Archive for January, 2012

On the ideal/non-ideal distinction in political theory (or, why policy is really hard)

January 21, 2012 4 comments

Something I’ve been meaning to talk about for a while is the ‘ideal/non-ideal’ distinction in political theory. A lot of ink has been spilled on exactly what the distinction is or should be, and up front I will say I haven’t read most of it (I really hope to soon get round to reading my former political theory tutor Lea Ypi‘s new book ‘Global Justice and Avant-Garde Political Agency‘, which has a discussion on the topic. Lea, if I screw this post up in some horribly obvious way – I’m sorry!). But the gist (I think) of the distinction is this: when doing ideal theory, we are thinking about what the perfectly just world would look like. When doing non-ideal theory, we are thinking about what justice demands of us in the imperfect world in which we actually live.

One way of thinking about what we are doing in political theory is that we establish what the ideal is (ideal theory), and then figure out how to make the actual world look as much like the ideal world as possible (non-ideal theory). I have a problem with this way of thinking about political philosophy. And it’s essentially the same problem I have with economic theories that are deduced from assumptions that are unrealistic, and whose conclusions are not backed up through some other methodology. The Lipsey-Lancaster Theorem ( or ‘Theory of Second Best‘) in economics states that when one of the optimality conditions for a theory cannot be satisfied, it does not follow that the that other optimality conditions still hold. That is to say, if your proof that x is optimal requires y and z, and y does not hold, it is not necessarily the case that the best alternative to x has z as an optimality condition. When I first read the paper, by Richard Lipsey and Kelvin Lancaster, my mind was blown. But it’s just a particular instance of a very general phenomenon: that when you have a deductive  argument following from certain premises, and then weaken one of the premises – all bets are off. It may be the case that a weakened premise can still support a weakened conclusion, but it’s equally possible that nothing follows at all.

I think this relates directly to the ideal/non-ideal theory question, because once you have weakened one of your assumptions about , say, what people are actually like (or especially what people can know, which is almost always ignored) then it just doesn’t follow that moving the world towards something more closely approximating the just world (as derived from ideal premises) is actually what justice demands of us. I take this to be a simple point of logic.

I think this can make the question of advocacy really difficult. If there is anything I have ever learned, it is that often an ‘answer’ to a problem requires a number of distinct elements in order to work. Once you take one of those elements away from me, I have to completely rethink what the right answer is (I find this to be especially true when thinking about financial regulation). If my ‘ideal’ answer would be a world featuring x, y and z, and I can’t have z, it simply doesn’t follow that I should still want x and y. X and y might be a deadly combination on their own! (For example, read x as ‘capital requirements for banks based on risk-weighted assets’, y as ‘having ratings agencies assess the riskiness of assets for regulatory purposes’ and z as ‘competition and competence in the ratings agency business’. We didn’t have z, and it worked out really badly). This means that people can so easily end up talking past each other, because they have different implicit assumptions as to what possibilities are allowed within the particular ‘non-ideal’ rules of the debate.

Of course, too often I use this as an excuse to be lazy about advocacy. I definitely have a tendency to go too far in the sceptical direction, and just throw my hands up in the air and say I have no idea what to do (although when it comes to effectively relieving deprivation, I generally trust GiveWell). But maybe I see difficulty where there is none. If that is the case, I would very much like to know.

Categories: Philosophy, Policy

Do I deserve my salary? (and how to read my blog)

January 21, 2012 1 comment

Given the balance of the things I write about, I get the feeling that people probably think I’m pretty conservative. I write quite a lot about taxation, the inability of the government to ‘stimulate’ the economy through spending and the fact that states are by nature coercive. And while I have become more conservative in the last 2-3 years, it is at the margin. Now, it just so happens that this is also the stuff that I find really interesting and I just feel like I have more things to say about it. It’s also the case that the standard of argument around these topics is extremely high in the blogs I read, and it’s more fun to get involved in that rather than amateur political philosophy (and Matt Yglesias has pretty much has that angle covered, with appropriate snarkiness).

