Stumbling and Mumbling

Brexit: the egocentric framing error

Chris Grey decries the stupidity of Brexiters:

So insular has the discussion in the UK been before and since the referendum that one might think that Brexit is simply a matter of the UK formulating its demands.

What’s going on here is a specific example of a more general error. It’s what David Navon has called egocentric framing – a tendency to see problems only from our own point of view rather than to put ourselves into others’ shoes.

We’ve all been stuck in traffic on a motorway and changed lanes only to see a few minutes later than the lane we left is moving faster. The mistake we make in those cases is to forget that other drivers are trying to solve the same problem as us with the same evidence and so make the same choices – thereby adding to congestion.

Investors make the same mistake. One of the best-attested stock market anomalies is the tendency for newly-floated shares to fall (pdf) in the months after being issued. A big reason for this is that buyers don’t put themselves into the seller’s position. They see what looks like an attractive business but fail to ask: if this company is so good, why is the man who knows most about it willing to sell? Simply asking that question would save people money.

The same thing is true in games. When I play chess, I find that I do better if I put myself into my opponent’s position, and ask: what moves is she planning? What weaknesses trouble her?

It’s common for intelligent people to regard Brexit negotiations as an exercise in game theory. And they’re right. But the essence of game theory is to think yourself into the position of the other party. That means doing the precise opposite of egocentric framing.

Doing so is doubly beneficial.

For one thing, it gives us insights into what the other party wants and what they are willing to trade. It leads to some of the principles set out by Fisher and Ury in Getting to Yes (pdf): separate the people from the problem; focus on interests not positions; and invent options for mutual gain.

For another, putting yourself into the other person’s shoes will lead you to act like him, or at least give off cues that you’re like him. This will lead to better results simply because people tend to be more generous to those who are like us in some way. Some researchers have found that waitresses who repeat customers’ words earn bigger tips (pdf) than others. And other experiments have found that mimicking (pdf) the body language of your interlocutor can improve the outcome of negotiations. As the authors of that latter study say:

Mimicking can be a highly effective tool in negotiations. Negotiators often leave considerable value on the table, mainly because they feel reluctant to share information with their opponent due to their fears of exploitation. Yet building trust and sharing information greatly increases the probability that a win–win outcome will be reached…Our research suggests that mimicking is one way to facilitate building trust and consequently, information sharing in a negotiation. By creating trust in and soliciting information from their opponents, mimickers bake bigger pies at the bargaining table, and consequently take a larger share of that pie for themselves.

But Brexiters are doing the exact opposite of this. Little Englanderism, the assertion of our specialness and the imbecilic antics of Johnson all serve to create a distance between us and the EU, when we should be seeking to minimize that distance. As Chris says, “every screaming headline and every bellicose punch-drunk interview from a Brexiter politician damages us more.”

And here, my patience runs out. Yes, government is a tricky business in which mistakes are inevitable. But we’ve a vast body of research which warns us of those mistakes, and which should equip us to at least avoid the obvious errors. The Tories, however, don’t seem able to do even this. The idea that they are best able to negotiate Brexit is not obviously founded in evidence. There’s more to negotiating than making strident demands.

The non-cost of the triple lock

Brad DeLong used to run a series of posts asking “why oh why can’t we have a better press corps?” Coverage of the pensions triple lock reminds me of his lament, because in one respect it is flat wrong.

The Guardian and the Independent agree that it is “expensive.”

Wrong, wrong, wrong.  

The minor problem is that it the triple lock doesn’t matter in the short-term. if inflation is over 2.5% - which is likely this year and possible next – the triple lock adds nothing that bog-standard uprating won’t. The FT wins a spotter’s badge for this:

The triple lock only becomes a bigger burden on the economy and public finances when the highest of prices, earnings or 2.5 per cent is greater than the growth in the absolute size of the economy.

Even this, though, is wrong. The lock will not be a “burden on the economy.” It is not a cost. It is a transfer from one group to another. As I’ve complained before, a transfer is NOT the same as a cost*. The pretence that it is serves a reactionary function as it creates the impression that the state is a burden when it is (often) not.

