VC Partner Selection (MY Recommended Reading)

(Matt Yglesias tweeted that there were interesting papers on the NBER home page today, so I checked them out. Here’s a summary of one of them.)

In Oct. 2005, Alan Blinder (Princeton) and John Morgan (Berkeley) published a paper¹ in which they argued that, among other things, small groups are better data analysts and decision-makers with the same data than individuals, and the quality improvement is larger than can be attributed to an individual’s abilities within the group. That is, basically, there is something unique about being in a group that produces better outcomes than either learning by doing or working on one’s own.² Blinder and Morgan, though, had artificial group homogeneity — they had a collection of students — while in practice, that homogeneity may not exist. Whether it does or not, we can ask the question of whether that loss of homogeneity is likely good or bad.

An NBER working paper from Paul Gompers, Vladimir Mukharlyamov, and Yuhai Xuan investigates the value of intragroup similarity. They break similarity down into two categories: “ability-based characteristics (e.g., whether both individuals in a dyad obtained a degree from a top university) and affinity-based characteristics (e.g., whether individuals in a pair share the same ethnic background, attended the same school, or worked for the same employer previously)” (Gompers 2). Then, looking at the venture capital industry, they investigate whether each type has a positive or negative effect on investment success.

Before questioning how group selection affects results, they began with the obvious prior question of how group selection occurs, and the results were not really surprising:

two venture capitalists that both hold degrees from top universities (potentially indicating high ability) are 8.5% more likely to co-invest together than individuals not similar in terms of being graduates of top academic institutions. An even stronger effect is documented with respect to non-ability-related, affinity-based characteristics. A pair of venture capitalists who graduated from the same university are 20.5% more likely to partner on a deal, and even more strikingly, the probability of collaboration between two individual venture capitalists increases by 22.8% if they are part of the same ethnic minority group. Partnership is also more likely to happen if the two venture capitalists worked at the same company earlier in their careers. These results on syndication decision represent strong evidence of homophilic selection in collaboration. [Gompers 6]

Surprise, surprise, people tend to select people like them in some superficial way, but at least the group decision-theoretic literature gives us the term “homophilic selection” to use to sound intelligent when talking about it.

There are reasons, of course, that affinity-based or ability-based selection could have positive or negative effects. Affinity-based selection could increase success if prior knowledge of a potential co-investor revealed valuable information to a venture capitalist about the follow-on investor’s risk preferences, analytical abilities, etc., but could decrease the likelihood of success if that prior knowledge were illusory. Gompers et. al. also suggest that personal utility from working with familiar people may decrease rate of return thresholds and encourage low-value investment . Ability-based selection may foster the creation of power couples VC dyads with outstanding discernment and business knowledge, but may also encourage groupthink and an increased desire for unanimity (4).

The investigating group found that ability-based selection improved the likelihood of success, while affinity-based selection gave strong evidence for a “cost of friendship.” Defining “success” as taking a company public, the researchers found that ability-based selection increased the likelihood of success significantly, with the first VC’s top degree worth an extra ~9% and the second worth an extra ~11%. They also found a huge cost of friendship: an 18% decline in the likelihood of success from having worked previously at the same company, 22% decline if a dyad attended the same undergraduate school, and a 25% decline if two VCs are members of the same ethnic minority. What’s strangest about this is that, despite the apparent huge costs of affinity-based selection, “affinity-based similarity not only determines people’s attractions to work together for the first time, but also increases their frequency of repeated collaborations” (Gompers 7).

The news on affinity-based selection isn’t conclusive though, since determining whether the cost is due to selection or treatment effects is difficult. Selection effects would arise in the investment choices that high-affinity VC pairs made. If selection effects were the source of the decreased likelihood of success, we could attribute the decline to a lower bar from personal utility gains, more difficulty in attracting low-affinity investors into groups for riskier investments, or “worse” portfolio companies having a harder time attracting low-affinity VCs because of the portfolio company’s inferiority (Gompers 22). If treatment effects were the source, the cost would come from the decisions the VC groups made after investing. By explanation,

