To look at the economy, or areas within the economy, from a complexity viewpoint then would mean asking how it evolves, and this means examining in detail how individual agents’ behaviors together form some outcome and how this might in turn alter their behavior as a result. Complexity in other words asks how individual behaviors might react to the pattern they together create, and how that pattern would alter itself as a result. This is often a difficult question; we are asking how a process is created from the purposed actions of multiple agents. And so economics early in its history took a simpler approach, one more amenable to mathematical analysis. It asked not how agents’ behaviors would react to the aggregate patterns these created, but what behaviors (actions, strategies, expectations) would be upheld by–would be consistent with–the aggregate patterns these caused. It asked in other words what patterns would call for no changes in micro-behavior, and would therefore be in stasis, or equilibrium. (General equilibrium theory thus asked what prices and quantities of goods produced and consumed would be consistent with—would pose no incentives for change to—the overall pattern of prices and quantities in the economy’s markets. Classical game theory asked what strategies, moves, or allocations would be consistent with—would be the best course of action for an agent (under some criterion)—given the strategies, moves, allocations his rivals might choose. And rational expectations economics asked what expectations would be consistent with—would on average be validated by—the outcomes these expectations together created.)
…
If we assume equilibrium we place a very strong filter on what we can see in the economy. Under equilibrium by definition there is no scope for improvement or further adjustment, no scope for exploration, no scope for creation, no scope for transitory phenomena, so anything in the economy that takes adjustment—adaptation, innovation, structural change, history itself—must be bypassed or dropped from theory.

Monday, though, he got up my nose [no link -- sorry -- stuff.co.nz doesn't actually want you to find anything easily]. He was discussing the new DSM-5, which has courted controversy by redefining psychological pathologies. We are all — well, half of us — apparently in need of treatment by the very people who decide whether we need treatment.

In his brief history of the DSM, Brockie said that psychology moved away from Freud to science. The meaning of this is clear: there is real, true knowledge that is produced through science, and then there’s all that other stuff that people believe without it actually being true, and that’s where Freud (and by extension, Lacan) belongs.

There are two enormous problems with this. The first is that this statement is glaring proof of the social production of scientific knowledge. I’d venture to guess that Brockie has not actually studied Freud, and has little knowledge of the split between Freudian psychotherapy and Anglo-American psychology. What he knows is likely to be what he’s been told, the stories he’s heard along the way. Science proceeds not only ‘funeral by funeral’ but clique by clique, lunch table by lunch table. Waving the ‘Freud’s not science’ flag isn’t so much a statement of fact but a not-so-secret handshake that marks him as one of gang.

And what a gang it is. They are in charge of funding, and funding allows science research. That’s the second problem with Brockie’s statement. They’ll say they want investigator-led research; they’ll say they want to give researchers the ability to follow their curiosity and investigate all manner of topics, regardless of where they might lead. The truth is, they are perfectly happy to strangle research in the crib if they don’t like it.

I know this, because they have strangled mine, repeatedly, while intoning ancient rites of scientific concern. They have just done the same to novel research proposed by a friend and colleague. We can show the theoretical basis for the work, we can demonstrate the linkages to international peer-reviewed literature, we can link the primary research to the hypothesis — we can do all the things these quartermasters of science demand. And then, they say that it isn’t ‘science’ because the science hasn’t been done because it hasn’t been funded.

It doesn’t help that we are talking about inter-disciplinary research – research that falls somewhere in between the disciplinary silos. Call it economic psychology, or psychological economics, or decision sciences if you like, but it is just the latest area of research in which we develop theories of human behaviour and test them. I’ve tried to explain it here (pdf), Andrew Dickson tried a different angle here, and yet another perspective is here. And still we get things like this 2012 article saying ‘Surprisingly little scholarly work has linked food and Lacan’.

Maybe that has something to do with funding decisions rather than lack of curious researchers. You want to say that Freud is not science? Give me a few a million dollars over several years to do the research. If I fail, you can have your talking point.

The scientists controlling the money are like Abraham, driven by Yahweh to demonstrate their obedience by sacrificing the young Isaac. But Yahweh is I Am Who Am, certain in His existence. Science can also be a jealous and uncertain Master, a Cronus who must devour his young to protect his reign. When he guides Abraham’s hand, he doesn’t stay the knife.

Note:  I apologise in advance if this is a bit scattered – if you have questions or comments note them down in the comments, you’ll be doing me a favour

Paying our labour and capital

Remember that I stated in part 1 that we want to think about taxation, and spending, in terms of changing the allocation of goods and services.  This is not saying that goods and services are “fixed” and we are moving them around – no no no no.  It is saying that we are instituting policies that change the mix of goods and services, giving up some and increasing the amount of others.  We are thinking about how to use our scarce inputs to create outputs.

