Hold the Gloom. The Economy is Changing, not Dying

I've been working on some other projects recently, but I wanted to respond to some of the increasing darkness and pessimism about the future that is seeping into public discussion. Take this article in Commentary Magazine, "Our Miserable 21st Century," which attracted much attention this week.

It turns out that the year 2000 marks a grim historical milestone of sorts for our nation. For whatever reasons, the Great American Escalator, which had lifted successive generations of Americans to ever higher standards of living and levels of social well-being, broke down around then—and broke down very badly.

The warning lights have been flashing, and the klaxons sounding, for more than a decade and a half. But our pundits and prognosticators and professors and policymakers, ensconced as they generally are deep within the bubble, were for the most part too distant from the distress of the general population to see or hear it. (So much for the vaunted “information era” and “big-data revolution.”)

David Brooks reinforces the message in the NYT here.

 Of course, it's a good thing to highlight problems. Opioid addiction and people dropping out of the labor force to live on disability and daytime TV are serious issues.  

But the despair is not justified. Society and technology and customs and institutions are always changing. That means we have to be resourceful and creative in making the changes work for us. It means we have to change how we think and realize some major 20th century social institutions need to adapt as well. 

We might have said much much worse about the economy in 1820 or 1830, just before the world got an order of magnitude wealthier than ever before in the following decades.  Malthus told us the mass of the population would be immiserated and kept at starvation levels, forever. Engels noticed working life in Manchester was horrific. Marx argued this was inevitable and would lead to such pain and rage the whole social system would be overthrown. 

None of this came true. The economy didn't collapse. It went through a boom of  stupendous magnitude and duration.

Now the problem is too little dark satanic mills and too much uninspiring lower class leisure like daytime tv? 

The world got hit with two massive shocks in the last twenty years. 

1. Global labor supply effectively doubled in the 1990s, both because of the entry of China and India into the world economy and because logistics and communication made it much easier to use remote labor.  The impact of that hit the American working class. A shock of that magnitude takes time to absorb.
2. Most new innovations are free at the point of delivery (Github, Facebook, Dropbox ) or not excludable goods, like cleaner air. 

A Shift in the Boundaries of the Market

That means we are seeing a shift in the boundaries of the market economy. Relatively fewer things will be exchanged for money, because the marginal cost of many goods  will be zero and distribution costs will be near-zero. Automation and artificial intelligence will only accelerate that trend. 

The shift in the boundaries of exchange is also because most of the new needs people have as society gets wealthier - status, affiliation, stimulation, meaning - aren't as easily bought and sold as grain or port wine or mousetraps .  

That doesn't necessarily mean disaster, though.  Most human societies historically have always had a smaller market sector. The "commons" was larger. Gift exchange, feudal or hierarchical obligation, family ties or subsistence agriculture have been far more important than the labor market for most of human history.  Women  mostly didn't work in the moneyed sector at all until forty years ago.  Indeed, even England only became a fully market economy in the early 1800s when the old medieval commons were enclosed and labor forced off the land to the cities or colonies. And it was only the requirement to pay government taxes in currency that forced many groups around the world into the market economy at all. The current  bundle of rules that make up a "job" or "corporation" and legal framework and expectations that go with them are mostly only 150 years old at most, not eternal  facts of nature.

In 1800 over 95% of populations worked the land. Now in the US it's about 3%. We have more agricultural productivity than ever, by a massive margin. But it's less important to the whole economy and population. The same thing will happen to the monetized exchange sector of the economy. The goods and labor market will be more productive than ever,  but a smaller proportion of the whole. 

We have a motivational and moral problem, not an economic problem

But it takes a lot of time for culture and human institutions and values to catch up. (See Douglas North, for example, or Avner Offer's brilliant The Challenge of Affluence.)  The main issue now  for humanity isn't starvation. It's motivation and what makes for human flourishing and the good life.  (Probably not daytime tv and OxyContin.)  It's  very much as Keynes foresaw in his famous essay Economic Possibilities for our Grandchildren. 

We've now actually solved the original economic problem of raw economic scarcity, starvation and disease. The problem isn't 30% child mortality or famine, as for most of human history.  Survival is rarely the problem any more. Instead, it's purpose. It's value and reward and how people get respect. That's an institutional, social or moral problem more than an economic one, which is why many economists can't handle it.

That's an epochal shift. We just have to figure out what to do with it. 

The Fourth Great Awakening

I read Robert Fogel's The Fourth Great Awakening and the Future of Egalitarianism over the holidays, and it is a very interesting book. Fogel is a Nobel Laureate in Economics (1993) , mostly for his earlier quantitative economic history and study of the historical economics of slavery in the US. Perhaps he felt liberated to write a much more original book, published in 2000. Yet it is based on deep knowledge of US history.

He focuses on the impact of the waves of religious revival in the US on broader growth and public policy. The main challenge for egalitarianism now is not material redistribution, he says, but the maldistribution of "spiritual resources."

The agenda for egalitarian policies that has dominated reform movements for most of the past entry - what I call the modernist egalitarian agenda - was based on material redistribution. The critical aspect of the postmodern egalitarian agenda is not the distribution of money income, or food, or shelter, or consumer durables. Although there are still glaring inadequacies in the distribution of material commodities that must be addressed, the most intractable maldistributions in rich countries such as the United States are in the realm of spiritual or immaterial assets. These are the critical assets in the struggle for self-realization. p2

Traditional measures of income inequality are inadequate. They ignore consumption of leisure and improved health, for example.

They focus on a variable - money income - that currently accounts for less than half of real consumption and that in a generation may account for less than a quarter of real consumption. Such measures shed little light on the most intractable forms of poverty (those related to the unequal distribution of spiritual resources). Nor do they bear on the capacity of individuals to overcome the social estrangement that undermines their quality of life. p3

So a politics based on income transfers is exhausted. That naturally leads to consideration of the good life.

A good place to begin a consideration of the content of a postmodern egalitarian agenda is with Socrates' question, What is the good life? That was a crucial question not only for the sons of rich Athenians but for the sons of the landed rich throughout history. Freed of the need to work to satisfy their material needs, they sought self-realization in public service, military adventures, philanthropy, the arts, theology, ethics and moral philosophy. p2

Naturally, I felt a huge sense of recognition and agreement at this point, as I believe that without some sense of the good life public action is empty. Fogel adds another twist. State action cannot redistribute such spiritual resources.

Realization of the potential of an individual is not something that can be legislated by the state, nor can it be provided to the weak by the strong. It is something which must develop within each individual on the basis of a succession of choices.

The quest for spiritual equity thus turns not so much on money as access to spiritual assets, most if which are transferred and developed privately rather than through the market. Moreover, some of the most critical spiritual assets, such as a sense of purpose, self-esteem, a sense of discipline, a vision of opportunity, and a thirst for knowledge, are transferred at very young ages. P4.

This is very much in tune with what I have been arguing on this blog. The main challenges we face are more ethical than economic now, about how people can be helped realize the good life and what kinds of behavior should be rewarded. It is surprising to see such a clear statement in this vein from an academic economist - although economic historians consistently seem more heterodox and interesting than mainstream model-builders.

We will look at more tomorrow, especially his emphasis on how ethical concerns develop over time.

 

 

 

More signs of a renaissance in psychology

This is an interesting column from David Brooks in the NYT, mostly because he sees many of the main challenges in public policy as a matter of better psychology.

What about the big problems? How do we get people to restrain government commitments now so that debt down the road won’t be so ruinous? How do we calculate the multiplier effects of tax cuts or spending increases among different subgroups of the population, or under different emotional conditions? How do we rig the context of budget negotiations so participants can actually come to a deal? How are people in different cultures likely to react to drone strikes? How do we structure sanctions against Iran to cause the greatest psychic humiliation?