Venture capital investors provide significant value-add to their portfolio companies beyond the supply of capital. Post-investment, they make important decisions and offer invaluable advice on a variety of issues: hiring and firing the CEO, the senior management team, and the board of directors; identifying customers or partnering opportunities; and devising a viable overall strategy, all of which are critical to moving the venture forward along the path to success. Thus, any inefficient decision-making post investment induced by homophily among high-affinity venture capitalists will negatively impact the success of the portfolio company they oversee. In other words, the lower likelihood of success of co-investments between venture capitalists that share similar characteristics is triggered by their making inefficient decisions or even mistakes that they would otherwise avoid with more diverse boards. [Gompers 23]

The researchers caution that the two stories have different implications. If the selection story is right, then it is the choice of investment with a particular group that fixes the likelihood of success. If the treatment story is right, then there is room for efficiency gains post-investment that suggest that the choice of VC partners is important not only ex ante, but continuing through the life of the investment (Gompers 23). Using Heckmann’s two-stage correction,³ they found evidence that a substantial percentage of the costs of affinity-based selection come from poor post-investment decisions.

The researchers conclude with levity that “to paraphrase Ralph Waldo Emerson, you cannot afford to be stupid with old friends when you are venture capitalists co-investing together” (Gompers 32).

The study may not be robust across industries. Affinity-based selection outside of the VC industry, in political collaboration (running mates, cabinet members, etc.) for instance, may be positive on success, and of course success would have to be measured differently. Regardless, the paper contributes to understanding how groups of a size between microeconomic individuals and firms and macroeconomic actors function.

We could, by the way, make the jump from the Blinder/Morgan paper and the Gompers/Mukharlyamov/Xuan paper to an indictment of the myth of individualism or an extension of “You didn’t build that” to the private sphere, but that’s a problem for another day.

1 – Never again will I so strongly urge reading the whole paper. It’s fascinating and does solid work at a level between micro and macro.

2 – Take that, individualists!

3 – Someday I’m going to learn all of the statistics. Wikipedia page is included for perusal, rather than because you need to understand Heckmann’s two-stage correction right now.

Page numbers refer to page in .pdf of paper, not pages listed on the bottom of the scan that constitutes the .pdf

Blinder, Alan, and John Morgan. “Are Two Heads Better Than One?: Monetary Policy by Committee.” Journal of Money, Credit, and Banking, vol. 37(5). The Ohio State University Press: Oct. 2005.

Gompers, Paul, Vladimir Mukharlyamov, and Yuhai Xuan. “The Cost of Friendship.” NBER Working Paper Series. Cambridge, MA: June 2012.

Bush Puns, Round II

I only read the introduction to The 4% Solution because I borrowed the book from Barnes and Noble (the perks of being a bookseller) and had to give it back, but here’s a quick reaction to that, at least. Fortunately, it briefly summarizes a lot of what the rest of the book will cover, so this is still an improvement over the New York Times article referenced in the last Bush post.

James Glassman wrote the introduction. In case you don’t feel like clicking the link and browsing his wiki page yourself, he’s a government nerd with a lot of publishing experience, and it shows. There’s no needling the left or lionizing the right in the introduction. It’s a no-nonsense preview of what the rest of the book will be about, and it’s concise and well-written. Anyway, to work.

Here’s how we start the introduction:

For the past few years, the United States has been afflicted by some of the worst of economic maladies: a financial crisis followed by recession and stagnation. Now many economic forecasters see sustainable U.S. growth declining by a full percentage point from its trend of the past seven decades. One point may not sound like much, but over the longer term, it has a huge effect. It means that the standard of living of an American born today will be roughly half what it would have been. [xv]

…if growth had continued at an identical rate. But this is really an argument that growth, for some reason, should follow its historical trendline. We’ll come back to that later. Glassman doesn’t just want the trendline back though. He wants bigger growth. This is consistent with how dick measuring functions on the national level. We were afraid of China because they were growing at 10% annually, and we thought of sub-Saharan African countries as backwards because their GDPs weren’t growing. Anyway, the point is that ambition means a bigger number when we look at our annual GDP growth. Here’s Glassman again:

President Bush believes in setting aggressive but achievable goals, and we established a target of 4% average annual sustainable GDP increases. Why 4%? We wanted to reach. To call for a return to 3% would not be so inspirational or aspirational. Four percent: We can get there. (emphasis added)” [xvi]

And this is where the growth plans start to be confusing. We’re going to average something that on the next page [xvii] Glassman says has happened 23 times in the last 60 years? The years in which we exceeded four percent growth were unusual as well; they included the massive capital account surpluses in the Reagan years and the huge military/space spending in early 60s. Later [xix], Glassman will claim that borrowing from foreigners won’t produce lasting gains if it produces gains at all, but some of the highest growth years in the chart he included were heavily dependent on borrowing from foreigners. It’s also true that, right now, since foreigners will literally pay us to hold on to their money for them, we should be able to borrow as much as we want without burdening future generations, but of course the long-run negative interest rate is a more recent phenomenon than the book’s realization.

