|Intro. [Recording date: April 7, 2016.] Russ: Now, what's special about specialization and trade? Why do you put it at the center of this economics primer that you've written? Guest: You could start by saying that Adam Smith, who is considered the founder of economics, started out, of course, talking about specialization. And I think that economists have a bit lost their way by getting away from that in the last 50 years. In some ways, the organizing principle of this book is, I'm trying to use the focus on specialization and trade to get people away from misconceptions that they hold about economics, and these misconceptions are misconceptions that economists have and that non-economists have. They are misconceptions that socialists have and that libertarians have. So it's really wide collection of misconceptions that you can address if you keep people's minds on the topic of specialization and trade. Russ: Let's start with macroeconomics, which is a good chunk of the book, though not all of it. What are some of the misconceptions that you feel are held by economists--and of course we've infected non-economists with those misconceptions, if they are such. What are they in the macro area that come from ignoring the importance of specialization and trade? Guest: Yeah. I always say these misconceptions have infected economic journalism probably worse than any others. I think--boy, it's hard to know where to start; and I'll probably forget some of them; you should remind me. But one of them is what I call the GDP factory [Gross Domestic Product]--thinking of the economy as producing just one type of good out of, you know, homogeneous labor, homogeneous capital, as if it were one factory, one business; and thinking that what's happening when there's unemployment, that's caused by the business--people not buying enough from the business. Now, that makes perfect sense for one business. That is, if I have a business and people aren't buying much of my product, yeah, I might have to cut back on employment. But that's not a good way of thinking of an economy as a whole, which is constantly splitting up work and reconfiguring work into what I call new patterns of specialization and trade. So, that's one misconception. Russ: Let's--well, go ahead; name a few more, if you'd like. Guest: Another way to think about it is, thinking of the economy as some sort of machine that you can operate with a gas pedal. And this gas pedal is spending. Again, that's just not the right way to think of the problem of organizing or coordinating an economy. It isn't a matter of hitting the gas or operating it with a few simple equations. It's a matter of people readjusting and really configuring to new forms of specialization in response to changes primarily in technology but also into tastes and to culture and other things.
|Russ: So, when you accuse journalists, say, or economists of making these mistakes, one of their responses would be, 'Well, of course we know there's not one big factory. Of course we know there's lots of different industries and sectors, and it's not just simply a matter of putting our foot on the gas pedal.' How do you respond to that? Guest: Well, I think that they probably would come back with even statements: 'Yes, we know we have a simple model, but at least it gives us some policy options. What are your policy options?' So, most of what I can come back with are, my policy options would be more microeconomic than macroeconomic. That you kind of have to help the economy as it solves this coordination problem. Russ: I'm making a different claim. And, by the way: I have the same challenge you do in my views on macro, which is 'Okay. So? Now what.' And we'll come to that later. Actually, I think you have some very interesting things to say. You are very modest about them, because they are not as dramatic, perhaps, or as marketable as some of the things that people on the other side say. But I don't think they are unimportant. But I am making the claim, here, that 'You are creating a straw man. Nobody believes there's a GDP factory. That's silly. That's not what economists believe. That's a parody.' Defend your claim that that's the way they see the world. Guest: Well, look, at, sort of--okay. So what macroeconomists and unfortunately what I think economists live by in general is The Model. If you've never done professional economists, this might be unfamiliar to you. But people write down a set of equations, of, say, 'Let Y be total output. Let L be the total amount of labor. Let K be the stock of capital.' And I'm sorry, but when you are doing that, you are reducing the whole economy to a single factory in your model. And I think economists have lost track of how far that model differs from reality and how important those differences are. It's as if accountants all of a sudden decided that their accounts really were the business. If you think about it, you know that accounting ledgers are not the same as the business. If they were, every business plan would be a successful business. But they are not. If accounting were everything, all the famous business tycoons from J. D. Rockefeller up to Mark Zuckerberg would be accountants. They are not. There is a lot more to business than accounting. And similarly, there is a lot more to the economy than just these simple models. Russ: So, let me defend the factory model. It's hard for me, but let me defend it here for a minute. Which is, I think the response of people you've criticized here would be to say, 'Okay, no, I understand that. Sure. It's a model. It's to simplify the reality, which is way too complex to model in any precise way. These patterns of specialization and trade that you are talking about can't be modeled very easily, if at all. So they are nice; that's lovely; but we've got to make decisions when people are out of work. And we know, both from our model and from the data, that there is a gas pedal. There is a way to stimulate spending at the factory or across factories, if you want me to be realistic: and that's to spend more.' You mention in passing this focus on spending. That is the dominant argument in macroeconomics over the last 70 years--which is, when things go bad, if things are not going well, what we have to do is, obviously the reason they are bad is there's not enough spending. And so, if the private sector--either investment or consumption is inadequate to keep the factories humming along, government has to step in and use what's called fiscal policy to make up the gap. And that's pretty straightforward. You know, my favorite moment--one of my favorite moments in macroeconomics in real life was getting to hear Joseph Stiglitz, Nobel Prize winner, say, in public, that it doesn't matter what we spend it on. Government spending is going to help the economy. So, is he just wrong? Guest: I think so. They--so, the theoretical argument for that, you know, I think rests very strongly on this sort of misleading model of the GDP factory. And so a fallback position is to try to make an empirical argument--to just say, 'Well, the data show that spending and monetary policy, which is another way to try to increase spending,' which the press really tends to misunderstand--they tend to think, describe monetary policy as if it were government spending money, giving you money to spend. But that's a different misconception. But in any case, the data on that are kind of--the beauty of spending as a policy to fix unemployment is entirely in the eye of the beholder. My guess is we've talked before about the challenges of dealing with macroeconomic data: that it's not an experimental science. It's a bunch of observations. And people can--statisticians or economists or anybody can interpret that data in whatever framework they like. And unfortunately, you cannot come up with decisive results that change anyone's mind. Again, that's something you've talked about with other people on the podcast--how rare it is for economists to change their mind based on statistical evidence. And, I think that when that does happen--when statistical evidence is influential, it's almost always in microeconomics and never in macroeconomics. To my naked eye, and I think to a lot of people's naked eye, fiscal stimulus does nothing. But if you run it through a standard macroeconomic model like the Congressional Budget Office Model, it works. But it works because it works. It works because it works in the model. The data aren't really telling the model anything. The model[?] are insisting on its interpretation of the data.