But I have a whole set of prior beliefs than I haven’t written about nearly as much, but that massively inform my political thinking. For example, I think there are incredibly compelling arguments to the effect that I owe the relative level of my income to factors way beyond my control. Imagine tomorrow everyone woke up and loads more people were good at consulting and not many people at all were good at flipping burgers. Prediction: my salary goes way down, fast food worker’s salaries go way up. My salary is a function of the supply of people offering my skillset, and the demand by other people for those skills. And whatever you think about free will etc., I certainly don’t control other people’s desires or skillsets. I’m but a tiny cog in a massive machine called ‘the labour market’.

That kind of thinking makes me pretty egalitarian. And if total redistribution of income was totally costless, I’d be pretty inclined towards it. But it very much isn’t costless, and I think it would have appalling practical consequences. If human beings were perfectly charitable and unselfish, then it would be fine. But we aren’t. We value ourselves over others. We get greedy when we get power, and massive income redistribution through the government creates a massive concentration of power. We always, always need to be thinking about what will in fact happen if we try and change something.

And this is why I write about the things I do. Because I think people don’t really understand the consequences of policy – and even if they happen to be right, they are almost certainly way too sure about it. The fact that we probably understate the effective tax rate as a percentage of their income for people with savings* doesn’t remotely mean (if correct) that the capital gains tax rate should be zero, or even less than it is now. But it probably does mean that you should have a weaker preference for the tax at the margin. I want you to update your beliefs to reflect new information. Where you end up at depends on where you started (FWIW, I started out thinking they should be taxed the same. I now think it is appropriate that cap gains rates should be lower than income tax rates).

One of the best books I’ve read in the last year is Selfish Reasons to Have More Kids by Bryan Caplan. Whilst the book as a whole is fantastic, it’s the structure of Bryan’s argument that is so wonderful. Bryan presents tons of evidence from twin adoption studies to suggest that genetics has a much larger role to play in the kind of person you turn out to be in the long run than the environment you grew up in**. If true, this means that raising kids need be nowhere near as stressful as most people make it to be. Suppose Bryan is right. If Bryan is right, and your beliefs on the subject of the effect of parenting on children has changed, you should have more kids than you were planning to before hand. Why? Because the cost of having them has fallen (individual parenting decisions aren’t as big a deal as you thought, so you can stop stressing about it). General rule: if the cost of something falls, or the benefits of something increase – you should want more of that thing. This is still consistent with wanting none of that thing, if the costs still outweigh the benefits. But it’s a great example of updating our beliefs to reflect new information (and I highly recommend the book).

I can’t present you with a complete and coherent position on anything. There’s just too many things to know, too many factors to consider and I’m not clever enough. Don’t get too hung up trying to figure out what I think. I’m not too sure myself, a lot of the time! Think at the margin, for yourself. Is this right, is this wrong, how does it affect what I already believe, should I be so sure. It’s not the natural way to think, but it’s the smart way.


* note: that statement depends on the fact that savings were at one point earned, which is obviously not true in the case of inheritance or expropriation

**provided the environment is such that adoption would be legally approved

Categories: Economics, Philosophy

Milton Friedman on method in economics

January 19, 2012 2 comments

Can’t remember how (H/T to someone), but recently came across this paper by Milton Friedman from 1966, entitled ‘The Methodology of Positive Economics’. It says pretty much everything I could ever want to say on the subject, and so much more. Here are a few fantastic excerpts:

Viewed as a language, theory has no substantive content; it is a set of tautologies. Its function is to serve as a filing system for organizing empirical material and facilitating our understanding of it; and the criteria by which it is to be judged are those appropriate to a filing system. Are, the categories clearly and precisely defined? Are they exhaustive? Do we know where to file each individual, item, or is there considerable ambiguity? Is the system of headings and subheadings so designed that we can quickly find an item we want, or must we hunt from place to place? Are the items we shall want to consider jointly filed together? Does the filing system avoid elaborate cross-references?

