm done now.

I never intended to demonstrate either of those things. I don't know how educated you are or are not, and you seem plenty smart enough to me. I just found your "step down from the ivory tower and look at reality!" attitude kind of condescending. I also enjoy discussions in general, but I understand if you're tired with this one.

Thanks for engaging me for this long.

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