These are the big questions, and most of our policies rely on crude folk psychology from a few politicians. But there’s hope. As Brian Wansink notes in Eldar Shafir’s volume, the 20th century saw great gains in sanitation and public health. The 21st century could be a great period for behavior change.

No mention of economics at all. Of course, economics has some things to say about credibility and commitment, such as the Kydland/Presscott time inconsistency literature. But the rational actor approach appears to be yielding diminishing returns. The focus of the social sciences can shift over time. I've been seeing more and more interesting things in psychology recently.

 

Double Entry and the Modern World

I read Double Entry: How the Merchants of Venice Created Modern Financeby Jane Gleeson-White last week, largely motivated by wanting to know some of the deeper reasons behind the surface apparatus of Quickbooks, which for various reasons I have to figure out soon.

It sounds like a dry subject. But the book is historically colorful, thought-provoking and well-written. Accounting numbers rule much of our lives and way of seeing the world. But they have a history and limits and flaws.

Measurement and capitalism

She tells the story of how Italian monk and mathematician Luca Pacioli in 1494 first wrote down the methods Venetian merchants had used to keep accounts, possibly for several centuries before that. The invention of double-entry clarified notions of cost and profit. According to some historians perhaps it led to capitalism itself.

In six pages Sombart set out his belief that the emergence of capitalism and the appearance of double-entry bookkeeping in the thirteenth century are causally related. He wrote: ‘It is simply impossible to imagine capitalism without double-entry bookkeeping; they are like form and content.’

Weber’s definition of a ‘capitalistic enterprise’ is derived from the concepts of double-entry bookkeeping: ‘a rational capitalistic establishment is one with capital accounting’. Like Sombart, Weber argues that double entry is significant because it makes possible an abstract measure of income and expenses—and therefore enables the calculation of profit, the key component of capitalistic business practice. Weber also believed that the formal rationality of double entry made the world a cold and disenchanted place—and, ominously, predicted that double entry would continue its rule ‘perhaps until the last ton of fossilized coal is burnt’.

The new double-entry methods caused a deeper change in perception:

He calls Pacioli’s treatise on double-entry bookkeeping ‘a major innovation in economic history’. First, because double entry provided the means of discarding all information extraneous to decision-making, leaving behind only numbers. And second, because it translated these numbers into a common measuring tool called ‘profit’, which allowed a relatively precise evaluation of actions. Double entry thus transformed business books from mere memory aids into records which allow the calculation of profit—and which can therefore be used to measure the success of each individual transaction and of a business generally.

But this did not come without a price.

We are now so familiar with this once innovative (and largely arbitrary) cost-benefit way of thinking that we take it for granted and cannot imagine it otherwise. And yet, as we shall see, this profit-driven way of thinking encouraged by double entry is not only driving managers to drink, academics to pull their hair out, politicians to short-term opportunism and most human beings to suffer in some way, but it is also destroying the world beneath our feet.

She argues that accounting is poorly suited to count environmental damage, for example. This is a problem when accounting has become central to the practice of policy and government.

National statistics

One of the main extensions of accounting is modern national income accounting. It is so familiar (at least if you have studied economics) that we forget how relatively recent it is. Keynes and Kuznets largely invented it, and both were skeptical about its use.

As a thinker of great depth and complexity who saw economics above all as a moral practice, Keynes was suspicious of statistics and considered these quantitative measures of the national economy as exceptional, emergency measures demanded by the times. In the budget speech which presented these accounts for the first time, the British Chancellor expressed the same view, stressing that the publication of official estimates of national income and expenditure should not be regarded as setting a precedent.

That did not stop a massive increase in the use of techniques which had proved useful during the war.

In 1952, very few statisticians were familiar with the theory and practice of national accounting. This would soon change irrevocably. The work done by Stone, Kuznets and others became the foundation of international accounting, and their national income statistics used to measure economic growth would soon become the key indicator of national success and government performance.

But even the main originator of much national income accounting was skeptical of its application.

But the accuracy and usefulness of national income measures have been questioned from the beginning, by Keynes and others, including Simon Kuznets himself. For example, Kuznets believed the national accounts should include the value of unpaid housework, despite the fact that including this vast contribution to the national economy would present statisticians with the difficult task of making monetary estimates of this valuable work. The US Commerce Department refused to calculate these estimates—and as a result Kuznets broke his association with the department in the late 1940s. Kuznets was also concerned about the effects on people’s lives of the modern economic growth that these statistics encourage as an end in itself.

GNP continues to be questioned as an adequate measure, most significantly recently in the Stiglitz-Sen-Fitoussi study.

Perpetual scandal

The numbers can often conceal as much as they convey, and we can mistake a false impression of precision for truth. The numbers sometimes are outright lies, for one thing. Accounting is also inseparable from scandals, she says, and always has been. People have not lost confidence in accounting despite failure to detect fraud or indications of problems on a litany of cases from Enron to Worldcom to RBS.

However, not only has no such fall ensued but it turns out that these accounting scandals are a regular feature in the landscape of accounting. They are as old as the profession itself, dating back to the earliest days of the formalised use of collective capital: the corporation. Corporations and accounting scandals go together like Gordon Gekko and greed. The nineteenth and early twentieth centuries are rife with corporate collapses of the magnitude of Enron’s and comparable in their elements. And they all stem from significant accounting misstatements orchestrated by influential senior managers. Equally, the responses of lawmakers and watchdogs have been the same over the past one hundred years: tinker around the edges of the law, found new watchdogs, proclaim a new era of greater scrutiny and let accountants and auditors out to play with the managers of vast sums of other people’s money.

We'll look at more tomorrow.

 

The Importance of Stocks and Depreciaton

 

We're looking at Double Entry: How the Merchants of Venice Created Modern Finance by Jane Gleeson-White, starting here. Book-keeping evolved into accounting as outside investors needed assurance that dividends were paid out of actual income, not capital.


Railways and factories also wore out, however, which led to another important concept: capital stock and depreciation.

The advent of the corporation raised several other key accounting issues; for example, how to calculate the declining values—due to wear and tear—of large investments in machinery, rails, rolling stock (or railway vehicles), and so on. This problem gave rise to the concept of depreciation.

It took a long time for accountants to come to terms with depreciation and properly accounting for assets. And this is still a problem, she says, when it comes to the environment since many assets are free.

This is because until recently economists have assumed that natural resources are so plentiful that any loss of them is insignificant, not worth counting. They assumed that natural resources like water, soil, forests and air were free gifts of nature.

But just as the nineteenth-century railway entrepreneurs had to learn that human-made capital—rails and machinery—wears out and must be depreciated, so some economists are beginning to understand that nature’s capital is also subject to wear and tear and depletion. Cambridge University’s Professor Sir Partha Dasgupta is one economist who is critical of the GNP and its use to judge the progress or otherwise of nations. He argues, ‘as so many economists have already done, that GNP’s main weakness lies in the fact that it is insensitive to the depreciation of capital assets’. And from an environmental point of view, this is critical.

The Modern Economy is about Stocks

This is no doubt true. But she perhaps over-emphasises environmental gaps to the exclusion of other social assets like trust or quality of life.

The larger point is we are often too focused on flows rather than stocks, including the depreciation of assets (stocks meaning an amount, like a stock of wheat, rather than an equity share like the stock exchange.) This is a basic economic distinction we often forget. As Dasgupta says, we need to be sensitive to the depreciation of capital assets.

We are much better at being conscious of flows of income rather than the valuable stock of assets which produces that income. Yet many of the great economic challenges of our era have more to do with stocks than flows of income. Many or our capital assets, such as the knowledge required to build an Intel processor or the song "Hey Jude" do not depreciate in the traditional way. They may have to be re-learned or passed on, but they do not wear out.

