Man Without Qualities

Thursday, June 01, 2006

Bad Economist? IV

As always, I enjoyed Arnold Kling's TCS article/review of David Warsh's fine new book Knowledge and the Wealth of Nations. And I also enjoyed the book itself - although I have some reservations with regard to the basic academic works of both Paul Krugman and (to a lesser extent) Paul Romer which are celebrated by Mr. Warsh. My reservations are for the most part not original, but they are serious, especially with respect to Herr Doktorprofessor Krugman's contribution. That's why I was a little surprised that Arnold's review does not mention, for example, Don Davis's very serious criticisms of Krugman's original papers, as I discussed here (for example). And although Professor Davis is now Chair of the Columbia economics department and was a professor of economics at Harvard at the time he issued his original criticisms, he does not even get a mention in Warsh's index!

It is true that Krugman to some extent recovered from the Davis criticism, but at the expense of having to make a great many concessions in the sweep of his original conclusions while concocting his (in my opinion) pretentious "New Geography." Krugman has admitted that his approach has a lot more to say about inter-regional trade issues than it has to say about true international trade. I discuss more of these reservations and developments here and here. I also mention that, in private correspondence with me, one economic Nobelist who knows something about international finance has rather openly disparaged Krugman's work. So, if Herr Doktorprofessor is correct to claim in his own review of the Warsh book (a review that Arnold correctly points out can barely conceal Herr Doktorprofessor's resentment that Romer gets top billing in the book), that "an intellectual revolution, largely invisible to the general public ... swept through the economics profession ...[in which] I was a prominent player," it would appear that not all sovereigns have yet recognized the new "revolutionary" government.

Of course, no one has an obligation to share any of my reservations about Krugman or Romer, but I think there is one aspect of their works that must be addressed in any meaningful evaluation of them: What significant predictions and policies flow from them. Consider Krugman's trade theories, for example. It is obvious that Ricardo's comparative advantage theory (supposedly displaced by the Krugmanian "revolution) has had tremendous predictive and policy consequences over the past two centuries - it is not necessary to list any. But can any reader provide one single example of an application of Krugman's theory to the creation of a policy that has clearly resulted in an increase in general wealth? Or of anyone's wealth (besides Krugman and his academic acolytes)? I can't. But every single day I notice many things in my life that were manufactured in countries with big comparative advantages to the US in doing so!

Similarly, what about real predictions - and I don't mean the silly game of testing Krugman's theory against "traditional" theories by doing comparative country analysis (as noted above, even that doesn't do Krugman much good - by his own admission). I mean predictions that help the society or someone make real money, or help some policy maker take a significant decision. Is the reader aware of a single currency trader, commodities trader or corporate CEO, COO or CSO or any other such professional who uses Krugman's theories to make predictions or plans in this period of intense globalization in which trade plays an ever larger role?

Similarly, is the reader aware of a single example of Krugman's work influencing anything relating to the EU Constitution debate - or the EU at all? Does the reader know of any politician who was alarmed or comforted by something from Krugman's work in connection with the greater integration of Europe? I'm not - and I was there when the French were deciding to vote it down! The arguments then and there were all about comparative advantage and input costs (Polish plumbers) within the EU region. Yet it is exactly in the zone of "regional" trade that Herr Doktorprofessor claims his insights have their greatest significance.

What about the ongoing Doha Round? For that matter, does any reader know of any significant WTO policy or concern or dispute that has been clearly influenced by the distinct trade economics insights of Herr Doktorprofessor Paul Von Krugman? I don't.

More generally: What example, in the real world, is a single meaningful application of Paul Krugman's trade insights anywhere outside of academe and academic journals? I am aware of nothing.

At least to my understanding, there is a lot more to - and remaining of - Paul Romer's work than Paul Krugman's work. That may be why Warsh concentrates on Romer. But Romer's work is not without its serious problems. Robert Solow - who is largely responsible for the very existence of the field of growth economics and won his own Nobel Prize for that work - has expressed serious reservations about Romer's contributions to "endogenous growth." Solow has made the uncontroverted point that it is trivial to make growth "endogenous" to a growth model, and that the trick is to make it endogenous in a way that is meaningful - which is what Romer and his people may (or may not) have done. I personally have reservations about Romer's assumptions concerning the nature of intellectual property, but such of my thoughts are not at issue here. Solow follows up his observation with more serious concerns, as the Economist's review of the Warsh book points out:

Mr Romer's theory, by contrast, calls for a more worldly response: educate people, subsidise their research, import ideas from abroad, carefully gauge the protection offered to intellectual property. But did policymakers need Mr Romer's model to reveal the importance of such things? Mr Solow has expressed doubts. Despite the caricature, he did not intend in his 1956 model to deny that innovation is often dearly bought and profit-driven. The question is whether anything useful can be said about that process at the level of the economy as a whole. That question has yet to be answered definitively. In particular, Mr Solow worries that some of the “more powerful conclusions” of the new growth theory are “unearned”, flowing as they do from powerful assumptions.

Professor Romer has not absented himself from all policy involvement by any means - as noted by Mr. Warsh. But in my opinion, Romer's involvement in the Microsoft case - and the case itself - was and remains a disaster. More generally, I am again aware of no meaningful policies or predictions from Professor Romer's work that have resulted in a clear gain for the economy or for any real-world players in it. Mr. Warsh seems to provide none. Can any reader help?