Now I have a strong preference towards private provision, given that voluntary prices are truly democratic and combine knowledge we don’t share as a society (but have internally as individuals), so let’s not get too ahead of ourselves in thinking we can “plan” the economy.

But, when looking at the issue we can say that we have a government sector, and a non-government sector. Labour and capital combine in both sectors to make goods and services … these are government goods and services and non-government goods and services.

Now if the government sector made goods and sold them to the public for a price, without raising any taxes, they would be just like any other firm.  In this case, the price paid for the government goods creates the income to pay for the labour and capital, and the labour and capital owners will purchase a mix of government and non-government goods at the relative prices

But government doesn’t work this way.  It pays for its goods by taxation instead of setting a price.  It uses this tax money to pay labour and pay capital when they create government products.  There is likely to be a reason for this, such as the existence of public goods, the urge to redistribute some products by providing them publicly, the desire for equal access to health and education.  That is cool.

In this context, the taxation is the government “claiming some proportion of non-government goods” to pay labour and capital with – since the labour and capital who produce government goods want to consume both government and non-government goods.  The government taxes non-government good providers, taking some of their output, and then sending over some of the produce of government production.

In this way, the tax exists in lieu of a price.

Now, while a price would see government goods and non-government goods produced with respect to their relative market value, taxation and spending is unlikely to lead to this same case for two reasons:

1. The government goods are explicitly being produced beyond their relative market value – as we believe there are non-market benefits associated with it.  This is redistribution through tax and corresponding spending.  In of itself this isn’t necessarily inefficient – with a lump sum transfer relative prices will just adjust.  We can view this as changing the “endowment” of underlying resources for different people.
2. Depending on the type of tax there are relative price effects, which reduce efficiency directly.  This occurs because it creates a gap between the cost of the good for the person buying it and the return for the person selling it (the “wedge”) – and so the very existence of the tax changes where people work, what they consume, and where capital ends up relative to the case where prices represent underlying value given the allocation associated with the government transfer.  This only occurs with taxes that influence relative prices – so not lump-sum taxes.

A web of prices, an ideal frontier, the fundamental welfare theorems

Now here is the way I see this idea when we think of spending, taxation, and the economy.

There is a set of resource (land, labour, capital, enterprenuers) and agents are endowed with some quantity of these resources.  Through trade, and the establishment of institutions and contracts, this leads to outcomes.  Prices in this case represent a set of relative values, and there is a frontier of outcomes (depending on initial endowments, that can be changed through lump sum government transfers) that can be seen as “pareto optimal”.  This is really just the fundamental welfare theorems which hold for perfect competition.

When we have a tax that isn’t lump sum, so it creates a wedge between the buyers and sellers price in a market, we end up in a situation “below” this frontier, which is in turn pareto inferior to a potential outcome.  This is why you will often see economists arguing for the idea of a poll tax with a progressive transfer system.  I’m not entirely sure – as I inherently see the transfers as having the same impact in terms of labour supply (unless we actually delink the benefit system from work), and believe that when equity concerns are taken into account some of these outcomes are not truly “pareto inferior”.

Now we don’t have perfect competition, it is more likely that we have monopolistic competition and the associated inefficiencies of that.  Modern policy oriented models do assumes this (eg DSGE models) and work from there.  However, even given this the tax principles are not terribly different – and as a result, I stick with useful simplifying assumptions to describe tax policy.

Furthermore, issues of information, incomplete markets, endogeniety and co-ordination failures, and oligopolistic competition do push us away from this idea, and provide scope for government interventions that are win-wins!  But at the current margin we already allow for those with policy – the “marginal” concept of taxation is very much along the area of trade-offs I’m discussing in these articles.

Trust me, these additional issues do play a significant role in how we try to discuss interventions – and many current interventions are based on it (eg monetary policy that tries to close output gaps, government intervention in markets over competition and consumer issues). Even if we “unrealistically” assumed perfect competition and perfect knowledge, the distributional impact of tax changes are insanely hard to work out – the best we can do (and that I’m aiming to do) is to provide a flavour for the direction of the different trade-off between taxes, not the magnitude or an implication of what we should do.

When we look at a range of marginal ideas such as “shall we try to ramp up healthcare” we are facing the traditional transfer problem akin to the fundamental welfare theorems, and this sort of exercise is useful.