So what happens when the stock of our valuable assets, properly defined, gets disproportionately much larger than money income flows? In many ways, our prime objective should be to increase the stock of assets. Income and distribution are secondary factors , especially of many of the benefits flowing from those assets are free. Some of our political thought gripes towards this, especially those who think capitalism should be left unfettered to create wealth which government can then redistribute. But that often confuses income with value.

We will come back to this point another time.

Finally, Gleeson-White emphasizes again how the numbers may often conceal deeper uncertainties.

Even accounting’s most fundamental concepts and practices, such as income measurement and asset valuation, are based on uncertainties. Accountants still cannot agree on how to define income, the measurement of which remains one of the intractable problems in financial accounting theory and practice. The valuation of assets only becomes more complex and more fiercely debated as modern global corporate structures and financial instruments become increasingly labyrinthine, and income measurement, the key to determining profits and therefore dividends, is inextricably linked to this contentious, chimerical practice of asset valuation. Nor is the crucial measurement of costs an objective process: costs are also highly contestable figures and may result as much from the collusion or rivalries of firms as from any other actuality. Accrual (or corporate) accounting—the need to allocate revenues and expenses between accounting periods and to value assets and liabilities at the end of an accounting period—raises problems which have never been solved and are probably incapable of solution. Numbers can be negotiated to make management look good. In effect, ‘accounts are used to justify decisions and to excuse mistakes’.

She concludes

In an era of international capital, when our wealth is more than ever tied up in its fortunes, and at a time when corporations, governments and financial institutions are demonstrating their fallibility on a global scale, it is essential that we are aware of the somewhat arbitrary laws of account that govern them—especially because it is in the labyrinthine workings of our accounting systems that value itself is assigned. It seems that if we want to bring our infinitely voracious consumerism into line with the resources of our finite planet, we must consider giving our planet a value that the market can recognise and account for, assign a monetary value to the oceans, air, forests, rivers, wildernesses. • Delete this highlight

(My bold). In the end, we come back to the problem of economic value. There have been many major shifts in perception of costs and decisions and stocks and accountability and depreciation. Together, they make up the modern economy.

It is time for another major shift, to cope with intangibles and abundance and our reliance on those abundant stocks. Value should not be defined by arbitrary default.

 

Krugman, Robots and Redistribution

There's a lot of attention to this post by Paul Krugman on long-term growth.

And this means that in a sense we are moving toward something like my intelligent-robots world; many, many tasks are becoming machine-friendly. This in turn means that Gordon is probably wrong about diminishing returns to technology.

Ah, you ask, but what about the people? Very good question. Smart machines may make higher GDP possible, but also reduce the demand for people — including smart people. So we could be looking at a society that grows ever richer, but in which all the gains in wealth accrue to whoever owns the robots.

Perhaps at some stage there will be a deeper discussion of these issues. He says in a related column he will talk more about long-term growth in due course. But, he concedes, economists know very little about long-run prospects.

The great bulk of the economic commentary you read in the papers is focused on the short run: the effects of the “fiscal cliff” on U.S. recovery, the stresses on the euro, Japan’s latest attempt to break out of deflation. This focus is understandable, since one global depression can ruin your whole day. But our current travails will eventually end. What do we know about the prospects for long-run prosperity?

The answer is: less than we think.

The long-term projections produced by official agencies, like the Congressional Budget Office, generally make two big assumptions. One is that economic growth over the next few decades will resemble growth over the past few decades. In particular, productivity — the key driver of growth — is projected to rise at a rate not too different from its average growth since the 1970s. On the other side, however, these projections generally assume that income inequality, which soared over the past three decades, will increase only modestly looking forward.

It’s not hard to understand why agencies make these assumptions. Given how little we know about long-run growth, simply assuming that the future will resemble the past is a natural guess. On the other hand, if income inequality continues to soar, we’re looking at a dystopian, class-warfare future — not the kind of thing government agencies want to contemplate.

Yet this conventional wisdom is very likely to be wrong on one or both dimensions.

An additional problem is economics has very little understanding of the drivers of productivity. I don't know how many times senior officials have told me that it is a "residual of a residual" in quantitative terms.

 

Redistribution

We've looked at these issues before, such as here and here.

In particular, we looked at an excellent survey of technological developments here. Diamandis and Kotler conclude their book Abundance: The Future Is Better Than You Think with this:

Our problem is not that we don’t have enough stuff—it’s that we don’t have enough ways for people to work and prove that they deserve this stuff.

However, simply transferring money from "the rich" to the middle class or the poor is ultimately self-defeating. It undermines self-reliance and self-respect and the fact that living is more than just having stuff.

Redistribution is going to be the core issue in coming years - but even the word itself is tainted with leftist welfarism.

Instead, we need a better conception of how people earn a living, especially if the labor market is in trouble. And that means a better idea of value. And that entails some idea of the good life for people, instead of liberal neutrality whose whole point is to avoid any discussion of value.

Economics has deep difficulty with this, because value is primarily an ethical issue which is not reducible to models. Indeed, we saw recently economics as a discipline sidestepped the problem of value in the marginalist revolution by replacing it with a poorly conceived mathematical treatment of utility.

The whole apparatus of pareto-equality and welfare economics is flawed. Liberal ethics is flawed. Both lack any conception of human flourishing. Automatic equality of respect destroys any prospect of a better life, because it corrodes value. If everything is equal, there is no value.

 

The rotten state of economics

"Something (Everything) Rotten in the State of Macro" says Paul Krugman on his blog. You don't say.

He takes a swipe at freshwater economists, but in just the same way has a complete inability to see any problems or limits with his own views. The profession turned into a sneering cult of irrelevant models, and he was part of that.

 

"More Heat than Light": the failure of modern economics

I'm going to turn now to Philip Mirowski's More Heat than Light: Economics as Social Physics, Physics as Nature's Economics, which is a quite devastating critique of mainstream neoclassical economics.

The heart of modern economics, he argues persuasively, was lifted wholesale from physics in the late nineteenth century. The trouble was that the main figures of the marginalist revolution, such as Walras, Jevons and Marshall, didn't quite understand all the math they imported into political economy.

The neoclassical founders almost all came from an engineering or natural science background. But they had a limited grasp of the state of the art of physics even at the time. Above all, says Mirowski, they failed to understand the importance of conservation principles in the math. To accurately measure change, something must stay the same. That means most of the edifice of neoclassical economics is based on stale physics contaminated by basic errors.

 

Substance and fields

What happened was basically this. Natural scientists struggled in the early nineteenth century with ideas of heat and motion, imagining fluids or ethers or substances. By the 1870s, that had given way to a unified view centered on energy, and the conservation of energy as it was transformed from one kind to another. Instead of fluids or other kinds of substance, physicists now thought of fields and forces, and worked out the vector math of kinetic and potential energy.

The heart of neoclassical economics, says Mirowski, is that economists replaced energy with utility in the same equations, and lifted the framework wholesale. The marginalist revoluton paralled the revolution in physics in preceding decades. Classical economists saw Value as a substance, such as the equivalent of wheat for the physiocrats or the labor theory of value for Ricardo and Marx. But for neoclassicals, Value was a field, like electromagnetism in physics. Kinetic energy was essentially spending and income; potential energy was utility.

He quotes several of the major marginalists who explicitly acknowledged that this is how they thought. But later economists mostly forgot these origins. The discipline has never been that historically self-conscious.