|Russ: I just want to comment on that in a way I haven't always put it that I think might be of interest to listeners, and maybe to you, Arnold. Which is, I was talking to my Dad the other day, and we were talking about the increase of the minimum wage to $15 an hour. And he said, 'Well, that's just going to kill jobs.' And I said, 'Well, a lot of people don't think so.' He said, 'Well, how can they believe that?' And I said, 'Well, they believe that the data say that the jobs aren't lost.' And he said, 'Well, can't they just go out and count them?' Which is a really plausible, seemingly reasonable thing. Which is: Well, let's just see what happened. Or see what will happen and keep an eye on it. And similarly, when we spend $800 billion dollars on so-called fiscal stimulus, well, let's just see if it created any jobs. Let's see if jobs went up. And of, in reality--and this I think is--when I think of all the different ways that I find econometrics depressing, and data in economics depressing, this is maybe one of the most important ones. Which is: there is so little accountability. If you can't count them--which you can't, and the reason you can't-- Guest: Well, didn't Garett Jones try to do something sort of like that? You might even have had him on-- Russ: I'm not sure we talked about that. Well, we may have, actually. I'll go back and look. But it was a long time ago. So many EconTalk episodes under the-- Guest: We are talking about 2010 or maybe even earlier. Russ: But of course the challenge there is it's like asking how many jobs are lost or gained by a trade agreement. 'We just see how many factories were closed, or moved to Mexico.' But of course that doesn't count the jobs that were created elsewhere in the economy. And even David Autor, in a recent conversation about China, who tried to measure very carefully--again, not counting, but using statistical techniques, trying to isolate the impact of Chinese trade and trying to hold constant all the other stuff going on in the economy--concedes that he did not, is not able in that framework to measure jobs that may have been created by the fact that we are spending--we get goods more cheaply from China. So, it's really important, I think, to think of this as it's not an easy argument to settle. You can't just look and say, 'Well, let's just see what happened. Guest: Yeah. Russ: The whole statistical analysis is attempting to isolate the one effect of this one variable. And I like the way you say it. You say, 'We only have one economy.' And that really limits our ability to do experiments. Guest: And, as I said, with the naked eye, it looks like when we were hitting the gas pedal the hardest with stimulus, employment was performing poorly. And then when we switched to austerity--and some people even said that's going to be horrible--or what they called 'austerity,' that is: easing up on the gas pedal--the economy picked up. Especially employment picked up. So, to the naked eye, it looks like the gas pedal is meaningless. And to me, the naked eye is at least as valid a way of looking at the data as torturing it through a model. Russ: Well, they are all complicated because you don't know what would have happened otherwise, whether we would have had even more jobs if we had gotten back to the gas pedal. And my problem is, I don't know how to assess that. So I tend to fall back on my own model. So, I'm going to confess that I have my own problems, which is that I have a framework, as you do, for looking at the world that's got all kinds of other challenges. It's true I don't have the ugliness of some of the empirical claims that some people make, that are overstated, in my opinion. But I don't really have an ironclad way to make my case, either. So I usually come back to some level of humility when I'm done. Guest: Yeah. That's certainly appropriate.