That is so unrealistic, man economists say such stupid thing

I have tried to be honest about assumptions.  Often when an economist does this, someone is a dork and says something like the above.  If someone appears that feels like commenting in this way, I am replying to you right here.

Excuse me for admitting that allocation is an incredibly complicated issue that requires great care and thought when setting up a policy.  Why don’t you just go back to telling the world about your “make everyone better off by magic plans” and not bother talking to me again.

Why am I bothering with this comment – because there are innumerable people out there who simultaneously believe:

1. There are really obvious and easy solutions to economic problems.
2. Economists make really dumb assumptions and are stupid.
3. Economists massively overcomplicate issues with maths and terminology.

I find those assumptions mutually inconsistent, and whenever I meet a person like that (which is far too often) I can’t help but feel that there is really something wrong in their life that they are trying to make up for.  If I had any empathy I’d be sympathetic – instead I’m going to write this part of my post to insult them.

To everyone who has avoided their snark and has constructive things to say – thank you, I want to give you a hug.

Conclusion

Hopefully these examples helped to clear up the idea of burden and distortion – it is an interesting issue, and one that requires careful analysis when we actually go to investigate policy!  Next week I will have an article up with some “ideal taxes” (poll taxes, land taxes, ability taxes), and I will touch on ideas of horizontal and vertical equity!  With all that we will be ready to hit factor taxes and consumption taxes the following week, inflation taxes the week after, and externality taxes the week after that.

Where I have gone in parts of this post is beyond where I’m heading on the Rates Blog posts – quantitatively I am talking about the same results, but the description involved is more involved.  It wouldn’t be fair to burden that on the larger public on Rates Blog who are less likely to be as nerdy as anyone over here … unless they are interested in the ideas, in which case I hope they see it!

By the end of it, we should all have an idea about the framework we view tax within.  Given that, we can make our own judgments about what is fair, and interpret the evidence about burden to try to figure out whether that makes much sense.  To be honest, all of that is far beyond me

Who would have thought that you would have to become an expert on NZ wool exports and labor relations in 1951 to decide if public debt affects economic growth.

I was convinced from the start of the HAP/R&R controversy that the New Zealand part of this story was explained by the 1950-1951 New Zealand Wool Boom and not the 1951 New Zealand Waterfront Dispute.

The 1952-53 New Zealand Yearbook shows that wool sales were 47.1 million NZ pounds in 1949-50, 107.5 million NZ pounds in 1950-51 and 52.7 million NZ pounds in 1951-52.

Most of this was caused by a change in price, not a change in output. The average price of wool rose from about 38 NZ pennies a pound in 1949-50 to 88 NZ pennies a pound in 1950-51 and fell back to 40 NZ pennies a pound in 1951-52. (There were 240 pennies to a New Zealand pound.) Production was about 298 million pounds in 1949-50, 294 million pounds in 1950-51 and 315 million pounds in 1951-52.

According to the HAP/R&R dataset New Zealand's nominal GDP (NGDP) was 1.101 billion NZ pounds in 1949, 1.396 billion NZ pounds in 1950 and 1.446 billion NZ pounds in 1951, so that was a substantial proportion of New Zealand's economy.

A good paper about the New Zealand Wool Boom is here.

I can't locate a free copy, nor can I save a PDF file I can cut and paste but I would summarize the episode as follows.

Demand for wool had been strong since WW II ended but supply had been unresponsive to elevated prices. When the Korean War started in June 25, 1950 there was an immediate elevation in the price of wool. Between that date and March of 1951 the price of wool went up two to three fold depending on grade (lower grades went up more, mainly because that was the kind of wool the military was buying). Demand wasn't simply driven by US military stockpiling as retailers actually used rising prices to induce even higher sales.

In January 26, 1951 the United States Office of Price Stabilization (OPS) imposed a general price ceiling measure designed to freeze the pre-war price-wage structure. The price ceiling on wool brought trading in Boston (the central US wool market) to a standstill and caused US participation in New Zealand wool auctions to more or less cease. This led to falling New Zealand prices until February 7 when an emergency exemption was granted to the US military through April 1. This caused prices to recover but once the exemption expired prices fell sharply. By June 1951 they had fallen by 50% and by March 1952 they had fallen a total of 70%.

Now, my sense from reading the history of the Waterfront Dispute is that it was less a strike than a lockout. The government brought in 3000 troops an unknown number of scabs to keep the dockyards running, and thereby crush the union.

The 1954 New Zealand Official Yearbook shows the Cargo Manifest Tonnage "cleared" (exports) fell from 1,163,934 tons in 1950 to 1,129,629 tons in 1951. It rose up to 1,173,577 tons in 1952.