The answers to these questions depend partly on logical, partly on factual, considerations. The canons of formal logic alone can show whether a particular language is complete and consistent, that is, whether propositions in the language are “right” or “wrong.” Factual evidence alone can show whether the categories of the “analytical filing system” have a meaningful empirical counterpart, that is, whether they are useful in analyzing a particular class of concrete problems.

Or this

Viewed as a body of substantive hypotheses, theory is to be judged by its predictive power for the class of phenomena which it is intended to “explain.” Only factual evidence can show whether it is “right” or “wrong” or, better, tentatively “accepted” as valid or “rejected.” As I shall argue at greater length below, the only relevant test of the validity of a hypothesis is comparison of its predictions with experience.

And, finally, this

One confusion that has been particularly rife and has done much damage is confusion about the role of “assumptions” in economic analysis.  A meaningful scientific hypothesis or theory typically asserts that certain forces are, and other forces are not, important in understanding a particular class of phenomena.  It is frequently convenient to present such a hypothesis by stating that the phenomena it is desired to predict behave in the world of observation as if they occurred in a hypothetical and highly simplified world containing only the forces that the hypothesis asserts to be important.  In general, there is more than one way to formulate such a description – more than one set of “assumptions” in terms of which the theory can be presented.  The choice among such alternative assumptions is made on the grounds of the resulting economy, clarity, and precision in presenting the hypothesis; their capacity to bring indirect evidence to bear on the validity of the hypothesis by suggesting some of its implications that can be readily checked with observation or by bringing out its connection with other hypotheses dealing with related phenomena; and similar considerations.

Such a theory cannot be tested by comparing its “assumptions” directly with “reality.”  Indeed, there is no meaningful way in which this can be done.  Complete “realism” is clearly unattainable, and the question whether a theory is realistic “enough” can be settled only by seeing whether it yields predictions that are good enough for the purpose in hand or that are better than predictions from alternative theories.  Yet the belief that a theory can be tested by the realism of its assumptions independently of the accuracy of its predictions is widespread and the source of much of the perennial criticism of economic theory as unrealistic.  Such criticism is largely irrelevant, and, in consequence, most attempts to reform economic theory that it has stimulated have been unsuccessful.

If you had told me three years ago I would be approvingly quoting Milton Friedman, I would have likely laughed out loud. If you haven’t yet, go read the paper. It’s brilliant.

Categories: Economics

On civility, and the purpose of the blogosphere

January 19, 2012 4 comments

There’s two basic positions you can hold on the purpose of the economics blogosphere. One position is that it is now one of the main avenues by which advancing knowledge of economics is generated and disseminated, as opposed to the slow-moving journals and small cabals of elite scholars who all knew what was happening and got to see the papers. Paul Krugman put it well in a recent post:

So now we have rapid-fire exchange via blogs and online working papers — and I think it’s all good. Work circulates even faster than it did then, there are quick exchanges that can advance understanding, and while it’s still hard to break in, connections aren’t as important as they once were and the system is much more open.

Another way to think of it is that all the stuff we’re arguing about is incredibly important, and that the primary aim is to advocate our best view of policy. Another Nobel prize winner put this view well:

Cowen apparently wants me to make the best case for the opposing side in policy debates. Since when has that been the rule? I’m trying to move policy in what I believe to be the right direction — and I will make the best honest case I can for moving in that direction.

Ok, I lied. It wasn’t another Nobel winner, it’s the same guy. Krugman wants to both advance our collective knowledge and efficiently proselytize what he thinks to be the truth at once, and I’m afraid that doesn’t work very well. A vibrant intellectual environment requires forceful argument, but also making a proper effort to understand your opponent’s position, to not mischaracterise their views or deliberately present a weakened version of their argument – and to lay off ad hominem attacks. I’d submit that it is pretty much the definition of an honest argument that you provide your opponent’s best case and clearly show why you think it is wrong. As for ad hominem attacks, John Cochrane provides a pretty good summary of some of Krugman’s more egregious offences.