You might object that the transfer is a cost to the young. No. Most young people will become old and thus will get a state pension. The triple lock is therefore a transfer from us to our future selves. And it is our future selves that will benefit more than today’s pensioners. If the triple lock remains place, young people will benefit from decades of compound growth, whereas today’s old folk will see only a few years of such growth before they die. As Albert Einstein said, “the most powerful force in the universe is compound interest.”

In fact, from the point of view of young people, it’s not clear that the triple lock is a cost even today. We must provide for a pension income somehow. The question is: do we do so via the state or via private pensions? And there is, as I’ve said, a strong case for doing so more via the state. Not only is it better placed to bear risk, but it is also cheaper: the charges on some private pensions can be pretty close to legalized theft.

We should think of the triple lock not just as part of fiscal policy but as part of pensions policy. From this perspective, it makes sense. Even for youngsters, it’s a saving insofar as it reduces the need to pay pension fund managers.

The triple lock, then, isn’t expensive**.

In saying this, I’m not just making an economic point. I’m also making a political one. Even when political journalists try to be neutral they are in fact biased. We, and they, should be more conscious of these biases.

* Actually, even in narrow fiscal terms, the triple lock isn’t that expensive. The OBR reckons that state spending on pensions will rise from 5.2% of GDP now to 7.1% by 2066-67 (table 3.7 of this pdf). This would leave spending lower than it is in many countries today: as the OECD says, UK state pensions are low relative to other rich nations. This is perfectly affordable, if we want it to be.

** Econ 101ers might object that pension provision via savings would increase the capital stock whereas provision via taxes wouldn’t. I doubt it. Even insofar as pension contributions go into the UK stock market, they only indirectly add to the capital stock simply because capital spending isn’t financed by issues of new equity. There are countless better ways of increasing the capital stock than by encouraging private pensions.

The demand for bastards

Earlier this week Michael Fallon warned that the Tories could use nuclear weapons as a pre-emptive measure. This is seen as evidence of “strong leadership” rather than the threat of a psychopathic war crime. At the same time, Labour’s promise of more Bank Holidays is presented as something fluffy and non-credible rather than as part of a plan to improve the UK’s terrible productivity.

Something odd is going on here.

The story of Juan Carlos Enriquez tells us what. He was ripped off by Donald Trump, and it took years to get his money back. But he voted for Trump.

What we see here is that there’s a demand for bastards. Being a dishonest psychopathic bully isn’t a disqualification, but a sought-after trait.

I’m not thinking here of the fact that many people prefer the unpleasant but competent boss to the nice but ineffective one. What I have in mind instead is that people interpret nastiness as a sign of competence. Nasty=tough=effective, at least when the nastiness is towards migrants or benefit recipients rather than to (perish the thought) bosses.

It’s not just in politics that this happens: boardrooms are stuffed with narcissists and psychopaths.

What’s going on here is a cluster of mechanisms. One is a form of wishful thinking. Just as people want to believe lies, so they want to believe a strong person can transform companies and societies.

Another is a fallacious form of the halo effect. People infer from the cliché that Mussolini made the trains run on time that you have to be like Mussolini in order to make the trains run on time. This is not necessarily true.

Another is that we mistake overconfidence for actual ability. We thus imbue the confident narcissist or tough talker with talents which he doesn’t actually possess.

A third is a tendency to under-rate emergence and bounded rationality and knowledge. This leads to a demand for “strong” leaders and a dismissal of uncertainty as weakness rather than what it is – a recognition of our complex world and limited cognition.

In her endless talk of contrasting here “strong leadership” to the weakness and chaos of Corbyn, Theresa May is of course exploiting all these tendencies.

There’s just one problem here. It’s often wrong*.

George Osborne tried this trick. He wibbled about “tough choices” which mediamacro interpreted as evidence of strength and competence. But of course, it wasn’t: the government borrowed £52bn in 2016-17, £31bn more than the OBR forecast in 2012, which means austerity failed in its own terms. It was pure vandalism.

And Fred Goodwin was a tough and ruthless leader at RBS, but also one of the most catastrophic bosses in history.

Sometimes, bastards are just stupid bastards.

