An Empirical Test for Economic Theories

Is economics a hard science, like physics? Or is it more like sociology and history? Many economists would like us to believe that the first is true, that economics is now firmly rooted in mathematics and empirical evidence.

In Seven Bad Ideas: How Mainstream Economists have Damaged America and theWorld, author Jeff Madrick asserts that the myth that economics is a science is one of the ideas that have inflicted damage on our country. In particular, he writes that for all the talk about being a science, many economists don’t care much about how their theories work in the real world. In Paul Krugman’s review of the book, he wrote, “Economists presented as reality an idealized vision of free markets, dressed up in fancy math that gave it a false appearance of rigor.”

It seems to me it’s time to do an empirical test of economic theories; an objective analysis of real-world results. For forty years from about 1930-1970, the policies of John Maynard Keynes were followed. Keynesianism included a strong role for government in regulating business and the markets.

In the 1970s a different economic model began to gain popularity, and in the U.S. the main proponent was Milton Friedman, so I’ll call this model Friedmanism. This model claimed that markets work best without government interference, because markets had an inherent tendency to always find perfect states of equilibrium. By 1980, with the ascendancy of Ronald Reagan and Margaret Thatcher, this new economic thinking began to dominate western economic thinking.

We now have forty years of Friedmanism to contrast with the forty years of Keynesianism. How do those two periods compare? Keynesianism produced strong economic growth and a relatively equal society with no major financial crashes. Friedmanism has led to poor economic growth, an increasingly unequal society, and regular and painful financial crashes. Interestingly, somehow these crashes are, in the end, only painful to the middle and lower classes; they are strangely rewarding to the 1%.

Ignorance of Income Inequality is Damaging to our Society

Three years ago the Occupy Wall Street movement got America’s attention with the cry of “We are the 99%.” Income inequality was put under a spotlight for a time. But how far did the understanding penetrate? Unfortunately, not very far.  

First, in a recent poll the average American thought CEOs made 30 times the wage of their employees, which hasn’t been true for 50 years. Today the figure is ten times as much—over 300 times.

Second, most people are completely unaware of the extent of wealth inequality, which is much worse than income inequality.  The wealthiest 20% in the U.S. own about 84% of the wealth. Think about that for a moment: only 16% of wealth is left for over three-quarters of the population. When you get to the bottom half of the population, those 155 million people own only about 2% of the total wealth.

To see an illustration of the income and wealth inequality in the United States, watch this episode of a TV show I did with Arthur Hancock in 2010.

The chart above, created by Pavlina Tcherneva, an economics professor at Bard College, vividly shows one of the contributors to the rise of income inequality in the last few decades. The graph portrays the distribution of national income growth during economic expansions since WWII. The blue represents the bottom 90%, the red the top 10%. In the last thirty years all the gains have gone to the wealthy, in fact, in the latest expansion most Americans have been losers—the truth is most of us don’t even realize we’re in an expansion, the Great Recession hasn’t ended for us yet.

In a recent column, “Invisible Rich,” Paul Krugman asks:

So how can people be unaware of this development [massive income inequality], or at least unaware of its scale? The main answer, I’d suggest, is that the truly rich are so removed from ordinary people’s lives that we never see what they have. We may notice, and feel aggrieved about, college kids driving luxury cars; but we don’t see private equity managers commuting by helicopter to their immense mansions in the Hamptons. The commanding heights of our economy are invisible because they’re lost in the clouds…

Does the invisibility of the very rich matter? Politically, it matters a lot. Pundits sometimes wonder why American voters don’t care more about inequality; part of the answer is that they don’t realize how extreme it is. And defenders of the superrich take advantage of that ignorance. When the Heritage Foundation tells us that the top 10 percent of filers are cruelly burdened, because they pay 68 percent of income taxes, it’s hoping that you won’t notice that word “income” — other taxes, such as the payroll tax, are far less progressive. But it’s also hoping you don’t know that the top 10 percent receive almost half of all income and own 75 percent of the nation’s wealth, which makes their burden seem a lot less disproportionate…

Today’s political balance rests on a foundation of ignorance, in which the public has no idea what our society is really like.