Like most economists, Krugman is highly attuned to fallacies of composition. So consider the following statement:

… there are people writing about economic issues who are a lot less confrontational than I am; how often do you hear about them? This is not a game, and it is also not a dinner party; you have to be clear and forceful to get heard at all.

But what if everyone behaves this way? If everyone shouts, then no one is heard. If the purpose of the blogosphere as a system is to advance collective knowledge, then I think this is a self-defeating strategy at what one might call the ‘macro’ level.

I would argue that civility is even more important in the blogosphere than normal academic settings, because one of the things that is highly valuable and unique about it is the quick feedback – but with that comes the tendency to initially misunderstand and mischaracterise. I cannot count the number of times that I have begun writing a post, and upon re-reading what I was linking to realised I had missed a key point. Sometimes I don’t catch it until after I’ve hit publish, and it really pains me that something wrong that I’ve written is ‘out there’. Not only is it is embarrassing, but it must also be so frustrating for the person who has been mischaracterised.

Now, I have only a very limited training in economics, but I’m also not exactly a dumb guy. This stuff is hard! And all the different parties have very different ways of talking about and conceptualising various issues, which can cause big problems with the more conversational style that blogging lends itself to. It’s very easy to see how something someone else has said doesn’t fit in to your framework, but to be able to step back and understand why a smart guy might believe something that seems *so* obviously wrong – that is actually a very difficult thing to do. I’m terrible at it. But then again, no one has seen fit to give me a Nobel prize.

Of course, if your view of the world is that the people you are arguing with are either mendacious idiots, or deliberately spewing falsehoods to advance their own agenda, then it is somewhat more understandable to take a more hostile attitude. If this really was a world of simple, Marxist ideological warfare then that point may have some merit. But to take that hostile attitude to everyone who disagrees with you is clearly counterproductive. Talking about Ari Fleischer’s tweeting, Krugman had this to say

this is an example of why policy debate is so frustrating, and why I’m not polite. The key thing about how the conservative movement handles debate is that it never gives up an argument, no matter how often and how thoroughly it has been refuted. Oh, there will be more sophisticated arguments made too; but the zombie lies will be rolled out again and again, with little or no pushback from the “respectable” wing of the movement.

In comments and elsewhere I fairly often encounter the pearl-clutchers, who want to know why I can’t politely disagree, since we’re all arguing in good faith, right? Wrong.

I’m sorry, but I completely fail to see why Bush’s former press secretary spouting nonsense on Twitter has anything to do with the live academic debates taking place in the blogosphere. If we had to document every misleading or false statement by someone who might inhabit some similar aspect of the political spectrum, we wouldn’t have time to do anything else. And I don’t exactly see Krugman pointing out every time a Democat says something utterly ludicrous about economic policy.

To cap it off, Krugman said this recently:

…by and large, ad hoc models like IS-LM are actually more useful [than rigorous models], in my judgment. But you probably do want to double-check your logic using fancier optimization models. Case in point: when I first got worried about the liquidity trap, I thought it was a myth, and set out to show that it was a myth using a simple NK model; what I actually found out was that my verbal logic was wrong, and it can indeed happen.

Was Krugman a fool and a knave before he discovered what he thought were good and rigorous arguments for something he previously believed was a myth? Of course not. So just don’t be surprised when we demand a very high standard of argument to be persuaded, rather than having our intelligence continually insulted. The condescending tone of his awful post on comparative statics, in the context of what was ostensibly a “debate” with Scott Sumner was staggering to anyone who had actually, you know, been reading what Scott was writing.

Understanding is an iterative process. It is incredibly easy to fail to grasp all the intricacies of what someone else has said, to know which particular choices of phrase were deliberate or not, and to accept the possibility of honest error. But as the process of understanding is iterative, and requires repeat interaction, this is only possible with a good dose of academic civility and the principle of charity. If we are to believe that the econoblogosphere really is the evolutionary adaptation of the profession to the age of the internet, then maybe we should start acting like it.