As Archie Brown has shown, the desire for strong leaders is often erroneous:

Popular opinion about whether a leader is strong or weak in the sense of being a dominating or domineering decision-maker can be extraordinarily wide of the mark…There is no reason to suppose that the “strength” of a prime minister’s leadership (in the sense of a domineering relationship with Cabinet colleagues) leads to successful government (The Myth of the Strong Leader, p 120)

In a complex society, decentralization and “weak” leadership might work better. As Clement Attlee said: “The foundation of democratic liberty is a willingness to believe that other people may perhaps be wiser than oneself.”

All of which leads me to agree with George Monbiot: “After 38 years of shrill certainties presented as strength, Britain could do with some hesitation and self-doubt from a prime minister.”

* But not always: one defect of agreeable people is that they can agree to the wrong things.

Beyond redistributive tax

Is there an egalitarian argument against sharply progressive income tax? I’m prompted to ask by John McDonnell’s plan to raise tax those earning more than £70,000.

From the point of view of raising revenue, he’s bang right to target these rather than the mega-rich. For one thing, there’s more of them. And for another, they are a slow-moving target. Whereas a multi-millionaire hedge fund manager might react to higher taxes by retiring, downshifting, emigrating or fiddling the books, middle managers and head teachers have much less wiggle room. Optimal taxation theory thus says we should target them.

And Ben Chu is dead right to say that people earning over £70,000 a year are rich - they’re in the top 5% of earners – and that denying this fact tends to serve the interests of the really rich.

There is, though, a problem here. People on higher incomes aren’t happier than others. In fact, ONS research (pdf) shows that those in higher income deciles are actually less happy (albeit not statistically significantly so) than those on middle incomes.

Yes, they enjoy higher life satisfaction and a sense of worth than others. And yes, net financial wealth more strongly correlated with subjective well-being. But higher earners aren’t happier than middling earners.

There are two reasons for this. One is that the richer you are, the more options you have, and so you’ll feel more regret about what you’re missing.

Another was pointed out by Adam Smith. It’s that high wages are often offset by other disadvantages, such as the disagreeableness of the work. Headteachers and middle managers are often stressed out; bankers and lawyers work stupid hours in unfulfilling jobs; and successful people, especially the minority who come from poor backgrounds, often suffer from imposter syndrome or a sense of alienation.

Yes, some lefties might think I’m bringing bring out the world’s smallest violin here – but that just shows a narcissistic lack of empathy. I’ve tried earning big wages. And it’s pretty unpleasant.

From a welfare egalitarian point of view, big taxes on high incomes aren’t altogether satisfactory.

In saying all this, I’m not merely parroting right-wing clichés against taxation. For one thing, the same data that tell us that high income earners aren’t happy also tell us that the poor are unhappier, more anxious and less satisfied with their lives than the average earner. This is an argument for redistribution – or at least for paying more heed to the mental health of the worst-off. And for another, there might well come a time when higher spending on schools and education requires higher taxes rather than more borrowing.

Instead, I’m questioning here whether income is the right base for taxation. I suspect instead that – at least in efficiency terms – there’s a case for shifting the burden onto land. (Yes, Tim’s right that the UK taxes property more than most countries, but we don’t do so terribly efficiently or equitably).

But there’s a bigger point I’m making. There must be much more to leftist thinking than redistributive tax. In particular, what matters is inequalities of power and autonomy. The tyrannical boss oppressing his staff might not be far up the income distribution, but he’s well up the power ladder. That matters. And one reason why many of the rich – yes, the 95^th percentile is rich – don’t feel good is that they lack power and autonomy, in part because of the conquest by managerialism over professionalism and craft skills.

For me, proper leftist politics would speak to these issues – and in doing so create a common interest between many of the financially well-off and the worst off. Traditional social democracy, however, has failed in this regard.

Another thing. I’ve never been happy with the utilitarian argument for higher taxes on the rich – that diminishing marginal utility means a rich man values £1 less than the poor one. The rich are different people than the poor, so we can’t so easily compare marginal utilities.

Bank holidays & productivity

Labour wants us to have more bank holidays. There might be a good economic case for this.

My chart hints at the point. It shows that, across 35 OECD nations, there is a very strong negative correlation (of minus 0.77) between annual working hours and GDP per hour worked. Countries that work less are more productive. The French, for example, are far more productive than the UK even though they spend all their time eating cheese.