There were two main problems with all this, however. First, without a conservation principle, the math didn't work. Conserving energy implied income and utility were a constant - so essentially the same thing. That would mean utility would be superfluous as a separate measure to money, which was not at all desirable. The point was often lost in a technical debate about "integrability". Leading physicists tried to explain the point to economists, who appeared to have been mostly baffled and nonplussed at the argument.

Secondly, physics moved on from its 1870-vintage "proto-energetics" state, as Mirowski termed it. The second law of thermodynamics implied entropy was always increasing, so interactions were not easily reversible. Special relativity, general relativity and quantum theory all upset the mechanical "Laplacian dream" of 1870s physics, bringing frames of reference, probability, indeterminacy and the role of the observer into the picture. Symmetries and conservation principles could be broken. Matter could decay. Particles could pop in and out of existence. In contrast to notions of inherent "scarcity", the whole universe might be a "free lunch", something which came from a temporary variation in nothing.

None of these could easily be incorporated into the neoclassical framework. However, economists insisted all the more stridently that they were pursuing disciplined science, in contrast to sociologists or anthropologists, while actual scientists were increasingly doing something quite different.

As long as the Laplacian Dream was their dream, they clutched neurotically at their portrait of persons as irrotational mental fields suffusing an independent commodity space, as science ebbed ever further away toward a world subject to change, diversity and indeterminacy, and at one with the observer. P275

And the outcome?

In brief, the practical dissolution of the energy concept in advanced twentieth-century physics has painted neoclassical economics into a corner. p388

Mirowski wrote the book in 1989. Of course, the metaphor of utility as (potential) energy looks even more strained today. We now know that the visible universe of 1870s physics is only 4% of the universe. The rest is dark matter and dark energy that we cannot as yet observe and don't understand.

So what? Some mainstream economists concede to his argument about the origin of the neoclassical model, notes Mirowski, but they claim it is not relevant to the subsequent evolution of the discipline.

But it is. They still want the appearance of science, while being stuck with a model which is increasingly divergent from science in reality, he claims. To talk about analogies to entropy, said Samuelson, for example, is always the mark of a crank. But Mirowski points out that Samuelson frequently published articles with tenuous links to physics himself. Indeed, the key to Samuelson's career was maintaining the appearance of scientism.

Economists have produced various ad-hoc conservation principles in the twentieth century, according to Mirowski, "but in the final analysis this is all one big shell game, with the offending conservation principles passed from one assumption to another." p274

 

Production

The metaphor of utility as an energy field is too embedded to be given up by neoclassical economics, he says The trouble is it is also a metaphor of instantaneous exchange, and as such it has proved consistently difficult to reconcile with production, which had been the focus of classical economics. Classical economics thought that value was created in production, circulated in trade, and consumed in consumption. Neoclassical economics was focused on exchange, and found it hard to explain production at all.

That inconsistency explains a proliferation of production functions in postwar economics, and difficulties with temporarily and the existence of firms through time.

Economists have effectively tried to reinvent a substance theory when it comes to production, says Mirowksi. But this is bound to be inconsistent with utility as a potential energy field. So the profession has not been able to settle on a satisfactory answer.

The situation was embarrassing, but no neoclassical was willing to come right out and say that production was superfluous or irrelevant in their scheme of things. (Lionel Robbins came the closest). p272

Scarcity

There are also implications for scarcity. The idea of scarcity as the heart of the economic (and human) condition was largely an artifact of the neoclassical approach, he says.

Prior to that time, scarcity as some sort of primordial state of mankind did not play any signficant role in the value theory of classical political economy. Only with the dominant impression that Nature enforced a general state of dearth, say, rather than the physiocratic notion of Nature's bounty, could it become possible to even think of economic equilbrium as a state of psychological counterpoise, hemmed in by the urgent necessity to clear markets in a state of stringent limitations. p240

This caused obvious problems.

The metaphor of utility as potential energy was predicated upon a Weltanschauung of a closed, bounded system that exemplified the natural state of mankind as enduring ineluctable scarcity. If and when production was to be introduced into this morality play, it had to be done in such a way as to prevent the contravention of the scarcity principle, all the while maintaining the field theory of value. p293

Of course, I think this is fascinating given I think one of our main challenges now is thinking through the implications of abundance.

Keynes, he says. succeeded in introducing a kind of value substance in the guise of "national income". That allowed the idea of an economic process to be reintroduced. There has been an immense effort in recent decades to link macro with rational choice "microfoundations." But this is doomed to failure, says Mirowski.

Keynes generated a theory of an unstable economic process by the instrumentality of his reversion to a substance theory of value, a tactic that allowed the joint conceptualization of production, growth and the passage of time in (relatively) internally consistent manner. In contrast, it is the avowed intention of the microfoundations school to renounce all value substances and to recast all macroeconomic analysis in the format of production and utility fields. It is precisely this choice that prohibits the logical modeling of process in priduction, in growth, and in exchange, as explained earlier in this chapter. The field metaphor cannot represent a circular economy where outputs become inputs and so on, ad infinitum. It cannot specify precisely what it is that grows in an economy. p346

Fields are just not suitable when time is involved.

.. the formalism of the field is useful only in cases where one can safely abstract away all considerations of process and the passage of time. p346

Utility

Mid-twentieth century neoclassical economics would have found an alternative to utility if it could, he says. The mainstream forgot how widespread concern about utility had become in the profession before the second world war. Mirowski quoted Viner as saying economists' understanding of utility was comparable to "the knowledge of heat prior to the discovery of the thermometer." It could not be satisfactorily measured. There had always been concern at how locating value in a purely mental framework came close to idealism or solipsism.

The development of the indifference curve approach and Samuelson's theory of revealed preference were not durable responses, either, and only served to obscure the origin of the utility metaphor. Revealed preference was not empirically tractable, for one thing, and confused preferences and behavior.

In the absence of the metaphor of utility as nineteenth-century potential energy, there is no alternative theory of value, no heuristic guide to research, no principle on which to base mathematical formalism, no causal invariant in the Meyersonian sense, and most threatneing, no basis for the claim that economics has finally become scientific. p368

So what does this lead to? There is, Mirowski says, no scientific method that can guarantee economics' scientific status.

This lesson is the legacy of the decline of positivist philosophies of science in the late twentieth century. Juxtapose this fact with the hypothesis that economic research has always met with the greatest difficulties in establishing the credibiliy of its results and fending off charges of charlatanism and quackery. p357

It is hard to revise the neoclassical framework without undermining it. New approaches do not have that problem. This means, he says, neoclassical economics will be vulnerable to new contenders for the role of social physics.

Theories of Value

And is there an alternative theory of value? Mirowski says there are two main alternatives. One is to deny any separate value, rarely advocated, but as represented by someone called Samuel Bailey (who I have never heard of).

This position argues that no economic phenomenon is conserved through time, and therefore scientific analysis is impossible. Whatever one might think of the truth of this option, it should be clear than the nihilism inherent in the program assures that in this instance there can be no legitimate research program called economics. p400

The other alternative is a "social theory of value", he says, based not on scientific or social metaphors , but in social institutions such as accounting conventions or property rights.

I doubt myself whether this is true. I imagine evolution is the main contender for an alternative scientifc framework, together with the notion of adaptability and "fitness" of some kind or another.

Conclusions

Overall, it is a very bracing read. It seems, at least to me, highly persuasive - but I would want to read some reviews and responses to make sure I am not overlooking flaws in Mirowski's own analysis. .

What it underlines is that utility and scarcity were chosen not so much because of their psychological or social accuracy, but because the math "worked". And if the math worked there was more scientific respectability. I have always had the firm impression that this was the driving force of major parts of the discipline, which is likely the main reason I did not become an academic economist. It did not ring true. It was about the aesthetics of models rather than genuine insight. It was about a particular quasi-religious view of rationality rather than solving problems.