For the record, I’d like to say that I personally consider Nick Rowe to be the gold standard* for argumentative style among bloggers, in terms of both the way he clearly lays out his assumptions and responds to comments and rebuttals. We would do well to emulate him.


*pun (and irony) fully intended

Categories: Economics

You don’t think about taxation the right way: capital gains edition

January 18, 2012 3 comments

Assume 50% income tax, 10% capital gains tax, and that a man (let’s call him Mitt) earns $1m in Years 1 and 2.

Scenario 1: Mitt spends all his post-tax income. His effective tax rate in Year 1+Year 2 is 50%.

Scenario 2: Mitt saves all his post-tax income from year 1, and it doubles in value. In years 1+2, Mitt’s earned income is $2m, unearned income $500k. He pays $1m in income tax and $50,000 in capital gains tax. His effective tax rate in Year 1 + Year 2 is 1.05/2.5 = 42%. But his effective tax rate in year 2 is 0.55/2 = 28%. Quoting the effective tax rate for the year in which capital gains are realised understates his overall effective tax rate, but does appear to generate the result that is overall tax burden is lower than someone without investment income.

However, this is not the right way to calculate the total ‘burden’ of the tax on Mitt. Steven Landsburg thinks about it a bit differently, as per usual, and arrives at a different result (emphasis his)

To understand Mitt Romney’s tax burden, you have to compare him to his doppelganger Timm Romney, who lives on a planet with no taxes. In the year (say) 2000, Mitt and Timm both earned (say) a million dollars. Timm invested his million dollars, saw it double over the past decade or so, and cashed out his investment this year, leaving him with two million dollars. Mitt, by contrast, paid 35% tax in 2000, leaving him with $650,000. He invested it, saw it double, and cashed out last year, paying 15% tax on the $650,000 capital gain. That leaves him $1,202,500, which is about 60% of what Timm’s got. In other words, the tax system costs Mitt almost 40% of his income.

By contrast, people on our planet without investment income collect their wages, pay 35% in taxes, and spend what’s left. The tax system costs them 35%, while it costs Mitt almost 40%. In other words, people with investment income bear a higher tax burden, as a percentage of their income, than anyone else

When I read this quickly on the train this morning, I thought this was misleading and wrote the first couple of lines of this post in an email to myself in order for me to finish it later. But very quickly I realised that Steve’s way is the right way to think about it.

Same assumptions as above

Scenario 1: Mitt spends all his post-tax income in years 1 and 2. Had there been no tax, Mitt’s income would be 2.0 times what it was ($2m rather than $1m).

Scenario 2: As above, Mitt saves all his post-tax income from year 1. Had there been no tax, Mitt’s income would be c.2.1 times what it was ($3m rather than $1.45m).

On this method, Mitt’s effective tax rate in my example above would be 52% rather than 42%. I think this is the right way to think about it, insofar as the total cost of all taxation to you is equal to the benefit you would accrue through the elimination of all taxation.

A few weeks ago, I linked to a Megan McArdle post, where she said

…we think about taxes the wrong way around. Most people think that raising a 5% tax rate to 10% is more noticeable (and painful) than raising a 50% tax rate to 55%. After all, the first represents a doubling of your tax rate; the second is only a 10% increase. But this is exactly the wrong way to think about it. The pain of a tax hike is determined not by how your current tax rate compares to your earlier tax rate, but by how your current disposable income compares to your earlier disposable income. Doubling the tax rate from 5% to 10% decreases your disposable income by about 5.25%. But raising it from 50% to 55% decreases your disposable income by 10%. That’s a much bigger whack.