The same correlation exists over time. We work only around half as much now as we did in the 19^th century, but we’re far more productive in those hours we do work.

Of course, correlation is not causality. A big reason for this relationship is that more productive societies use their greater wealth to take more leisure.

But this might not be the whole story. It could be that the imposition of shorter working hours can help to spur productivity. Parkinson’s law tells us this. It says that work expands so as to fill the time available for its completion. If a manager knows that he has a long week to fill an order, he’ll take that long week. A shorter week could sharpen his incentives to increase efficiency.

Also, if people are working longer they get tired and jaded and so less efficient. A recent study of call centre workers has found that productivity falls as working hours rise even for people working quite short hours. This corroborates evidence from a very different industry – British munitions workers (pdf) during World War I. John Pencavel writes:

Employees at work for a long time may experience fatigue or stress that not only reduces his or her productivity but also increases the probability of errors, accidents, and sickness that impose costs on the employer…Restrictions on working hours – those imposed by statute or those induced by setting penalty rates of pay for hours worked beyond a threshold or those embodied in collective bargaining agreements – may be viewed not as damaging restraints on management but as an enlightened form of improving workplace efficiency and welfare.

France’s imposition of a 35-hour working week, for example, did seem to lead to a boost to productivity.

Of course, more bank holidays alone won’t close the massive productivity gap between the UK and other countries. But they might be one of many policies that might help.

There is, equally, a very long tradition of denying this. Nassau Senior opposed the 19^th century Factory Acts limiting working hours because he believed that profits were made in the last hour. He was plain wrong (pdf). Mightn’t his 21^st century counterparts also be mistaken?

It depends upon your view of British bosses. If you think they’re clueless inflexible buffoons, then there’ll not be a boost to productivity, because they won’t be able to rejig working methods sufficiently. If, however, you think they are smart enough to justify their big wages and egos, you’ll be more confident. From this perspective, it’s the right who should be more welcoming of Labour’s proposals than the left.

So why aren’t they?  It’s because to them, managerial control is a good thing in itself.

Herein, though, lies the radical question posed by Labour’s proposal: should the job of increasing productivity – which should be our top economic priority – be entrusted wholly to managers, or is there instead a case for intervention by the state and (in different respects) workers? Even if Labour is wrong, it is at least asking a good question.

"Not enough money"

On the Today programme this morning John Humphrys repeated an ancient ideological trick of the right. He asked (1’24” in):

Why should the British taxpayer when they see that there’s not enough money for instance for hospitals or schools…why should they be expected to [spend on foreign aid]?

But why isn’t there enough money for schools and hospitals?

The answer, of course, is that the Tories have chosen to suppress spending on them. They could instead raise taxes to spend more on health: there’s a good economic case for taxing the moderately rich, and an even stronger one for taxing land more. Not doing so is a political choice.

And in the short-run there’s a case simply for borrowing to spend more on the NHS.

Whilst Humphrys was asking his question, others were reading reports that mortgage rates have fallen to a record low. They’ve done so in part because bond yields are near record lows. Government borrowing costs are negative in real terms: 20 year index-linked gilts yield minus 1.8 per cent, which means that for every £100 the government borrows today it need only repay £70 in today’s money. The simple maths of government debt means, therefore, that the government can both borrow more and reduce the ratio of debt to GDP over time.

If it makes sense to borrow to buy an over-priced house, doesn’t it also make sense to borrow to build new hospitals?

That the government is not doing so on sufficient scale is a choice. The overworked doctors depicted in Channel 4’s Confessions of a junior doctor are the result of policy decisions.

Which is why Humphrys’ phrasing is so odd. Simply saying there is “not enough money” invites the more gullible listeners to think this is an unavoidable fact rather than a free choice.

This, of course, is an old trick. The rich and powerful have always wanted underlings to believe their preferences and interests are natural and immutable. Aristotle’s idea of natural inequality (which persists today), the Divine Right of Kings, defences of slavery, Thatcher’s talk of “there is no alternative” during the 1980s recession and bosses’ crocodile tears about “unavoidable” redundancies, all fit this pattern. It’s part of system (pdf) justification (pdf). And there’s never a shortage of lackeys to promote the myth. As the old hymn (written by a namesake of Mr Humphrys) went:

God made them high and lowly,
And ordered their estate.