The book is also highly illuminating , not to say shocking, about the origins of utility in modern economics. I've often talked before about how ethical theory went off the rails in the eighteenth and nineteenth centuries, dropping the older tradition of the virtues and the good life for a more utilitarian, neutral and welfarist approach. Mirowski excavates a much deeper layer of intellectual history underlying current economics. It was not a matter of an import from Bentham. It was an import from physics, and just more or less happened to be called utility.

The metaphor of potential energy as a utility field locked economics into an increasingly less productive path for a century - and to a large extent still does. I knew most of the arguments about indifference curves, production functions and revealed preference, of course, but I was much less familiar with the intellectual history of the arguments. It is fascinating. And disturbing.


Perhaps most of all, it shows how value theory is the great unsolved problem at the heart of economics. That is what I have been grasping toward in my own terms on this blog. To understand the future of the economy , we have to be back up into ethics and the question of the good life and human flourishing. That, after all, is the only place a valid notion of value can come from.

 

Shaking the British Establishment

It's interesting that Canadian Mark Carney has been appointed Governor of the Bank of England. Carney is very able. But it is a huge blow to BoE insiders like Paul Tucker, who had spent twenty-five years specifically working very are to get the top job someday.

Interestingly, it is a sign of much deeper disarray and loss of confidence in the British economic establishment. From the Guardian:

Rachel Lomax is practically the definition of establishment: Cheltenham Ladies' College followed by Cambridge and the LSE; principal private secretary to then-chancellor Nigel Lawson; deputy governor of the Bank of England for five years until 2008. Which makes what she said on Friday evening all the more startling.

This being a debate on the future of capitalism in the People's Republic of Bristol, the audience were satisfyingly radical – but Lomax was just as bluntly and disarmingly political. The former Treasury mandarin made no bones about admitting that she had been part of a project of "dismantling a version of capitalism" and replacing it with "Anglo-American neo-liberalism". You'd struggle to get scholars of Thatcherism to speak with such straightforwardness, but here it was coming from one of the era's key backroom players.

And now this co-architect of Britain's economic model as good as admitted that the system she had helped create was broken. But Lomax had one question: "Where is the revolutionary thinking?"

You surely couldn't ask for a better measure of the economic mess we're in, that even members of the establishment are now calling for revolution.

Striking as it is, such despair isn't exceptional. Indeed, it now appears endemic among the policy-making elite. Whether you look at Westminster or Threadneedle Street, Britain's economic officials reek of policy fatigue – of having riffled through all the pages in their textbooks without getting a good answer.

That also exists here in the US.

 

Futility and stock-picking

Active managers have had another bad year, says CNBC. Traditional stock-picking and bottom-up analysis doesn't work any more.

 

Just as in 2011, only about 1 in 5 active managers are beating their benchmarks in a year marked by the same type of headline volatility caused by events in Europe and fiscal concerns closer to home.

While the advantage of passive over active is nothing new, the near-record level of futility is, and the cracks are beginning to show.

[...]

"The market is being driven by macro factors," Flam said. "So most professional advisors have a background in evaluating companies, industries, economies. It's not in politics, and politics is what dominating the markets over the last couple of years."

Political factors are about decisions and perception, not ratios.

Aristotle: Virtue and Happiness

I'm going to conclude a series of posts about Aristotle's The Politics , which start here.


He warns again against simply doling out surplus, as in a welfare state - which apparently happened at the time, and notoriously so later in antiquity in the form of Roman bread and circuses.

On the other hand if revenues are available, one should not do what popular leaders today do - make a free distribution of the surplus. (When people get it, they want the same again: this sort of assistance to the poor is like the proverbial jug with a hole in it.) .. Every effort therefore must be made to perpetuate prosperity. And since that is to the advantage of the rich as well as the poor, all that accrues from the revenues should be collected into a single fund and distributed in block grants to those in need, if possible in lump sums large enough for the acquisition of a small piece of land, but if not, enough to start a business, or work in agriculture. p375

Independence is preferable to simply handing out revenues, he thinks. It is a timeless thought. Often we think we are the first generation to confront a problem, or we are wonderfully modern and sophisticated. But it is just as often because we don't know how often it has been confronted in the past. We forget lessons which were already manifest in 350 B.C.

 

A constitution needs a view of the most desirable life

However, he comes back to his main point. We have to know what the good life is to design political institutions to achieve it.

If we wish to investigate the best constitution appropriately, we must first decide what is the most desirable life; for if we do not know that, then the best constitution is also bound to elude us. p391

He believes that virtue is the precursor to prosperity and happiness.

Thus people suppose that it is sufficient to have a certain amount of virtue; but they set no limit to the pursuit of wealth, power , prosperty, reputation and the like. {But} it is not by means of external goods that men acquire and keep the virtues, but the other way around; and to live happily, whether men suppose it to consist in enjoyment or in virtue or in both, does in fact accrue more to those who are outstandingly well-equipped in character and intellect, and only moderately so in the possesion of externally-acquired goods. p392

Of course, one of the more difficult issues in life is that sometimes character and virtue are not rewarded, of course. Time and chance happen to everyone. But it is still probable that as a rule people who are prudent and temperate and courageous and honest will do better. Parents generally teach their children to be honest rather than lie, after all. And living happily has only a tenuous connection with wealth and material goods beyond a certain threshold, as we know from the Easterlin paradox.

So Aristotle may overstate the point when he says

Let this then be agreed upon at the start: to each man there comes just so much happiness as he has of virtue and of practical wisdom, and performs actions dependent thereon. p392

But we would like it to be true. And in the long run, on average, it probably is true - and, like Pascal's bet, it is probably better to act as if we believe it is true.

 

Defining the Good Life

So what's the good life, or the best life? Not asceticism or denial or honor/shame or material success.

For the present, let this be our fundamental basis: the life which is best for men, both separately, as individuals, and in the mass, as states, is the life which has virtue sufficiently supported by material resources to facilitate participation in the actions that virtue calls for. p393

Although this is open to all, some avenues attract the most ambitious.

Both in earlier and in modern times men most ambitious for virtue seem generally to have preferred these two kinds of life, the statesman's or the philosopher's. p395

We have to have some purpose, or target.

The well-being of all men depends on two things; one is the right choice of target, of the end to which actions should tend, the other lies in finding the actions that lead to that end. p427

Aristotle is very teleological, of course. I often complain about liberal neutrality. But there is a liberal teleological tradition as well, and a leftist one stemming from Marx and Hegel. The problem is the good life they aim at is a vague abstract equality without much substance.

I would add another element. We need a choice of target, if nothing else because the economy and society naturally evolve regardless of whether we choose to perceive it. We can and ought to at least choose the fitness and selection criteria for the kind of change we experience.

So was it worth looking in such detail at a classic work, from a world in which a trireme or a horsecart was high technology? Yes. While looking up the Easterlin reference above, I came across this previous quote from Deirdre McCloskey in this blog post:

The great economist Simon Kuznets, notes his student Richard Easterlin, believed that "the `givens' of economics- technology, tastes, and institutions- are the key actors in historical change, and hence most economic theory has, at best, only limited relevance to understanding long-term change.

The technology has changed since Aristotle's day, of course. But tastes and institutions are still the key actors which we need to understand in a much less superficial way than our own parochial view allows.

And that is why stepping far outside our own parochial view , right back to first principles at the origin of many of our conceptions about ethics and politics, can give us a fresh perspective on our current challenges.

Aristotle: Citizenship and Constitutions

We're talking about Aristotle's The Politics , starting here, because it's useful to go back to first principles and get a long view of our political and economic problems.