I very much want to like Paul Romer and his work (I confess that my sentiments towards Herr Doktorprofessor Paul Von Krugman are more complex, but the reader already knew that). Heck, I used to be a mathematician, and I love a good functional analysis/game theoretic riff as much as the next guy. So I would be very much in the debt of any reader who could help clarify my thinking with a few choice examples or rebuttals of my concerns.

My e-mail address appears above. Operators are standing by!

In truth, it appears that Arnold is trying extra hard to be nice in his review - which is not surprising since Arnold Kling is generally an extra-nice sort of person. Since he is being nice, he would probably have highlighted any clear benefit or application of these theories. That he didn't mention any such benefit or application speaks volumes about his likely true sentiments. But there is room for ambiguity in comments like this:
I have to separate my views of Krugman the New York Times columnist (execrable) with my views of Krugman the research economist (original and significant).
The economic models on which both of Professors Romer and Krugman have made their reputations employ rather involved (but not cutting-edge) mathematics. Such models are hugely hard to construe intuitively - one needs to first crank through the mathematical calculations they disgorge. In contrast, people like, say, Becker, supply mathematically rigorous arguments to back up their intuitive arguments, but the intuitive arguments make perfect sense before the mathematics is trotted out. That's not true of models of the Romer/Krugman type. That makes the fine structure of their mathematics much more central to the whole process - and makes it very easy for the mathematics to obscure intellectually weak (that is, overly powerful!) assumptions that support the model.

My guess is that models of the Romer/Krugman type have lots of mathematical eccentricities and mathematically obscured weaknesses. Davis' assault on Krugman's work is one example. It's interesting that Warsh focuses on Krugman's and Romer's efforts to address "transversality" as an effort to establish that their models are in a particular manner "stable." Ironically, Davis showed that Krugman's model was highly unstable in a totally different manner! That is, Davis showed that Krugman's initial results depended on what Krugman presented as a faux innocuous simplifying assumption - an assumption that was both seriously wrong and anything but innocuous.

The Krugman/Romer generation of economists is not the first to employ fancy mathematics. It looks like some people think that even the fine structure of now-venerable general equilibrium is wrong - or at least not economically meaningful. Observations available here and here and here argue that some of the basic papers in general equilibrium theory have also obscured the weaknesses of the theory with a cloud of mathematics, as in this summary:
[O]ur findings show that the existence results [of general equilibrium theory] are mathematical theorems devoid of any economic sense. As a consequence, this paper implies a direct criticism of dominant economic theory from two points of view. The first one being the theoretical soundness and rigor of neoclassical theory. The second criticism is more general, as it concerns the relationship between mathematics and economic theory.

I do not endorse such criticisms of general equilibrium theory, nor do I fully agree with the significance that these critic assign to it. General equilibrium theory is an odd part of economics. Often praised as "the most important this or that of 20th century economics...," it often just sits there. Sometimes it seems mostly to form the "foundation" of the Arrow/Debreau reputations. As the critical papers note, nobody seems to have spent a lot of time picking apart even the basic functions that the models use to see how they square with supply and demand requirements.

But what might be a "leave it alone as a sacred cow" attitude may be changing with the dawn of the new hyper-mathematical models of the Romer/Krugman type. Even the willingness to closely examine the mathematical fine structure of general equilibrium as may be such an early effect.

UPDATE (June 2): Don Luskin gets results! In response to Don's link to my post an astute reader provides a clear example of how one can make money with Herr Doktorprofessor's thinking (if not his trade theories):

Dear Robert,

(I need to remain anonymous, but please feel to share with your many readers. And thank you for your work. I've CCed Donald, as I know he'd enjoy this letter to you.)

Paul Krugman and his theories and beliefs have made me money. Seriously. That's because I'm a Paul Krugman contrarian.

I remember a lesson from a finance professor at Wharton. He stated that the most useless person in the world is someone that is right half of the time. Those that are right more often than chance should be watched carefully, and mimicked. And those that are wrong more often than chance should be watched VERY carefully. The person that is consistently wrong will provide you with opportunities to create wealth again and again.

Paul Krugman is such a person.

I have made money by betting the opposite of what Paul thinks, both in legitimate financial markets and "illegal" betting sites. For example, when he became convinced that Dean was the man to win the election, I made money on Kerry winning the primary. When Paul was convinced that Kerry would win the whole election, I bet on Bush. Paul last year said the bubble in the housing market would burst. I knew that I could wait a year, and any bursting would be very slow than very sudden. Paul is convinced that growth is slow and that unemployment is high -- I've been long the market (and very happy) since he turned into a sourpuss.

I conservatively estimate that Paul Krugman has earned me an 'excess return' of about $25,000 on my capital over the past five years, adding about 5% more to my portfolio annually.

The Times Select fee is well worth the price, as it lets me know what Paul thinks. So I can bet the opposite.



There you have it! Found money!

And, as a bonus, the reader is invited to steal (er, "use") this valuable contra-Krugmanian recipe as a consequence of Professor Romer's finding that the world is a better place because we can all work the same recipe at the same time without getting in each others' way.

So, Grasshopper, may your economies of scale increase without limit .... even in the long run!

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