The Tories would love voters to believe that underfunding of schools and hospitals is a necessary result of big government debt. But this is a lie. And Humphrys is helping to propagate it – like all stooges down the ages.  

The conservative Left

In some respects, it is the right who are Marxists and we leftists who are conservatives.

Take for example, this characterization of Marx:

The dictatorship of the proletariat…is characterized by majority rule, extra-legality, dismantling of the state apparatus and revocability of the representatives. (Jon Elster, Making Sense of Marx, p448)

This is pretty close to Douglas Carswell’s position: support for referenda and the recall of MPs. By contrast, we lefties are more cautious about change. We no longer envisage the move to post-capitalism* as arising through one-off events but rather as a longish process of what Erik Olin Wright calls (pdf) interstitial transformation or Williams and Srnicek call accelerationism.

Accelerationists want to unleash latent productive forces. In this project, the material platform of neoliberalism does not need to be destroyed. It needs to be repurposed towards common ends. The existing infrastructure is not a capitalist stage to be smashed, but a springboard to launch towards post-capitalism.

Our vision of change is quite a conservative one. Like Oakeshott and Burke, we are sceptical of grandiose rationalist blueprints but instead see the move to socialism as much like the market discovery process - a process of trial and error, building on what works. And we distrust snap decisions taken in the heat of the moment and favour instead gradualism and cool scepticism. We now leave Leninist talk of “crushing saboteurs” to the far right. As we are less arrogant and cocksure than them, we’re more tolerant.

Carswell’s right to say he’s “pretty unconservative”. In fact, he’s probably less conservative than me.

There’s another sense in which I’m to the right of many on the right. My support for worker democracy rests perhaps as much upon my Hayekian influences as my Marxian ones. Hayek opposed central planning because he thought that economic knowledge was necessarily dispersed and fragmentary and so we needed some better mechanism than top-down planning to aggregate that knowledge. He thought the price system did the job. However, many economic decisions are taken not in the market but within organizations. They too need an information aggregation mechanism. That mechanism is workers’ voice.

One reason why I suspect this will work is that workers have skin in the game. Those with job-specific human capital or loyalty to the firm have skin in the game; they have a greater incentive to ensure the firm succeeds than do managers who jump ship or walk away with big pay-offs after lousy custodianship. Worker democracy is incentive-compatible. That’s a pretty conservative idea.

It’s right-wingers who support bosses and top-down planning who are out-of-date crude Marxists. We lefties have moved on.

In fact, there’s another reason why I at least am conservative. It’s that the things that conservatives profess to admire – sometimes I fear insincerely – can be best achieved under egalitarian modes of production. If you want real (pdf) freedom, you need a citizens’ income so that people are empowered to choose different kinds of lives, and you need to destroy corporate tyrannies. And if you want a proper-functioning dynamic market economy, you need to loosen capitalists’ power over the state and to overcome the coordination problems which retard innovation and investment under capitalism.

Many on the right have forgotten the virtues of old-style conservatism: an awareness of bounded knowledge and rationality, an appreciation of decentralization and a cherishing of freedom. We lefties, though, have now learned them.

* I avoid the word “socialism” so I don’t confuse those braindead right-wing bigots who equate socialism with central planning.

Neither inequality nor poverty

Was Blair right? Miles and Simon have been debating this.

Blair said (pdf):

I don’t care if there are people who earn a lot of money. They’re not my concern. I do care about people who are without opportunity, disadvantaged and poor.”

He walked the talk. Tax credits, more generous pensions, fuller employment and the minimum wage helped reduce poverty whilst his government did little to restrain the rise in very top incomes. Miles approves of this. And he has a good point: poverty is a great evil.

This, though, misses something – the maths. If the rich are getting richer and the poor are getting better off, then for a given level of income, somebody must be getting worse off. The “Blairite society” of super-rich but little poverty is one in which the middle class is relatively poor.  