Our instinct when we think about the burden of taxation is to take the tax we think we actually pay, and divide that by our pre-tax income under the existing tax regime. The right way to think about our total tax burden is the difference between post-tax income under the tax regime and post-tax income under a no-tax regime, and the right way to think about the burden of a marginal tax increase is the change in your post-tax income relative to your current post-tax income.

Alexander the Meerkat.

Categories: Economics

The somewhat suspect epistemology of economics

January 13, 2012 2 comments

“Don’t think, but look!” – Wittgenstein, Philosophical Investigations (66)

I’ve been wanting to write something about the epistemology of economics for a while, and have been spurred on by Noah Smith’s post yesterday, linking back to an older piece from Frances Woolley at Worthwhile Canadian Initiative. I recommend you go and read them yourselves if you like, and here I take a very similar line to Noah.

As anyone who did the equivalent of Logic 101 will know, deduction is essentially a schema for truth preservation. A logically valid inference is one where it is not possible for the premises and the negation of the conclusion to be true at the same time. If you put in truth and do it right you will get more truth out at the end – but if you start with garbage, then all bets are off.

People often talk about the idea of there being a conflict or dichotomy between inductive and deductive styles of reasoning. I don’t think that’s the right way to think about it. Sure, if you deduct from premises that are self-evidently false (read: most premises in economic models) then you have no reason to think the conclusion will be true. But if you go about inducting will-nilly without some kind of vaguely deductive model about how the world works, then you will end up believing all kinds of crazy things. What I think we do most of the time is create models from simplified premises that may not be ‘true’, but are a starting point from which we can see whether the simplification still gets us to the right answer. But how can we know whether it gets us to the right answer?

By testing it. By making predictions and seeing if they come true.

Deductive models, when they begin with premises that are either obviously false or gross simplifications, are only ever worth anything as a preliminary to inductive testing. Furthermore, if you are beginning with premises that you think are self-evidently true, then you need to seriously question whether you are right*, or even saying anything at all**.

In Frances’ post, she describes a genuine distinction between the ways in which traditional economist and behavioural psychologists in fact go about trying to understand the world, and ends on a wistful note:

Dabbling in economic psychology or behavioural economics is a little like taking the red pill –  you go down the rabbit hole, and wake up realizing that the entire world is an illusion…

I want a purple pill – a merging of the red and the blue – that would allow me to merge behavioural insights into a coherent model of economic behaviour…

But I don’t know if such a thing is even possible.

I can see there is a genuine issue with the mathematical complexity of a more realistic model of decision making. The model may become too complex to manipulate in order to generate novel results. But I don’t think this is the biggest problem. I’m pretty sanguine about the fact that straightforwardly false assumptions are knowingly put into models (it works in physics!). The economist’s biggest problem is that even with really simple assumptions, the phenomena he/she is attempting to model are often too complicated to be amenable to robust inductive testing. And this can be used as an excuse not to try***.

My belief that recessions are caused by monetary disequilibrium is basically the product of a model where you simplify the economy to assume there is only money, generic units of ‘output’ and sticky prices. It generates the prediction that reducing the value of currency in such circumstances will help achieve full employment of resources and an economic recovery. But who says this is the ‘right’ simplification to make? Well, this chart from a 1992 book by Barry Eichengreen, is a good place to start (h/t Brad DeLong)

Obviously, this graph by itself doesn’t constitute proof. Some people who would disagree with me also cite this chart in support of their view, or disagree that it provides much by the way of evidence. But if it wasn’t for the fact that the graph looked like this rather than the other way around, I’d think that maybe the money-output simplification is not a good one to make. The point being, the model generates predictions about what we should expect to happen in recessions when either the money supply is increased, or it is signalled that the central bank will do so if necessary. The model gives you an idea for where to look. It is not a substitute for looking.