And the wealthy, in control of the media and the government, have a vested interest in keeping us ignorant.

A Guaranteed Annual Income

I have been thinking and reading about the implications of the coming robot revolution ever since I wrote my first post about it. The essence of that post is that artificial intelligence (AI) and robots have been steadily increasing in computational ability and they are about to put almost everyone out of work. In fact, some observers suggest that this is already happening: this is why the unemployment rate has stayed so stubbornly high in the last few years. There are economists who forecast 50 to 75 percent unemployment twenty years from now. What would this mean? How would people live without jobs?

Economist Paul Krugman wrote a column last summer called “Sympathy for the Luddites,” in which he suggests a basic income for everyone is the only solution.

This fall, activists in Switzerland collected enough signatures to bring a referendum to the ballot that calls for a minimum income for every citizen in the country. When the group brought the petitions to Parliament, they also brought a truck filled with 8 million coins, one for every Swiss citizen. If enacted, the measure would guarantee an income of about $2800 per month per citizen, regardless of any other income.

Business Insider published an interview with Daniel Straub, one of the people who initiated the Swiss referendum, and Straub linked the concept of a minimum income to the future of robots:

BI: Why choose a minimum income rather than, say, a higher minimum wage?
DS: A minimum wage reduces freedom — because it is an additional rule. It tries to fix a system that has been outdated for a while. It is time to partly disconnect human labor and income. We are living in a time where machines do a lot of the manual labor — that is great — we should be celebrating.

I agree with Straub that we should celebrate this—I imagine our robot future in a very positive way—but of course there are many dystopian views. I guess that’s not surprising in our culture, where the movie industry constantly pumps out films portraying a bleak future where the machines rule, the earth is devastated, and humankind fights for survival.

Our Robot Future

I was a child in the 1960’s, and one of my favorite cartoons was “The Jetsons.” 

I expected that my future would look like the world portrayed in the show—I particularly wanted to jet around in my personal rocket ship. (I didn’t play too much attention to how boringly conventional the family structure was—dad goes to a dull job while mom goes shopping.)

In the 1950s and 60s the technological advances of the twentieth century inspired dreams of a future of leisure. “Design for Dreaming” wonderfully illustrates these dreams  (This is the MST3K version and well worth watching!), including technology that liberates women from the drudgery of housework. And that has come true: I can remember my mother laboriously defrosting our refrigerator on a regular basis. Now my refrigerator does the work for me.

But as the century wore on it seemed like the grandiose dreams of the future were just a fantasy. What happened to our personal rocket ships? We did get lots of new technologies, like computers and smartphones that have made life more interesting and productive, but they have also made our lives more complex and caused us to work more, not less.

What happened to that dream of leisure?

Kevin Drum warns in a recent Mother Jones magazine article (May/June 2013, “Welcome Robot Overlords. Please Don't Fire Us?”), that most of us will soon be living lives of leisure, but it’s not going to be pleasant.

He provides a fascinating analogy to describe how the foundation for this future has been building so slowly that we are mostly oblivious to it; but we are just a decade or so away from seeing it transform our world (see the bottom of the article for a description of this analogy).

The essence is that artificial intelligence (AI) and robots have been steadily increasing in computational ability and numbers, and they are about to put almost everyone out of work. In fact, Drum suggests that this is already happening: this is why the unemployment rate has stayed so stubbornly high in the last few years.

When is the last time someone pumped your gas for you? Think of how many service station attendant jobs have been eliminated. Grocery store cashiers are soon to be obsolete. How many receptionists have been put out of work by businesses using interactive phone answering software?