|Russ: Let me tell you what I like about the specialization and trade idea in the macro setting, and then what I think is less convincing and you can respond to it. I think in the aftermath of the Recession of 2008, the fact that there were thousands and thousands of construction workers and manufacturing workers who were put out of work by a combination of, say, increased trade with China, increased technology, a slump in housing starts--all those folks had to find new jobs. And I think focusing on what is going on at the micro level for them to be able to find those new jobs is very powerful. What I found less powerful is why the problem started in the first place. Although technology can disrupt the patterns of specialization and trade, it seems to me that other things that you're not as fond of, such as monetary policy, perhaps other rules of the game that the government imposes--those can have effects that are outside of specialization and trade. So, for me it seems like a little bit of an asymmetric world that you are selling. Which is: there are a lot of reasons why economies might stumble going forward, but when they have to recover, they have to be looking at these kind of issues that you focus on. What do you think of that summary? Guest: I'm not sure what criticism you are making. So, you want to rephrase it? Russ: But you understand the praise. Yeah, good. The criticism part is--there's two parts to the business cycle. There's the bust and then there's the recovery. I understand the recovery part. I think it's really useful to think about people having to reestablish creating value in their work life. They have to find an opportunity where the value they create is higher than the amount they take from the business and pay in compensation. So I think the speed of recovery is very much affected by the challenge of having to find new patterns of specialization in trade. I don't see that story being as effective in explaining why the patterns fall apart to start with--why workers get laid off. And there, I don't want to go back to the GDP factory, but I'm probably doing it implicitly in some fashion when I think about fiscal mistakes or monetary mistakes. Guest: Okay. Yeah. I want to lean away from thinking in terms of fiscal or monetary mistakes. One thing that I'm willing to grant a lot of potential to is financial disruption. And let me just make an aside--I'm sure to refer to this at some point; this may not be the most appropriate point, but Acemoglu and others have a working paper on what they call 'network effects in the economy.' And they find that when one industry has problems, other related industries have problems. Not a big surprise. So, sometimes an industry that has a lot of suppliers, when that industry is affected, suppliers are affected. And sometimes when there's a supply problem in one industry, that affects the industries that depend on that industry to supply it. And, gee, not shocking stuff. But it was nice to see somebody looking at these industry patterns. So in any case, I think the financial industry in some ways is in the middle of a lot of these network effects just naturally, because all patterns of specialization and trade that are complex involve financing. If you just think of, you know, the butcher and the baker and the candlestick maker trading with one another through the intermediation of money, or just think of--we know that a surgeon shouldn't mow her own lawn. She should in effect trade a few minutes of surgery for a few months of lawn-mowing service. But she doesn't do that by barter. She does that through financial intermediation. And also when people create patterns of specialization and trade that involve multiple steps in production. So, you get the shovel--you get the plow to, get a tractor to mow the field, and then you plant the seed, and so on: Well, you are going to need to finance these sort of multistage production processes. So the bottom line is the financial industry is kind of at the center of a lot of these networks. And so you could imagine big disruptions in the financial industry reverberating into big disruptions in other patterns of specialization and trade. So, that might be one story of why busts get--in the boom-and-bust cycle--why the busts get kind of clumped together: If you get a sudden collapse in a central industry, like finance, or maybe in the 1970s, oil production was such a central industry. But again, finance can be a central industry, and if there's some collapse there, you can imagine that it takes quite a while for adjustments to reverberate throughout the economy.
|Russ: Well, you're not very fond of monetary policy as an example of what might cause it. And yet your story does open the door there to monetary disruption, whether it comes from the central bank or changes in velocity and private sector response to interest rate, etc. There are basically, because money is the intermediate way that we avoid barter and interact with each other and allowing specialization, it does raise the possibility that changes in that variable could have economy-wide effects. Guest: Yeah. Two issues with that. First of all, I don't like the mechanical--you know, an x-percent change in the money supply will cause a y-percent change in another variable. I don't like that. And the other issue I have is, I think people have a natural desire to kind of stabilize and adapt to sort of conditions involving money. So I think prices tend to be much more stable than you would think if you thought that there were these automatic responses to the money supply. I have this phrase, that money and prices are a consensual hallucination. That is, it's more of a social convention that, okay, this was the price yesterday; that's what we expect it to be tomorrow. You know, we have some general expectation of where prices are going to be, and we couldn't operate without that. If you are going to buy some equipment and hire some workers knowing that what you produce might not appear for another year or two, you have to have some notion of what general prices are going to be a couple of years from now. And so I think those are fairly stable. And I also think that what people use as money to transact with is very adaptable. So, I'm inclined to--and this makes me a real outlier in the profession--I'm inclined to minimize the role of the government's money supply in affecting how people deal with the problems of using money and credit and specialization and trade. I think the Fed is just one bank among many. It's a pretty big bank, especially now. It does a lot. But in the grand scheme of things, I think people are adapting their uses of money and credit, and can in some sense offset a lot of the things that the Fed does on a month-to-month basis. Russ: Yah. I don't have much to say about that, other than that I think, it's a very outside-the-box view. I don't understand how you maintain that view in the face of the evidence. And in particular--I'm just going to take one example, and then we can move on. It's a micro example. I like the idea that there are social conventions; there's cultural impacts on how we look on prices and money. But, look at the price of oil over--the last 6 months. It's fallen from about $4 to $2 at the pump. It's a huge change. It changes almost--for a while it was changing almost every day. And we all rolled with those punches. The suppliers rolled with those punches. The retailers rolled with those punches. And I apologize--I probably have the timing wrong, and the amounts. Guest: Right. That's okay. Russ: But the basic point is that there's been an enormous change in the supply of energy, and that's had a real impact on price. And nobody just persisted in charging the same price every day. Supply and demand is very powerful. So, I don't understand your skepticism about those kind of market forces. Or, maybe I'm misreading you. Guest: No, yeah--I think that's [?], because it lets me clarify. Relative prices change all the time. And they change secularly; they change when things move. But I guess, what I'm saying is that I don't think that this sort of, sort of general inflation rate is something that the government can fine tune. I think something like the price of oil changing in response to market forces, yeah, absolutely. But that happens against a background in which--if the price of oil moved by $2 but we had no idea what that meant because we didn't know whether other prices were remaining stable or doubling or going up or down by 15%, then the whole world would be very noisy. The reason that the price of oil is meaningful and we understand the impact of it is we have a sense that, at the moment, most other prices are roughly stable. And I think people need that, and naturally gravitate toward that. And it might not be literally stable. You could have a period where people just expect prices, 'Yeah, they'll go up about 3 or 4% on average.' Some will go up more, some will go up less. But I'm just saying that people get used to an environment of prices and they expect it to persist for a fair amount of time. And if it didn't persist, that would produce a lot of noise and difficulty. That kind of happened in the 1970s. The 1970s I think is the much tougher experiment, empirical example, for me to deal with, because there was the case where, you know, inflation clearly went up, clearly had an impact, and clearly went down. And my story of prices being a social convention doesn't have a ready explanation for that. Russ: Yeah, and you talk about that in the book.