People trained in economics are often very good at thinking at the margin. And at the margin, in macroeconomics I think we**** need a bit less abstract thinking and a lot more casual empiricism. It doesn’t take a genius to point out that some very popular explanations for the housing boom don’t even pass the laugh test once you take a cursory glance at the relevant data. It shouldn’t be a point of dispute, pace John Cochrane, that nominal changes obviously have real effects. People with some economics training ought to be very good at quickly correcting such things. But quite frankly, we could do a lot better – especially when it comes to correcting ourselves. Too often we don’t even bother to look; easily satisfied by a little just-so story about incentives, or an elegant but unrealistic model of a messy reality.

(File under self-admonishment.)


*I’m not going to argue now about what may or may not count as ‘self-evidently true’, but suffice to say that the set of things that are self-evidently true is a somewhat miniscule subset of the things people believe to be self-evidently true

**I’ve heard people defend the economist’s model of ‘rationality’ on the basis that you can take pretty much any action by any person and identify a set of preferences that makes that action ‘rational’. But if you say that, you haven’t created a ‘theory of action’ with any useful content, but rather created a schema by which we can model people’s actions if we can identify the terms of the schema empirically. If you have no way of telling what a person’s preferences are except insofar as they are revealed by their actions, and you stipulate the preferences are always consistent, then you don’t have a useful theory of anything. You can ‘model’ ex-post facto anything I do by attributing some set of beliefs and desires to me, but that doesn’t mean you remotely understand or predict what I will do or have done

***If you think that it is not in the business of economics to generate empirical predictions, then I have the right to ask why I should give a rat’s ass about economists’ views on policy

****I did IB economics and intro micro/macro at Oxford. It counts, OK?

Categories: Economics, Philosophy

The real lesson of the debt burden debate

January 7, 2012 1 comment

It was such a simple argument.

Every ‘IOU’ has a corresponding ‘UOMe’. So, if you consider the set of all people alive at any point in time, the IOUs can’t be a burden on those people because (at the aggregate level) any repayment is being made to other people who are alive. The set of people alive cannot be burdened (if there is no transfer between time periods). Here’s Nobel laureate Paul Krugman on the topic a few days ago (emphasis mine):

That’s not to say that high debt can’t cause problems — it certainly can. But these are problems of distribution and incentives, not the burden of debt as is commonly understood. And as Dean says, talking about leaving a burden to our children is especially nonsensical; what we are leaving behind is promises that some of our children will pay money to other children, which is a very different kettle of fish.

I used to buy this line, until I grokked Nick Rowe’s argument that if different cohorts of people overlap, then Krugman’s argument (that it is nonsensical to say that debt could be a burden on our children) falls apart. There are still empirical questions as to how much of a burden it is*, but it is not a question of identity or tautology.

This is an illustration of a profound epistemological problem with using grossly simplified models of reality. Before this argument began bouncing around the blogosphere, I had a kind of model in my head that did not factor in overlapping generations of people. It produced the result that debt cannot be a burden on future people. In the context of that model, that is the correct result. But by leaving out overlapping generations, it so happened I left out a crucial detail.

There are good reasons that we simplify in order to model and understand. Sometimes (arguably always) it is just not possible to factor in everything. Whether or not this is a problem basically boils down to whether the stuff you omitted makes a difference to the answer to the question you’re asking. But how do you know you haven’t omitted a crucial detail? In the physical sciences, you can create testable predictions on the basis of your model and run experiments. Most of the time, you can’t do that in economics (or at least every result is controversial due to the problems of trying to isolate particular variables in complex systems). We can’t run an experiment in the real world and say “hmm, the future people in this experiment have been burdened by the debt, so I guess my model is missing out something important”.

Luckily, in the case of the debt burden you can show the model is quite possibly missing out something important just through a simple thought experiment. That’s the exception rather than the rule. Most of the time, we have a lot less independent confirmation of our models than we think we do.

To paraphrase CS Lewis – not only do we believe that our models are right, but it is often by our models that we decide what is right. This is, to put it mildly, a problem.


*Essentially, it depends on the degree to which either the debt is sustainable because NGDP growth is higher than the interest rate, or older cohorts leave bequests to their children

Categories: Economics