Citizenship

One matter which has attracted attention in social democratic circles in the last few years is the notion of citizenship. (I have a recollection of a long discussion in David Held's Models of Democracy, but haven't read it in a while.)

In general, however, our conception of citizenship is now very confused and unclear. It mostly tends towards simply residence, or miminal civic inclusion, rather than any common ethnicity or values or beliefs. Multiculturalism has become the ideal on the left, as well as sectional rather than national identity. We have had an immense shift in the last fifty years from ideas of national self-determination and decolonization to purely civic membership, with no obligations except to obey the law and pay taxes.

Aristotle ( who spent much of his life as a foreign resident in Athens) is adamant that citizenship is not just residence. Instead,

What effectively distinguhes the citizen proper from all others is his participation in giving judgment and in holding office. p169

A citizen must be capable of meaningfully participating in deliberation. So is the good man and the good citizen the same thing? Not quite. For one thing, it will depend on the kind of consitution a citizen lives under.

Not that good ruling and good obedience are the same virtue - only that the good citizen must have the knowledge and ability both to rule and to be ruled. That is what we mean by the virtue of a citizen - understanding the governing of free men from both points of view. p182

You cannot, on this perspective , really be a citizen by simply asserting rights or claims against the whole, rather than also seeing the perspective of those who must meet those rights and claims and comsequences.

And the virtue of the ruler and the citizen are not the same. The virtue of the ruler is mostly practical wisdom, or phronesis, which is neither theoretical nor technocratic, but skilled ability to judge particular situations. The virtues of the private citizen are wider.

Strikingly from our perspective, as a rule he also believed anyone who works as skilled craftsman or works for wages for others cannot be a citizen...

for it is quite impossible, while living the life of a mechanic or hireling, to occupy oneself as virtue demands. p184

That perhaps vanished as a sensible view with the increased scale of organizations with the industrial revolution. But the notion that one must have time and energy to reflect still stands, perhaps.

The common good

He then separates good from bad constitutions. The notion of a good constitution is very clear:

It is clear that those constitutions which aim at the common good are right, as being in accord with absolute justice; while those which aim only at the good of the rulers are wrong. p189

Looking to simpy private advantage, "be it of the one or the few or the mass" is a deviation, when the interests of one section of the community take precedence over the others.

This has contemporary relevance as well. Seeing politics as simply a matter of demographics, of sectional interest and redistribution and faction, obscures and denies the common good. I think this is where the Democrats, as a coalition of minority and special interest groups, usually go wrong, and where the GOP is joining them with its increasingly libertarian tone. Assembling enough sectional coalition elements to get to 50.1% is not the same as advocating for a view of the common good.

It also prefigures much contemporary analysis, such as the notion of "inclusion" in Why Nations Fail. Small groups often focus on dividing a small collective pie to their own advantage, instead of making the pie bigger.


Of course, there can be different views of the common good. But you need some conception of the good. And you need to go beyond the shallow Pareto optimality of welfare economics to have any real insight into the common good. We will come back to this later.

So Aristotle distinguishes six kinds of rule: monarchy, and its deviant twin tyranny; aristocracy (in the old sense of rule by the aristoi, or the best and most virtuous men, not traditional European landed upper classes) and its deviation, oligarchy, typically the rule of the few or the wealthy; and polity, which is "political control exercised by the mass of the populace in the common interest" versus its somewhat deviant twin, democracy, which is rule only "for the benefit of the men without means." , ie the poor. p190

 

Expert Judgement

Although he is against giving power to those with little or no time to reflect or use their reason, he is nonethless very supportive of wider participation. Almost 2300 years before the rise of the middle classes in Europe, Aristotle emphasizes wide deliberation and the importance of the middle sort. For one thing, a wider group often makes better decisions.

For it is possible that the many, no one of whom taken singly is a sound man, may yet, taken all together, be better than the few, not individually but collectively, in the same way that a feast to which all contribute is better than one supplied at one man's expense. p202

Interestingly, this is a little different from 'many chefs spoil the broth' or the cult of leadership. This too prefigures what we find today, such as the greater accuracy of aggregate economic forecasts that we were looking at the other day.

He has a dietary analogy: it is actually preferable to include "rougher" classes in discussion with the powerful:

By thus mixing with the better sort, they render good service in their states, in something like the way that a combination of coarse foods with refined renders the whole diet more nutrtious than a small amount of the latter. p204

So, says Aristotle, democracy is "the most moderate of the deviations" p239. And polity, the ideal, " is a mixture of oligarchy and democracy." p259

Similar comsiderations apply to experts, according to this author who spent twenty years in the original Academy. There are some things in which they should be judged by their peers. But in others, users are much better judges than expert producers.

.. that provided the mass of the people is not too slave-like, each indiviudal will indeed be a worse judge than the experts, but collectively they will be better, or at any rate no worse. Secondly, there are tasks of which the actual doer will be neither the best nor the only judge, cases in which even those who do not posses the skill form an opinion on the fnished product. .. So too the user of a rudder , the helmsman, is a better judge of it than the carpenters who made itl and it is the diner not the cook that pronounces upon the merits of a dinner. p205

This reminds me of William F. Buckley's assertion that "I'd rather entrust the government of the United States to the first 400 people listed in the Boston telephone directory than to the faculty of Harvard University ."

Expert judgement has its limits, according to one of the first experts.

 

Aristotle: Household, Wealth, Common Property

We're talking about Aristotle's The Politics , starting here.

The household

The first few chapters, on the household, do seem like a relic of a distant 350 BC, and are best hurried through. It is hard to relate to the small farms or city households of ancient Athens or the Troad. This household management, oikonomia , is however the origin of the term "economic."

Most objectionately to modern readers, he believes some people lack the capacity for deliberative reason, so that they are slaves by nature ( although ancient slavery was not racially based). He also takes for granted strict division between the sexes. The head of the household must have moral virtue in its entirety; others, such as women, children, and slaves, in lesser degree.

He was perhaps more enlightened than many of his time , but he was of his time. He took for granted that, as a matter of practical necessity, some had to labor, not least because they were not suited to do anything else.

Of course, for us automation has removed much of the raw mechanical labor from life, although the economy still has an insatiable appetite for cheap labor in many agricultural and service industries. And we more optimistic about people's capacity for reason (although sometimes I wonder, if you see any episode of Access Hollywood or other celebrity glop).

What he says also entails one expects much more from the free, independent head of household in moral terms than children or servants or dependents. We still believe that of children, of course. Perhaps the capacity for moral virtue differs, and that is something we set aside in contemporary debate.

Wealth

He talks about the acquisition of property, and the definition of wealth. Wealth, properly thought of, is a tool:

Solon in one of his poems said "no bound is set on riches for men." But there is a limit, as in the other skills; for none of them have any tools which are unlimited in size or number, and wealth is a collection of tools for use in the administration of a household or state. (P 79 in the Penguin edition).

Of course, one can acquire goods without limit, but the function of the household is to use them.

The reason why some people get this notion into their heads may be that they are eager for life but not the good life; so, desire for life being unlimited, they desire an unlimited amount of what enables life to go on. Others again, while aiming at the good life, seek what is conducive to the pleasures of the body. So, as this too appears to depend on the possession of property, their whole activity centers to business. For where enjoyment consists in excess, men look for that skill which produces the excess that is enjoyed. (p85)

This of course is still a live political issue - is there a point where we have enough? How much is enough? (the title of a book I looked out a few weeks ago). It is also very much linked to questions of environmentalism. There is a very old tradition which sees the answer to human happiness not in prosperity and abundance but in limiting human desires. That ancient ascetic creed can surface today in those who want us to abandon growth and return to a significantly simpler lifestyle.