|Russ: Let's move on to political economy. I love, and I'm going to read a quote from the book, which I really love--it kind of captures I think one of your tenets of the way you think of both politics and economics. Here's the quote:
As outsiders, economists see some of the conditions in a market, but they omit other factors. In that regard, economists are no different from other outsiders. To the extent there are outsiders who see a flaw in how the market serves consumers, those outsiders have the option of starting a business to address the problem. That's what entrepreneurs do all the time. And they are the main engine of economic progress. However, entrepreneurs are often mistaken, and new businesses often fail. By the same token, economists and policy makers are also capable of making errors. What we should be comparing is not the existing market configuration, with an ideal based on a simple model, but the market process of error-correction with the political process of error correction.Close quote. And somewhere along, else, you talk about how that process of error correction in the political world isn't so viable. So, expand on that, if you'd like. Guest: Well, okay. There's definitely a lot there. So, my point is, first of all, don't compare, sort of theoretical outcomes--in particular the Nirvana fallacy of, well, you know, we could have this ideal outcome, with what you see as a flaw in a given outcome; but compare processes for improving outcomes. And if you compare the process you get the--I argue that the market has a better trial-and-error process. I think--maybe something that would be useful would be examples. Just, you know, if you think of the problem of sort of, go back to the classic Market for Lemons problem: supposedly, I don't have information as the used-car buyer about the quality of the used car; and if you have a good used car, you have no way of distinguishing that you have a good used car from a bad used car. What's going to happen is going to be a market failure. And, what we've seen is all sorts of market efforts to solve that problem. We have companies that track what's happened to cars over time, whether they've been in accidents or not. We have companies like CarMax that select good used cars and offer guarantees. So, all sorts of solutions come up. But, when economists look at these problems, they act as if: 'Oh, I've discovered this problem that the only solution is for government to jump in and do something.' And their government solution might or may not be as good as what the market would come up with. And if it's not as good as what the market would come up with, it's going to persist anyway. Russ: So, do you think it is inappropriate for economists to even suggest what the so-called optimal outcome is in those kind of settings? And the policies that could in theory get you there? Guest: I think it's pretty often misleading. I mean, take--I'll take on one of the leaders of our profession. Greg Mankiw is always talking about a Pigovian Tax, the Pigou Club: We need to tax carbon more. How does he know how much? If you look at all of the things that the market has been doing to change the mix of energy--you know, sort of --adjust what we do, and compare that to coming up with an exact number for a Pigovian tax: Certainly the possibilities for error are there. And, just as one other point: It always seems one directional. How would you know if your tax on carbon had ever gotten to be too high? And you just say, 'I hate carbon; let's tax it more.' There's no way of knowing what the amount is. Russ: Well, I think you'd respond, 'We're going to have to measure the size of the externality caused by carbon emissions leading to global warming leading to human challenges of health, or whatever they are, wellbeing. And it's in the ballpark, I think you'd respond.' And you suggestion is to do nothing. Just to hope that somehow this enormous externality is going to solved by private action. That, you're an ostrich. Guest: Yeah. Well, I think--it's not an argument that I think I have sort of [?] overwhelming logic on my side. And it may even be not the best example for me to pick. But the--in any case, there certainly are worse ways than a tax of dealing with it. And you are right: You can, in principle try to estimate all these costs and benefits and try to come up with the best approach. But, I think, again, you run this through the political process; and what are the chances that the political process comes out with the tax that you recommend? More likely it comes out with all kinds of special exceptions and subsidies and favors. So, when you actually go through the sausage grinder you don't come up with anything close to what you like. I realize I'm sort of changing the argument. Russ: Well, that's all right. I think that's the more interesting argument. I don't think you are--I don't think it's going to be easy to measure those externalities. That's how I respond when I'm thinking about those issues. And we already have a tax on carbon, we subsidize it in other places. I think one of the hardest things to figure out is: What are we doing to carbon now? Are we encouraging it or discouraging it? Given the incredible complexity of regulations, taxes, and subsidies surround energy, exploration; and then on top of that you have issues like the electric car. Which you could use as an example of your case, where an entrepreneur is solving an externality. But it's not obvious an electric car leads to less carbon. It just leads to less carbon coming out of the car. You still have to charge the battery; and that is usually carbon-driven. Etc., etc.