This has its drawbacks – especially perhaps from a conservative point of view. As Deirdre McCloskey has argued, a bourgeois society embodies virtues of prudence, justice and regard for others. A Blairite “winner take all” society jeopardizes these: why work hard at school and university (and incur massive debt) when it’ll only get you grunt-work and no hope of a decent home? And an insecure and embittered middle class also threatens political stability. Back in 2013 Fraser Nelson wrote:

Our middle classes — the great stabilising force in our society — are falling fast. It’s hard to imagine the British bourgeoisie taking to the streets, but someday soon they might turn around and say: ‘Sorry, but we’re really rather mad and we’re not going to take it any more.’

Perhaps Brexit. Ukip and the rise of insular, anti-market sentiment vindicates him: inequality can be bad for economic freedom.

Of course, my concerns would be irrelevant if the Blairite society were to lead to faster economic growth and hence a growing pie for all. But this hasn’t been the case. Quite the opposite. Since the mid-90s, growth in GDP per head has slowed.

And it might have done so because of the Blairite shift. Simon’s right to say that the super-rich engage in rent-seeking. But this isn’t confined to the likes of Arron Banks meddling in politics. It also happens in the workplace: rising CEO pay has come at the expense of shareholders and workers. And there are several reasons to suspect that a big take by the super-rich reduces economic growth. Not least of the mechanisms here is that it leads to worse politics by reducing trust.

Miles might be right that it’s better to have a society of super-rich and no poverty than one in which there’s poverty and no super-rich. But this is a close call. And it omits a third option – a society in which there is both no poverty and no super-rich. It is this that we should be striving for.

Another thing: Yes, I know the Gini coefficient has fallen in recent years. But this tells us little: the Blairite society might have a low Gini because there’s a low gap between the middle class and the poor even if the rich are very rich.  

Against marginal product

David Moyes says Jordan Pickford has been a better player than Dele Alli this season. This set me wondering about marginal productivity theory.

To see my point, think about how we’d test Moyes’ claim. We could look at what the two teams did in games which Alli and Pickford missed. But there are too few of these to draw robust inferences, and doing so would be impossible for a player who hadn’t missed any games*. Instead, we could compare how Sunderland would have done if Pickford were replaced with a next-best alternative to how S***s would have done with a next-best replacement for Alli. In effect, we’re asking: what are their marginal products?

I suspect that Pickford’s marginal product consists in converting heavy defeats into narrower ones: this still leaves Sunderland relegated, only with a lesser goal difference. Alli, by contrast, has converted draws or losses into wins. That’s a bigger difference.

This, I think, highlights three problems with marginal productivity analysis.

The first is that marginal product is the result of a hypothetical question. For example, in considering my own marginal product, I ask: how would the IC do without me? That’s a hypothetical to which we cannot give a precise answer. This is true of much of neoclassical economics. As Noah says:

Demand curves aren't actually directly observable. They're hypotheticals - "If the price were X, how much would you buy?"

In this, he’s echoing Sraffa:

The marginal approach requires attention to be focused on change, for without change either in the scale of an industry or in the ‘proportions of the factors of production’ there can be neither marginal product nor marginal cost. In a system in which, day after day, production continued unchanged in those respects, the marginal product of a factor (or alternatively the marginal cost of a product) would not merely be hard to find - it just would not be there to be found. (Production of Commodities by Means of Commodities, pv)

Secondly, in football there’s a high ratio of noise to signal: performances are due in part to luck. This is true not just in football. Consider two men of equal ability who become CFOs of start-ups. One start-up becomes massive, the other struggles. The man who joined the former will be many times richer than the latter. But that’s more to do with fortune than with human capital or marginal product: firms don’t usually grow big because they've got a slightly better CFO than the firm down the road. Anyone who’s mind isn’t befuddled by Randian nonsense will know that our lives and incomes are the product of luck. But we know that people are terrible at distinguishing luck from skill – in part because they suffer from the outcome bias.

Thirdly, imagine a top goalkeeper were playing for a better side than Sunderland. His performances would then make a difference to his team’s points: a couple of great saves per game would convert losses to draws or wins, rather than 4-0 defeats into 2-0 ones. His marginal product would be higher.