In other words the mass of cargo moved fell by only 2.9% and rose by 3.9% the following year.

What about the actual value of exports? Exports *rose* from 183,752,000 NZ pounds in 1950 to 248,127,000 NZ pounds in 1951, and fell back to 240,561,000 NZ pounds in 1952

Wool exports rose from 74,653,000 NZ pounds in 1950 to 128,176,000 NZ pounds in 1951 and fell to 81,998,000 NZ pounds in 1952. Note that wool exports increased by over 70% in 1951 and amounted to nearly 52% of all exports that year.

So it would appear that the 1951 Dockyard Dispute had little effect on actual exports. [note: links tidied from source]

The focus on financial stability, and system risk in the banking system, is due to concerns that a sudden shift in asset prices could lead to a breakdown in the financial system – due to concentration, bank-runs, or some concern about fragility.

This is all well and good.  I think we need to be careful with these arguments.  I think we also need to identify why and what the failures are.  But, overall this is a way forward.

And it does nothing to truly “prevent bubbles”.  If someone wants to “overpay” for something, they can, and will – and as a society we shouldn’t give two hoots about someone pissing their own money against the wall.  True story.

If we tell people the RBNZ is “stopping bubbles” they will just assume that whatever is happening isn’t a bubble.  Does this actually seem like it will help anyone?  The RBNZ can’t really control asset prices, and it definitely can’t control them in the face of “irrational exuberance” (protip, the RBNZ doesn’t control people’s expectations of future house price appreciation).  The goal is to prevent the popping of a bubble having enormous spillover effects onto the broader economy.  If the RBNZ is doing its job right we will STILL HAVE BUBBLES – and people who took on the risk will still HURT THEMSELVES.

As a result, I hate the current description.  I hate the focus on asset prices themselves, rather than the direct stability of the banking system.  And I hate that we aren’t more focused on trying to identify where the risks and failures and and how to quantify them.

We focus on two specific issues, the way taxes distort behaviour, and the idea of where the burden of tax falls.  As we explained in the first article these issues are really really difficult to actually work out – and the purpose of the second argument is just to give a “flavour” to the argument.  In honesty, if you wanted to figure out the true burden and distortions you’ll have to get yourselve a series of these CGE modeling economists armed with other economists who focus on normative judgments.

Last time I promised to discuss tax systmes that seem idea, that we don’t use.  And why we don’t.  Well, that is now the next article.

Also, thanks to Agnitio who helped me clear up this article.  It is a fairly wonkish one, and he came in at the last minute and helped me clarify what the hang I was doing

• School breakfast programmes really don't seem to increase the likelihood of that kids eat breakfast at all;
• To the extent that they improve outcomes in some studies, we really can't tell:
• whether the effect is from changing the timing of breakfast, in which case we should instead have a morning tea break;
• whether the effect is any better than just giving those families an equivalent cash transfer.

Ever since the crisis erupted I have, especially privately, called the “rebalancing” argument one of the most pathetic quasi-economic arguments imaginable.  I found it difficult when a large section of the New Zealand economics community started using it, because apart from being a close to meaningless metaphor it also has the disadvantage of misleading people – confusing macroeconomic policy ideas with “compositional” issues, leading to the typical “fallacy of composition arguments” which lead to bad bad policy.

It is with this in mind that a good friend of mine sent me this BERL report on rebalancing the macroeconomy.  And it is with the recognition that it is not just BERL – but a large section of New Zealand’s economists – who make this argument that I aim to discuss why the focus on discussing rebalancing is bad economics.

Rebalancing is a term used to hide value judgments and sell a moral argument about the “right structure of the economy” – it is not an objective way of facing the trade-offs of policy choices, and as a result is it a bastardisation of what economists should be describing for the public.

“Rebalancing is a morality play about borrowing – nothing more”

When talking about rebalancing people throw out lots of statistics and ratios, making it sound like we can be better off in some way by changing what “NZ Inc” produces.  This is popular with the left and right – with left wing and right wing think tanks both going on about this.  We need to “improve tradable GDP” and do less “non-tradable GDP” and make NZ Inc more like China Inc.

But like political discussions on productivity, or the assumption that we can redistribute income without any efficiency cost, this is entirely missing the point.

See this line in the BERL report:

We conclude that the underlying factors driving New Zealand’s macroeconomic imbalances have deteriorated considerably since 2008

"Major sporting events are big business and bring substantial economic benefits to the host region, so there is fierce competition globally to secure events."