|Russ: But on this political issue, which I think is the really interesting issue: I have the exact same thought; and then I wonder if I'm just being unfair to my intellectual opponents. Because, if I say--which I do, often--well, that's nice in theory, but that's not what's going to actually happen: Like you said, the sausage grinder is going to ruin stuff. And, does that mean you shouldn't even talk about the good? You should not even propose the "best policy"? Guest: Well, let me make another point before I get back to that. Which is a point I also make in the book. Which is that, it isn't that the political process kind of just makes random errors. I think it actually makes very systematic errors. What it does is it always seems to work in the direction of subsidizing demand for something and restricting supply for that same thing. So, I use in the book the example of housing and housing finance. Now, if you put together all the policies at the Federal, state, and local level, for the most part they subsidize demand for owner-occupied housing or for mortgage-financed, so-called owner-occupied housing. And they restrict supply. And if you think of the economic theory of public goods and externalities, that's almost never going to be the right policy. Because the theory of public goods and externalities is usually, we're producing too much of a good that has a negative externality, like pollution; or we're producing too little of a good that has a positive externality, like vaccination. And so you either want more of the good that you are producing too little of or less of the good that you are producing too much of. But if you subsidize demand and restrict supply, you don't get more or less necessarily. All you get is a higher price. And if you think of that in terms of who benefits, the people who supply the good benefit from the higher price. And the people who demand it don't benefit, although some of them get compensated by the government subsidy. Russ: Yeah; they are insulated a little bit from the [?] Guest: They are insulated. And it really gets back to this core issue of specialization and trade, going back to, Adam Smith recognized, when you specialize, you have a very strong interest in the market in what you produce. You have a much more diffuse or dilute interest in the stuff which you consume. So the politics are always going to push in this direction of subsidizing demand and restricting supply. That's the way the politicians can please the people who care most about the product--the suppliers--and still kind of appease the consumers a bit. Russ: Well, the burden is spread widely, diffused across taxpayers. Guest: Yes. Right. So that political tendency is not an accident. It's a very natural tendency for the political process to evolve in that direction. So, for economists to--in theory, economists would say, 'Oh, we're perfectly pure. We're going to act, only recommend policies that are optimally in our public-goods/externality framework.' But to do that knowing that when the politicians get ahold of it, they are going to distort it and turn it into the subsidize-demand/restrict supply result, is, I think, disingenuous. Or naive, certainly. Russ: I want to come back to that in a minute--the insight. But I just want to think about the implications for my behavior as an economist. Does that mean I should never propose policies that I think are good because they are always going to be beaten up by the political system? [?] George Stigler said it's a waste of time to try to propose good things or bad things. He used to disagree with Milton Friedman about this. Friedman would say, 'I think we ought to do x.' Stigler would say, 'What are you doing? That's ridiculous. The political process is going to work its way through this problem, responding to political incentives, and our job is to observe that, like monkeys in a zoo in a cage.' So, isn't that what you're saying? Guest: I guess I'm saying that I would have more hope if we could change the culture--let's say, having more people read this book, ha ha-- Russ: And listen to EconTalk. It's happening. We're moving along. Guest: Yeah. To change the culture so that people have, realize--first of all, they have a better appreciation for the market process, because there's a lot of people who market against the market process, as it were. And even more cynicism that they do have about the political process; and that they channel that cynicism, hopefully more constructively and effectively than they can channel it now. I think people are plenty cynical about the political process, but the political process keeps expanding, nonetheless. Russ: Well, that's because there's always that voice that says, 'I'm going to do it differently when I get in.' I always find it amusing when someone says 'Well, if you were President, what would you do?' And I'd say, 'Well, if I were President, I wouldn't be an economist. I'd be a president: I'd be a politician.' [?] use your economist hat; but I won't be wearing it. I'll have taken it off. That's the start, for people to accept that.