Some new products coming that will reduce the need for humans in other jobs: driverless cars mean we’ll no longer need taxi drivers; implants that sense an impending heart attack and call 911 via your smartphone will reduce the need for all kinds of medical services; computers that grade student’s papers and scan legal documents eliminate the need for teacher’s assistants and lawyers.

Krugman uses Fire Department Analogy

A couple of posts down while discussing socialism I use fire departments as an example of socialism in action. In today's New York Times column, "The Fire Next Time," Paul Krugman brings in fire departments to skewer Mitch McConnell's position on financial reform:

On Tuesday, Mitch McConnell, the Senate minority leader, called for the abolition of municipal fire departments.

Firefighters, he declared, “won’t solve the problems that led to recent fires. They will make them worse.” The existence of fire departments, he went on, “not only allows for taxpayer-funded bailouts of burning buildings; it institutionalizes them.” He concluded, “The way to solve this problem is to let the people who make the mistakes that lead to fires pay for them. We won’t solve this problem until the biggest buildings are allowed to burn.”

O.K., I fibbed a bit. Mr. McConnell said almost everything I attributed to him, but he was talking about financial reform, not fire reform. In particular, he was objecting not to the existence of fire departments, but to legislation that would give the government the power to seize and restructure failing financial institutions.

But it amounts to the same thing.

Krugman then goes on to claim that McConnell is "pretending to stand up for taxpayers against Wall Street while in fact doing just the opposite."

The financial industry is going to pull out all the stops to avoid regulation, and the Republicans are their willing lapdogs. The Democrats aren't much better, unfortunately. We'll get some lukewarm reforms that will give the Democrats something to brag about in this fall's election, but in a few years we'll be suffering from the next market failure.

[T]he financial industry wants to avoid serious regulation; it wants to be left free to engage in the same behavior that created this crisis. It’s worth remembering that between the 1930s and the 1980s, there weren’t any really big financial bailouts, because strong regulation kept most banks out of trouble. It was only with Reagan-era deregulation that big bank disasters re-emerged. In fact, relative to the size of the economy, the taxpayer costs of the savings and loan disaster, which unfolded in the Reagan years, were much higher than anything likely to happen under President Obama.

Deficit Scare Tactics

Paul Krugman’s column “Fiscal Scare Tactic” today confirmed my assertions below that the deficit news stories are a political tactic:

Many economists take a much calmer view of budget
deficits than anything you’ll see on TV. Nor do investors seem unduly concerned: U.S. government bonds continue to find ready buyers, even at historically low interest rates. The long-run budget outlook is problematic, but short-term deficits aren’t — and even the long-term outlook is much less frightening than the public is being led to believe…

Why, then, all the hysteria? The answer is politics.

The main difference between last summer, when we were mostly (and appropriately) taking deficits in stride, and the current sense of panic is that deficit fear-mongering has become a key part of Republican political strategy, doing double duty: it damages President Obama’s image even as it cripples his policy agenda. And if the hypocrisy is breathtaking — politicians who voted for budget-busting tax cuts posing as apostles of fiscal rectitude, politicians demonizing attempts to rein in Medicare costs one day (death panels!), then denouncing excessive government spending the next — well, what else is new?

The trouble, however, is that it’s apparently hard for many people to tell the difference between cynical posturing and serious economic argument. And that is having tragic consequences.

For the fact is that thanks to deficit hysteria, Washington now has its priorities all wrong: all the talk is about how to shave a few billion dollars off government spending, while there’s hardly any willingness to tackle mass unemployment. Policy is headed in the wrong direction — and millions of Americans will pay the price.

I’m also reading Joseph Stiglitz’s new book on the financial meltdown of 2008, Freefall, and he confirms my assertion that President Clinton was distracted from his campaign pledges by warnings about the size of the federal deficit after he became president. Stiglitz was part of Clinton’s economic team in the early years of his administration along with Larry Summers and Robert Rubin. Stiglitz wrote, “Bill Clinton had sacrificed much of his presidential ambitions on the altar of deficit reduction.”