I think the answer is it is almost impossible to define what "enough" is, or what wealth itself is, without some conception of the good life and flourishing. Seeing wealth primarily as a tool for particular purposes, something to use and activate, rather than a pile of gold or financial assets is productive. It can be hard to transform financial assets into a flourishing, happy, secure life, as many celebrity divorcees or high-profile occupational burnouts know.

Aristotle also somewhat disapproves of trade and charging interest, "since it arises not from nature but from men's gaining from each other", views which were to still resonate late into the modern period, and underpinned nobility looking down on the merchant classes. We have seen this before, (including a quote from the Politics) in the deep suspicion of many religious and philosophical traditions of the institution of money.

But pragmatist that he is, he can have a shrewd appreciation of business. Thales of Miletus, he says, was criticized for making little money from philosophy. So one year he cornered the olive oil presses on his island just before a good harvest.

He made a lot of money, and so demonstrated that it is easy for philosophers to become rich, if they want to; but that is not their object in life. .. the principle can be applied more generally: the way to make money is to get, if you can, monopoly for yourself. (P90).

And that is also why we have to be very careful of monopolies and businsss restrictions and regulation sometimes.

It is also an illustration of how most ideas in the humanities and social sciences are rediscoveries or permutations of much older themes. Michael Porter would advise the way to profitability is to build barriers to entry (Competitive Strategy: Techniques for Analyzing Industries and Competitors). Warren Buffett looks for businesses with a "moat."

Against common property

Aristotle then turns to the state and comparative politics, looking at a number of constitutions including Athens, Sparta, Crete and Carthage.

He has a modern skepticism for Plato's notion of communal ownership or modern socialist property, not to mention sharing wives and children:

The greater the number of owners, the less respect for common property. People are much more careful of their personal possessions than of those owned communally; they exercise care over common property only insofar as they are personally affected. Other reasons apart, the thought that someone else is looking after it tends to make them careless of it. P108

That is also true for organizations, which is why assigning responsibility and accountability is often so important.

What was later called "to each according to his needs" is also met with skepticism by Aristotle.

For if the work done and the benefits accrued are equal, well and good; but if not, there will inevitably be ill-feeling between those who get a good income without doing much work and those who work harder but get no corresponding extra benefit. To live together and share in any human concern is hard enough to achieve at the best of times, and such a state of affairs makes it doubly hard. P114

This has a very contemporary ring about it, no doubt because it is such a timeless human response. So common ownership of property has inherent difficulties. At least, he says, existing laws are strengthened by familiarity.

Far better is the present system - provided that it has the added attraction of being a matter of habit and of being controlled by sound laws.

Even if you could fix a level of common possessions, and achieve absolute material equality,

to fix a moderate amount for all, that would still be no use: for it is more necessary to equalize appetites than possesions, and that can only be done by adequate education under the laws. ... And civil strife is caused by inequality in distinctions no less than inequality in property, though for opposite reasons on each side; that is to say, the many are incensed by the inequality in property, whereas more accomplished people are incensed if honors are shared equally, for then, as the tag has it, 'good and bad are held in equal esteem. p129

This is very important for my interests, as an obvious response to economic abundance is some kind of minimum or basic income. It is an essential illustration of the issues which surround distribution more generally.

The matter of equal esteem and distinctions is also important. It suggests the difficulties of those small slivers of society which have actually achieved abundance in the past. The behavior of aristocracies (or as Aristotle would more likely say, oligarchies) is highly instructive. When landed estates mean they have no immediate material needs, the result has often been a focus on rank and status and courtier affectation, not a higher form of achievement or freedom.

It also is clear that many of our contemporary political issues are claims or conflicts about equality of esteem, more than economic equality.

Moreoever,

Secondly, the depravity of mankind is an insatiable thing. At first they are content with a dole of a mere two obols, then, when that is traditional, they go on asking for more and their demands become unlimited. For there is no natural limit to wants and most people spend their lives trying to satisfy them. p131

Such is the fate of the welfare state as it develops toward fiscal catastrophe, perhaps. And it is a general warning about the complications and difficulties of redistributing wealth.

In general, he is concerned with the immediate psychology of how people will see things and behave in practice, rather than ultimate principle, which is why it is useful wisdom.

We of course instinctively see how what he says helps explain why the USSR and other communist states got into trouble. But it is also a warning against some of our own practices, though that may be harder to see.

 

Change

He is very conservative with a small c.

.. it is clear that there are some occasions which call for change and that there are some laws that need to be changed. But looking at it in another way we must say that there will be need of the very greatest caution. ..A man will receive less benefit from changing a law than damage from becoming accustomed to disobeying authority. .. The law has no power to secure obedience save the power of habit, and that takes a long time to become effective. Hence easy change from established laws to new laws means weakening the power of the law. p138-9

Habituation is a major theme in his ethical approach. There can be significant downside to basing institutions and expectations on the thin and fragile ground of rational choice alone.

What should reformers take from that? Not that reform or major change is impossible, or ought not to be attempted. But that you have to be aware of the practical difficulties and downsides, and do something to avoid or confront or control them. As I said before the election, the left's dreams often turn into darkness , because they look at one shining principle at the expense of daily reality and psychology.

Progress should be measured not by intentions but by actual flourishing lives.

Of course, seeing this as wry, shrewd advice depends on assuming that some elements of human nature are constant, and the human predicament has some timeless elements that unite us with someone who lived so long ago. In international relations, there has been a long debate over Thucydides, and whether his similar observations of power politics and war and history in Ancient Greece (The History of the Peloponnesian War) still have application today.  

I would say that we do advance a little in social understanding over time. But not as much as we think.

I'll look at more tomorrow.


 

 

Aristotle and the beginning of the Western tradition

With the election still reverberating in the air, it's a good time to get some longer perspective. I read Aristotle's The Politics (Classics) a few weeks so, but haven't talked about it yet. It is going to take at least a week to go through all the ramifications of this book.

Why read something two thousand years old?

Let me explain first of all how I was led to this. I started off this blog asking what had gone wrong with the economy. The answer, as I've gradually come to think, is we have a set of institutions and practices which are designed for scarcity, the oldest problem of mankind. But the basic things of life are now superabundant, at least in the West. We have more material stuff than we know what to do with. Our problem is not starvation, but obesity.

So we have solved the "economic problem", as Keynes called it. As we become more and more efficient and productive, the amount of labor devoted to the exchange economy - services as well as manufacturing - is plunging, just as agriculural employment did before in the nineteenth century. The economy is sputtering as a result.

Mainstream economists are confident that demand will simply shift to newer goods and services. But the nature of our wants and preferences are changing. Most mainstream economists are oblivious to this, because they take tastes and preferences as exogenous. The discipline ignores changing preferences by definition. It is a profound blind spot.

Many of the other things we want in life are changing, as we ascend what Maslow called the hierarchy of needs. The issue is that the things we increasingly want more of are not easily packaged and sold as excluable, non-rivalrous goods and services. They are not as suited to be as easily sold in the market, or delivered by the welfare state. It is difficult to establish clear property rights. (Ask the music or newspaper industries). Alternatively, as technology advances, the marginal cost of so many new goods and services is so low that (as in Facebook, or Google, or Flickr, or other paragons of the new economy) it is easier to give them away to the consumer.

Most of the value in the economy is now intangible, but we have been slow to catch up with the consequences. Mainstream economists are wrong to assume that new jobs will always be created to replace old ones, even though that has been true for the last two centuries.

I have become frustrated with our general lack of answers for what we do with the economy once many of the things we want are not material or easily tradable - such as connection, enjoyment, security, love and relationships, meaning and purpose. These are the things we turn to once we have enough shelter and food and security.