|Russ: But I want to expand on your point, because I think it's quite deep, actually. And I enjoyed that part of the book--I noticed it. But it didn't stick with me the way it has in this elaboration of it. So, two places--housing is one example. It's very powerful. We have all these zoning restrictions, and we make it hard to build new buildings and start new projects, and at the same time we subsidize demand, which pushes up the price of housing artificially. Doesn't necessarily mean we have more houses. We just have more expensive houses. We could have more. But not as many as we'd have if we didn't restrict supply. But health and education are two obvious examples where the same thing is going on, right? Guest: Yeah-- Russ: We are subsidizing demand tremendously through all kinds of artificial ways--third party payments, etc., in the case of health. And then we don't let the number of hospitals or doctors expand much. So, strangely enough, it makes doctors really comfortable. And hospitals really profitable. And so then people say, 'Well, then we should do something about that.' And they do try, sometimes, kind of, sort of, a little bit. Guest: Yeah; I think it's even stronger than just sort of, you know, the government not expanding. The government, in the case of hospitals, they require this Certificate of Need. And that has restricted the supply of hospitals. And of course all sorts of medical licensing restrictions exist, especially at the state level. You can be licensed to do something in one state but not in another. You can--they pile on the requirements for these things. And education accreditation is controlled by the incumbents in the industry, and there's hardly been a new accredited college in the last, you know, few decades. So, they really are very active in restricting supply. It's not just they are not adding to it. They are active in restricting supply and subsidizing demand. And, I think it takes two seconds to think about that and think about how absurd that is. It's sort of like chasing your tail. And yet, economists don't point out how absurd that is. They act as if there's actual public policy going on, when what's going on has nothing to do, nothing remotely to do, with any economic theory of externalities or public goods. Russ: Social welfare.
|Russ: Let's shift gears. That was very interesting. I want to shift gears and go back a little bit to the issue of re-establishing new patterns of specialization and trade, because I want to make sure we talk about this. And it's a little bit related to this issue of political economy and what things we should be emphasizing as economists. At one point in the book you talk about how we should stop talking about what's optimal and talk about what kinds of institutions and processes we ought to have. What do you mean by that? Guest: Well, I think, when you talk about what's optimal you are saying that--I think you are kind of acting as if the, kind of, technology and tastes are all given, and let's figure out how to get to some social optimum. And when you are talking about institutional quality, you are saying, 'Well, nobody knows what the optimum is--and the optimum changes because people make new discoveries; culture changes, tastes change. So, what you want are institutional processes that you think help make these elements of change work out for the best. Russ: So, in the area of specialization and recovery from a recession, a part I found very interesting, is you talk about the decline in mobility in the United States, and new business formation. The dynamism of the labor market is an issue that we talked recently with David Autor. And you say the following--you are talking about the decline in the rate of new business formation and household mobility. You say,
Some of that decline may be due to changes in the structure of the economy. One factor is that the largest secular growth has been in health care and education where it's very difficult to compete against established institutions. Another factor is that the age distribution of the population has shifted upward, which might lead to less flexibility and less risk-taking. Another factor is the rapid decline in the value of physical labor relative to work that requires cognitive skills.Those are all fantastic examples of change. I think a lot of people want to pick their own favorite in there and say, 'That's what's causing this problem.' But it's really a very complicated and wide-ranging set of changes, over the last couple of decades in the United States. And then you say the following--and then I'll shut up and let you talk:
The main point here is that better economic outcomes arise from patterns of sustainable specialization, trade, or form. Those patterns do not come about as a result of tinkering undertaken by the Federal Reserve, by deficit spending undertaken by Congress. It requires the creative decentralized trial and efforts of thousands of entrepreneurs and individuals seeking the best way to use their talents. Probably the best thing that the government can do to encourage new forms of specialization--specialization, is to rethink existing policies that restrict competition, discourage innovation, and retard mobility.So, I think that's really a fantastic way to think about these issues. Why don't you expand on that, if you'd like--what you have in mind there? Guest: Okay. So, things that specifically sort of retard innovation--one is, you know, the restrictions on entry into education and health care. I think that there is a tremendous entrepreneurial potential there. There are certainly a lot of entrepreneurs who want to get into education. But most of them wind up trying to serve the government as the client. Similarly in health care: there are a lot of entrepreneurs who want to get into that, but the most profitable thing to get into are things that the government is leading the charge on, like electronic medical records. Electronic medical records may or may not be the most cost effective solution in health care, but the government would, at least at the start of the Obama Administration was throwing tons of money at that. So that's--so, if you wanted to be an entrepreneur in health care, that's what you did. You didn't try to solve any of the other problems in health care. So, you know, that's one example of an impeding mobility. The credentialization of many professions, that's gone up from what--I think even the issues [?] for the President, got into that issue: that somehow, like 5% of jobs at the end of WWII required a license and now it's something like 30%. That's excessive. And that impedes mobility. Let me throw out another thing that I think impedes mobility, is the--linking health insurance to employment. I think that does a couple of things. One is, it has a tendency to lock people into jobs. Another is it's a big tax on employment. I think we now tax, sort of, low-wage employment, higher than just about any other activity I can think of, because of the payroll tax being so high and the requirement that employers provide health insurance. That just puts a huge barrier into experimenting with hiring people and trying to come up with new ways of using people. I think if I could wave one magic wand today, it would be to reduce payroll taxes and offset that some other way, either higher income taxes or, you know, preferably for me, lower government spending. Russ: Well, I'm not sure that would make a difference. But I think, smaller government--which would be a way to get the tax lower--would be a good way to get there. But that's just my philosophical view.