This tells us that, in teams, an individual’s marginal product is beyond his control: if Pickford had better colleagues, his marginal product would be higher. A similar problem arises in many large firms. As the late Herbert Scarf wrote:

If economists are to study economies of scale, and the division of labor in the large firm, the first step is to take our trusty derivatives, pack them up carefully in mothballs and put them away respectfully; they have served us well for many a year. But derivatives are prices, and in the presence of indivisibilities in production, prices simply don't do the jobs that they were meant to do. They do not detect optimality; they aren't useful in comparative statics; and they tell us very little about the organized complexity of the large firm.

For me, flaws such as these mean that marginal product theory doesn’t make much sense as an explanation of wage levels. We should abandon it as a mental model in favour of bargaining (pdf) models. In these, matches between workers and jobs lead to surpluses, and the surplus is divided according to the balance of power.

In such models, human capital raises wages insofar as it generates surplus and gives its holders outside options which enhance their bargaining power.  But human capital and “marginal product” aren’t the whole story. All the things that affect bargaining power, such as technology and unions, also matter. Such models are consistent with the theory that inequality is due to the rise of superstar firms (pdf). They’re also consistent with the fact that minimum wages don’t destroy many jobs. And they help explain rising CEO pay better than marginal product theory.

What I’m appealing for here is for economists to abandon unscientific just-so stories and to think instead about the real world. In this world, wages are determined not by unobservable entities such as marginal product but by – among other things – power (pdf).

* S***s did well during Harry Kane’s injury. Few would say this is evidence that Kane is a poor player, and not should they.

On "mainstream" economics

“It doesn’t matter whether a cat is white or black, as long as it catches mice.” I was reminded of this quote from Deng Xiaoping by the debate between Simon, Brad and Unlearning Economics over the role of mainstream economics. For me, what matters isn’t whether economics is mainstream or not, but whether it does the job of explaining reality.

I’ll take three different examples.

The first is austerity. Brad’s right that some mainstream economists supported austerity. But so what? What matters is the strength of the arguments, not who makes them. And many mainstream arguments were weak. Reinhart and Rogoff’s claim that debt-GDP ratios above 90% reduced growth was just plain incorrect. And whilst Alberto Alesina was right to point out that there have been cases (pdf) of expansionary fiscal contraction, those cases aren’t relevant to the situation we’ve been in since 2010.

It looks as if austerity has depressed growth. That’s consistent with what Simon says is mainstream thinking about the economy at the zero bound, but also consistent with MMT*.

My second example comes from the day job: defensive stocks have for years done better than the textbook CAPM predicts around the world – a fact first pointed out by impeccably mainstream economists. This is a counter-example to Russ Roberts’ claim that “most economics claims are really not verifiable or replicable.”

There are (at least) three interpretations of this. The most mainstream, I suspect, is Frazzini and Pedersen’s (pdf) – that market imperfections (limits on borrowing) generate high demand for high-beta stocks, causing them to be overpriced. Alternatively, there might be a behavioural explanation: investors' lack of attention or overconfidence causes them to under-price defensives and over-price growth. (Is behavioural finance mainstream? I don’t give a damn). And even further from the mainstream is Falkenstein’s claim that there is in fact no trade-off between risk and return.

Which theory is most right? In one sense, it doesn’t matter. The fact that three different ideas both point to defensives doing well strengthens my belief that they’ll continue to do so.

My third example is inequality. It’s obvious that the simplest version of mainstream economics doesn’t explain a rising income share of the 1%: the idea that bosses are paid their marginal product fails because it implies that the men who brought down banks in 2008 should have had salaries of minus billions, which they did not. But what about the idea that inequality is due to superstar firms (pdf)? Or to agency failures? Or to shifts in bargaining (pdf) power? Are such theories “mainstream” or not? There might be a type of academic pedant who cares. But I don’t. What matters is: do they fit the facts? Do they do a better job than, say, Marxian theories?

What I’m trying to get at here is an agreement with both Simon and Unlearning Economics. I agree with Simon that economics should be a vocational subject which addresses real-world issues. But I also sympathize with UE. Economics should be more diverse simply because different perspectives help explain different problems: this is why we should study classical economic thought. The question is not: what’s mainstream? It is: what’s right?

* I’d be a lot more sympathetic to MMT if its proponents weren’t so damned longwinded.