In other words, we need to take a much deeper look at what makes people flourish; not just what simply ensures survival, because flourishing has to be the objective of the economy from now on. And that means it is sensible to take a step back and look at long-run answers to this question, and older conceptions of human nature.

This is all the more important because most of our political theory has ignored this question for two hundred years, as the idea of ends or the "good life" have been sidelined. Liberal political theory - and I mean here liberal in the broad sense, which covers most of the current political spectrum - has as a matter of conscious intention no sense of what flourishing means or what our ends should be. Instead, it asks how people can minimally coexist together in a largely neutral state. In other words, it focuses almost entirely on the referee rather than asking what game we are playing, and what our goals are.

So, among other things, I was riveted by this book : After Virtue, by Alisdair McIntyre. He argues our ethical theory has become incoherent because we lost the much older tradition in the West, dating back to Aristotle, which is based on the virtues. That tradition places much more emphasis on character and judgement than impartiality, and it seeks the "golden mean" and ways to avoid excess rather than universal rules.

I read Aristolte's Nicomachean Ethics. There has also been a revival of interest in virtue ethics in contemporary philosophical circles. It has even reached some brave mavericks in the economics profession, such as Deirdre McCloskey's magnificent books.

I think many of our most intractable current political disputes arise because we argue over distribution without any reference to the virtues or actual flourishing. The left thinks equal distribution is enough. The right tends to want some standards of behavior or work ethic, but finds it hard to articulate this in liberal or libertarian terms. So it falls back on "the market". Our basic economic and political issue is what "fairness" means.

The Politics

This is why I wanted to read Aristotle's other major book, The Politics. Right at the dawn of the western tradition, he discusses what a society focused on virtue and flourishing and the Good Life ought to look like in practice. Part of the fascination is he is, of course, one of the foundational thinkers of the West, one of the most brilliant thinkers who ever lived. As an educator, he profoundly influenced the next two thousand years of history, including the Islamic world via Avicenna and the medieval Chirstian world via Aquinas. In practical terms, he tutored the most brilliantly successful conqueror in history, Alexander the Great, as well, so he is not simply an ivory-tower theoretical hermot. He taught in post-democratic Athens, but was eventually forced to flee by the mob who were hostile to Macedonian non-citizens like himself.

So we have a pragmatic voice of wisdom from a world which had grappled with many of our issues of freedom, leisure and democracy, but which is absolutely disintersted about our own political divisions. Aristotle lived two millenia before America was even discovered.

We will start off with what he says about household management, oikonomia - the origins of our word for economics.

 

Rationality and Sustainability

I happened to come across an earlier discussion on this blog as I was talking about "data-driven rationality" and consistency the other day.We looked at Nobel Laureate in Economics Amartya Sen.

He says:

Rationality of choice.. Is primarily a matter of basing our choices - explicitly or by implication - on reasoning we can reflectively sustain if we subject them to critical scrutiny. (p179-180)

That is a much better way to look at things than narrow internal homo economicus consistency. Instead, there ought to be some reflection and an ability to sustain an argument against external argument.

 

Prediction and Bayesian testing

I still have a little more to say about Nate Silver's The Signal and the Noise: Why So Many Predictions Fail-but Some Don't, which I have been looking at starting here.

I argued in this post the other day that what we need for predictive success is not so much big data as self-awareness. Hypothesis testing ought to help us revise our point of view.

Silver rightly emphasizes prediction is largely a means to an end:

The philosophy of this book is that prediction is as much a means as an end. Prediction serves a very central role in hypothesis testing, for instance, and therefore in all of science.As the statistician George E. P. Box wrote, “All models are wrong, but some models are useful.” What he meant by that is that all models are simplifications of the universe, as they must necessarily be. As another mathematician said, “The best model of a cat is a cat.”Everything else is leaving out some sort of detail. How pertinent that detail might be will depend on exactly what problem we’re trying to solve and on how precise an answer we require.

I keep talking about the importance of purpose, for example here about the difference between maps and models.

The potential pitfalls mean we have to know ourselves, says Silver:

This is why it is so crucial to develop a better understanding of ourselves, and the way we distort and interpret the signals we receive, if we want to make better predictions.

Frequentism

However, much recent statistics has run well and truly off the rails by assuming that error arises from our measurements rather than our perception or judgement. Silver criticizes simple-minded statistical "frequentism", which he says mostly stems from nineteenth century English statistician Ronald Fisher.

The idea behind frequentism is that uncertainty in a statistical problem results exclusively from collecting data among just a sample of the population rather than the whole population.

The idea is you can act as if you can repeat an experiment innumerable times. The more random experiments you do, the more accurate the outcome.

Essentially, the frequentist approach toward statistics seeks to wash its hands of the reason that predictions most often go wrong: human error. It views uncertainty as something intrinsic to the experiment rather than something intrinsic to our ability to understand the real world. The frequentist method also implies that, as you collect more data, your error will eventually approach zero: this will be both necessary and sufficient to solve any problems. Many of the more problematic areas of prediction in this book come from fields in which useful data is sparse, and it is indeed usually valuable to collect more of it. However, it is hardly a golden road to statistical perfection if you are not using it in a sensible way. As Ioannidis noted, the era of Big Data only seems to be worsening the problems of false positive findings in the research literature.

 

Frequentism dominated statistics in the twentieth century. Fisher criticized Bayesian statistics (which we will come to in a moment) for beng insufficiently objective. But, says Silver,

Nor is the frequentist method particularly objective, either in theory or in practice. Instead, it relies on a whole host of assumptions. It usually presumes that the underlying uncertainty in a measurement follows a bell-curve or normal distribution. This is often a good assumption, but not in the case of something like the variation in the stock market. The frequentist approach requires defining a sample population, something that is straightforward in the case of a political poll but which is largely arbitrary in many other practical applications. What “sample population” was the September 11 attack drawn from? The bigger problem, however, is that the frequentist methods—in striving for immaculate statistical procedures that can’t be contaminated by the researcher’s bias—keep him hermetically sealed off from the real world. These methods discourage the researcher from considering the underlying context or plausibility of his hypothesis, something that the Bayesian method demands in the form of a prior probability. Thus, you will see apparently serious papers published on how toads can predict earthquakes, or how big-box stores like Target beget racial hate groups,which apply frequentist tests to produce “statistically significant” (but manifestly ridiculous) findings.

Plenty of investors have lost their shirts by having risk models which assume that market events follow a neat normal ( or similar ) distribution.

Bayesian Probability

Instead, Silver strongly advocates the older Bayesian statistics. In essence, one must specify a prior probability of an outcome , based on one's current beliefs. Bayes' formula then specifies how you should alter that probability in response to incoming data and events, which produces a posterior probability. It is about recognizing your current expectations and beliefs, amd learning from new evidence.

The Bayesian viewpoint, instead, regards rationality as a probabilistic matter. In essence, Bayes and Price are telling Hume, don’t blame nature because you are too daft to understand it: if you step out of your skeptical shell and make some predictions about its behavior, perhaps you will get a little closer to the truth.

We took a step backwards when frequentism arose.

As we will see, science may have stumbled later when a different statistical paradigm, which deemphasized the role of prediction and tried to recast uncertainty as resulting from the errors of our measurements rather than the imperfections in our judgments, came to dominate in the twentieth century.

For me, the point about Bayesian probability ( which I haven't ever used professionally) is not so much the math but a procedure which requires you to test and revise your beliefs in response to evidence. I think Silver overdoes Bayesian probability as THE answer, but his main target in his own intellectual world is likely very much the frequentists. He is a statistician. So we can understand his emphasis on an alternative statistical tradition.

Incidentally, I am no statistician, but I have been intrigued in the past by Keynes' arguments in his A Treatise on Probability (Classic Reprint), but I'll leave that for another time.