|Russ: It is interesting that the market is looking for ways to get around those inflexibilities in health care and education. The technology of MOOCs (Massive Open Online Courses), the digital revolution in health care, the potential to visit doctors online in virtual ways. The regulatory framework is not really prepared for it. It's somewhat similar to what's going on in transportation, right? There's all kinds of innovation going on that are solving what I would call government failure. Ways that have restricted, that you are talking about. Guest: But that's actually a good example. I mean, look at how rapidly Uber is having an impact on the economy. And suppose you try to do anything comparable in health care. I mean, the simple fact is that taxing medallion owners were too slow and too politically weak to stop Uber. Russ: In some places. Guest: But if something like that showed up in higher education or medical care, in some sense it already has shown up, it gets killed. Russ: Well, I wouldn't say it gets killed. I'd say it's--you're right, people fight back against it. I think it's unclear what's going to happen there. And I think the potential in health care is going to be much more dramatical because not only are the restrictions bigger but also the potential gains are so large that people will fight very hard to get those barriers gotten rid of and destroyed. So I think there could be some serious changes there. Guest: Well, we'll see. In the--I mean, to me, health insurance as it's structured is just on the wrong track. It's not really insurance. It's a pre-paid health plan. Russ: Yup. Guest: And yet I would say if anything has happened over the last several years it's been to entrench that further in the name of so-called reform. So, I'm not sure I'm as optimistic--I mean, it really will be a battle between the entrepreneurs trying to innovate and the incumbents trying to protect existing rents. And I'm not sure I would bet on the entrepreneurs so heavily in health care and education. I wish I could. Russ: Well, I agree with you that they are not going to win in the sense of overturning allowing more competition within the current framework. But I think there's the potential for technology to destroy the current framework. Somewhat akin to Uber, right? Guest: Yeah. Russ: So, it's not going to be easier to start a medical school. That's not going to change. Guest: Right. Russ: It's not going to be easier to be a doctor without certification. Licensing, that's not going to change. What's going to change is it potentially can be so inexpensive to solve certain health care problems via technology, I won't need to go through the current system. There will be an alternative. So, we'll see. Guest: Yeah. Well, that's an optimistic view. Russ: I'm not sure I'm optimistic. But if that would happen, I'd be optimistic about it having a big impact. We'll see.
|Russ: I want to close with a metaphor you talk about in the book, which you and I have talked about privately in our conversation, and we talked about it here on EconTalk with Jim Otteson a little while back: which is the camping trip that G. A. Cohen, a Socialist, has proposed. Talk about the metaphor of the camping trip and why you don't like it. I find it extremely interesting, because I think it really captures what people don't like about market forces and what they do like about top-down alternatives. Guest: Okay. So, imagine you are on a camping trip and somebody just said, 'Let's organize this as a market economy. You'll be paid a certainly amount for peeling potatoes. You'll be paid a certain amount for setting up the tent.' People would say, 'That's kind of crazy. Here we're friends; it's sort of obvious what we need to do. Let's all pitch in and do the camp.' And I think that's absolutely valid for a camping trip. The bad move is to say that that camping trip, then, is a valid metaphor for the economy as a whole. Because it's not. Several things to notice about the camping trip. First of all, the tasks that are needed are relatively simple. There are very few people: you see all the people on the camping trip; there are 6 or 8, maybe 10 people on the camping trip. So you don't have to organize and coordinate lots of people. But above all, when you go on that camping trip, you take with you stuff that required millions of tasks: Where did the clothing come from? Where did the pots and pans come from? Where did the tent come from? All these tasks had to be coordinated. So, you are pretending that all those problems of coordination didn't exist, when you say that the whole economy can be run like a camping trip. The other thing to think about is that on a camping trip, the tasks are all approximately equally difficult or undesirable; and people's talents at them are probably approximately equal. In the real world, people's talents and inclinations are different. And the difficulty and pain involved--or not pain but discomfort--involved in different tasks is different. So, I would love to be, let's say, a professional guitarist in a world where each according to his ability--in a world where we could decide what we want to do, self-organize, spontaneously decide what to do: I'd like to be a guitar teacher, let's say. Probably nobody would like to be a sanitation worker or a chicken farmer or something like that. So, how, in a socialist economy do you get people to be chicken farmers or sanitation workers? At that point, you have to use pretty heavy-handed coercion, if you are not going to pay them. Russ: Well, you could just take turns, like you do on the camping trip, or in the dorm room that we share: we rotate. I think the example that Cohen gives, which I think is very powerful, is that, he says: Imagine if one member of the camping trip, having been on a similar trip years before, knew about a water source that no one else knew about because they'd never been there; and he proceeds to sell that water, exploiting the other people because he has information they don't have. He has that information solely by virtue of the fact that he was lucky enough to have come there before. He doesn't have to work for it. And I think that captures very powerfully the way a lot of people feel about capitalism. They feel that way about the luck component. They feel that way about people who were born into situations where they have certain advantages and get ahead. Is that a relevant point, that Cohen makes there? Guest: I think it is a relevant point. I think that there's, again, relative to Nirvana, there is something ugly about capitalism. There