Tuesday, May 8, 2012

Perhaps the Biggest Libertarian Bias in Economics

Oxford Macroeconomist Simon Wren-Lewis has an excellent recent post on libertarian bias in economics:
In RBC models, all changes in unemployment are voluntary. If unemployment is rising, it is because more workers are choosing leisure rather than work. As a result, high unemployment in a recession is not a problem at all. It just so happens that (because of a temporary absence of new discoveries) real wages are relatively low, so workers choose to work less and enjoy more free time...

If anyone is reading this who is not familiar with macroeconomics, you might guess that this rather counterintuitive theory is some very marginal and long forgotten macroeconomic idea. You would be very wrong. RBC models were dominant in the 1980s, and many macroeconomists still model business cycles this way. I have even seen textbooks where the only account of the business cycle is a basic RBC model...

Yet what seems like a rather important fact about business cycles, which is that changes in unemployment are involuntary, is largely ignored...

What could account for this particular selective use of evidence? One explanation is ideological. The commonsense view of the business cycle, and the need to in some sense smooth this cycle, is that it involves a market failure that requires the intervention of a state institution in some form. If your ideological view is to deny market failure where possible, and therefore minimise a role for the state, then it is natural enough (although hardly scientific) to ignore inconvenient facts. For the record I think those on the left are as capable of ignoring inconvenient facts: however there is not a left wing equivalent of RBC theory which plays a central role in mainstream macroeconomics.
Wren-Lewis focuses on RBC models, and the central role they play in macroeconomics. I'd like to add another libertarian bias. This one is throughout economics, not just macro. It's fundamental, integral -- and I believe, tragic. It's how in economics the concern, the goal, is almost always Pareto optimality rather than total societal utils optimality.

A common reason given is that it’s hard to measure total societal utils. Well, it’s hard to measure lots of things, so is it then optimal to completely ignore them, and just go 100% with random luck for our strategy of optimizing them? Even for things that are of great, fundamental importance to us, our strategy should be just ignore them, spend zero time thinking about them and trying to optimize them, and hope that by random luck you end up doing a good job of optimizing them?

We can’t improve on that? When you choose a city and a home, do you say it’s hard to estimate the expected utils I'll get from a home, so I’ll just throw a dart at a map of the world and decide that way? I’ll put no thought into it whatsoever, and completely ignore the great deal of important information that I do have, and can get, because it's hard to estimate the utility I'll get from a given home? Of course not.

Plus, you think it's hard to estimate the utils people get from goods, but it's not hard to rank, for any and all bundles, which will give higher utility? You're not ok with a function that estimates utils, but you are ok with one that ranks any and all bundles of goods by the utility they will provide a person, or all persons? You're ok with saying a function like lnX does this, THAT'S Ok, that’s a close enough to reality estimate, we're ok with all of the assumptions behind that, but not a util function?

And in any case, the field already commonly assumes a representative agent and a continuous utility function for dollars. So you're assuming all agents (people) have the same exact function that describes the utility they get out of any amount of dollars. Already we've assumed enough then to talk about total utils for all members of society added together (although in the model for this to really be useful in total utility analysis, you need to be explicit that there's not one agent, but many with homogeneous utility functions), yet somehow this is "controversial", or "outside the bounds of economics", we can only talk about the extreme libertarian concept of change only with unanimous consent (i.e. Pareto optimality), and never change in order to increase total societal utils (total societal utils optimality).

Clearly it’s hard to get a more pro-libertarian and anti-utilitarian bias than saying I’ll almost always make Pareto optimality (changes are only made if there is unanimous consent) a central focus, and almost always completely ignore total societal utils (changes can be made if it's for the greater good). You're virtually coming right out and saying I'll almost always be a libertarian in my analyses and almost never a utilitarian, or anything in between.

This fundamentally underlies, and profoundly influences, economics towards libertarianism. For example, it allows the profession to by and large ignore the fact that severe diminishing returns of utiltiy from dollars means that substantial progressive taxation can skyrocket total societal utils.

We do have this general notion of inequality as, for many economists, being bad, in of itself, but because we can pretty much only talk about Pareto optimality, and never optimizing total societal utils, we can never really talk about how the extreme concavity of utiltiy makes it so that progressive taxation can skyrocket total societal utils (and that's not even counting positional/context/prestige externalities, and the fact that there can be enormous social returns from investing progressive taxes in the poor and middle class through, for example, education, and in high externality public goods).

Think of how different economics would be (and the effect on policy over the long run) if it were acceptable and common to calculate and optimize total societal utils in models -- and to care about it.

Thank goodness we now have the emerging happiness research, which is saying we DO care about total societal happiness (utils, at least largely). But predictably, who do we see attacking this research?.