are going to be advantages that people have that you can consider to be unfair. The challenge is to come up with something better. And there, you end up--and especially the challenge is difficult given the complex coordination problem and the lack of information. There's just nobody who sits up there in the throne dispensing cosmic justice. We're all kind of equally ignorant about a lot of things, and we know a lot about a few things; and the question is how can we coordinate given those limited information sets that everyone has. And I think one of the misconceptions that both non-economists and economists have is they act as if there's going to be somebody out there who has so much information that they can dispense cosmic justice. And it's frustrating that nobody's in that position. And when nobody's in that position, what do you do about it? And I think the best thing, unfortunately--or fortunately--is to let the market process work itself out. It's often a better solution than to give somebody the power that they would use effectively if they had this overarching knowledge. But then have that confront the reality that their knowledge is not at all commensurate with their power. Russ: That was very well said. I would only add one thing on the camping trip that's the way I think about it, which is: I choose to go on the camping trip, with a bunch of friends. I don't go with strangers. I don't go with random people. And if I went with random people, it wouldn't be a very pleasant camping trip. Not so much because--it might be more interesting than my circle of friends. But getting those tasks executed and dealing with the person who knows about the well far away can be much more difficult, if they are not people I care about. And when you care about people, whether it's in a family--which is what the camping trip is really about; it's an illusion to talk about it, somewhat of an illusion to suggest it could be a wider range of folks--friends or family, either one, we solve those problems all the time. Because we have information about them; and we care about each other. And I think what the camping trip--to me, the Nirvana part of the camping I like the idea of--is, it would be nice to live in a world where people would be happy to work as sanitation workers and serve other people. That's not the world we live in. Most of us, it's not clear who should be that loving of other people. Even if they were that loving, why should it be put on some people and not others, whatever you call the negative tasks? And by the way, I assume some sanitation workers find their job satisfying and relatively pleasant, to think about cleaning up things. Just because I don't find it appealing doesn't mean others don't. But I think that's the essence of your point. Which is, we're all different. And we differ not just in our skills and not just in our values, but we differ in how much we care about each other. And that complicates the camping trip with 330 million people in all kinds of obvious ways. It's the Hayekian knowledge problem. It's just not solvable. Guest: Yeah. And even beyond the knowledge problem, I think what you're alluding to is people don't naturally deal with strangers in friendly, warm, peaceful ways. And just getting them to cooperate at all in an impersonal way through the price system is a great thing. Russ: Yeah. That's right. And lastly, the guy who wants to sell you the water because he's been on the trip before--you don't go camping with him again. Guest: That's right. Russ: He has an opportunity to exploit us; if he does, he'll pay a price for it. You could argue it's not big enough. But that's another-- Guest: Right. There's a way to solve that market failure: somebody will sell you a bottle of water to take along; next time you won't have to worry about that guy. Russ: That's right.
|Russ: Let's close with a psychological issue; and if you don't want to talk about it, just say so. I find it interesting that you and I share something, which is something of a repudiation of our graduate school training. So, part of this book that you've written is a reaction to MIT (Massachusetts Institute of Technology)--what you call explicitly MIT economics, where you were trained. And some of my evolution as an economist is a reaction to my Chicago training--that, in a parody of it, markets work perfectly; everybody is perfectly rational, that's what we should assume; that things can be measured well. And I've revolted against some of that. Maybe a lot of it. And you seem to have revolted against some of your earlier macro training at MIT. Have any thoughts on why that's the case for us but not for others? Most people are very happy with the medicine they swallowed when they were younger. What happened to us? Guest: Well, I guess we--broadly, you can come up with three stories, right? Well, two observations. Neither of us has this--currently has an academic position. So-- Russ: We're not Professors, anyway. Guest: Yeah. So, put those two things together. One is that the causality runs from not having not-academic positions to sort of rejecting, becoming heterodox. That is the sort of sour grapes hypothesis, as it were. Russ: Yep. Guest: Another hypothesis is it goes the other direction. That is, we just naturally thought differently and therefore didn't find our way into the-- Russ: standard-- Guest: the in-crowd. The third possibility is just random correlation. I'll just say, in my own case, I can remember discomfort pretty much from Day One at MIT. That, I felt like my undergraduate education was--there was a lot of critical thinking involved, a lot of different points of view brought out of plausible. And, you know, it was really kind of a mathematical brainwashing. And I remember being conscious of it at the time. And many students complained about [?] the time. Of course, maybe graduate students complain in all sorts of environments. But, I never fully bought into that, into the hubris that, you know, these mathematical models were building, or great things, or that this is the way to be an economist or do economics. So, I'm trying to resist the sour grapes interpretation and go for a little bit--you know, I had an inclination to be heterodox to begin with, and that's why things turned out the way they did. In any case, for me, I'm quite happy for the way things have turned out. I feel like, just to do modeling over and over again would have meant learning very little about the real world. And I feel like I learned much more from other experiences. I'm quite happy with how that turned out.