Most confusing, though, is this line: “Why 4%? We wanted to reach.” The discussion around this had to be something along the lines of picking the biggest growth target anyone could imagine might still be reachable, and this is where I think the message starts to reel, at least with respect to the individual/market-centered narratives conservatives usually focus on. In endowing “reaching” for 4% economic growth with some kind of moral quality, Glassman and the others in this book make the claim that the purpose of individual activity is to realize national economic goals, rather than the usual thin lie about the national economy working for individuals. I’m not trying to claim that this attitude isn’t prevalent at the national level, only that this seems a little bit… transparent? Transparent. Usually the purpose of individual activity, at least in the market narrative, is to make one’s life better, but this is clearly something different.

… or at least for a moment it is. Quickly, we’re back on the rugged individualist narrative.

The objective of economic policy is to allow hardworking individuals, no matter their status at birth, to take advantage of opportunity and achieve a good life. [xviii]

But again, we’re on uncertain ground. This sounds like a concession that hardworking individuals may not be able to take advantage of opportunity and achieve a good life without economic policy. That would suggest that the academic right, at least, is willing to admit that differences of opinion about economic policy are of degree rather than kind, which would put the mainstream academic right almost as far out of touch with the mainstream non-academic right as the mainstream academic left is. Or at least, that’s what it sounds like until you get a little further down the page:

Policy that encourages growth solves what Lord Keynes in 1930 called ‘the economic problem.’ Keynes wrote that ‘the economic problem may be solved, or be at least within sight of a solution, within a hundred year.’ Keynes was wrong about many things, but even in the depths of the Great Depression, he got this prediction right.¹ The United States solved the economic problem a while ago, by putting the principles of the free market into practice, but we are now in danger of losing our way for good.² [xviii]

Now we’re back on track with the usual policy calls from the right. “We did the free market once and it worked!” doesn’t suggest much for current policy, but it’s comfortable and easy and demands less critical thought than trying to find out what’s different now, or even to what particular “not now” we ought to compare current economic conditions. The usual argument is more clear on the next page:

A government can tax its citizens – or borrow from foreigners, as we have been doing recently – and use the proceeds to hire all sorts of workers. But the gains, if any, are fleeting because: a) no government knows how to allocate labor productively, and b) the money used to create the jobs ultimately comes from people and firms that actually do know how to allocate productively. [xix]

What would happen if some of those people who knew how to allocate productively were hired to fill government posts? I can only assume they’d forget everything they used to know, just as know-nothing government employees gain all kinds of useful productive knowledge as soon as they jump to the private sector. I mean, just look at the list of Treasury secretaries – worthless, as a class, by the way, because they’re part of government – who used to be effective as heads of private (usually financial) firms.³

Glassman does make an important point though. Despite calls for austerity now (!!) from conservative camps around the world, he points out that growth will do a much better job of reducing the deficit and debt than tax hikes or spending cuts. Projecting 4% growth starting in 2017, Alex Brill of the AEI found debt reduction in the neighborhood of $3.7 trillion, or a roughly 25% improvement over current projections, by 2021 [xx]. This in theory functions through a virtuous cycle, in which growth decreases debt, which frees up the economy to grow more, which further reduces debt.

The next argument is for a revision of the tax code, focusing on a shift away from income taxes and toward taxes on consumption and property [xxii]. This sounds, on the surface, incredibly regressive. People outside the highest wealth quintiles necessarily spend more of their incomes on consumption and have more of their wealth tied up in property. With that said, this type of change to the tax code isn’t an awful idea as long as it targets accumulated idle wealth of all kinds rather than just property. If anyone wants seriously to believe in the trickle down argument,⁴ an “idle wealth” tax would provide incentives to make wealth productive, and for the more rabidly patriotic, we could tax anything invested overseas at the idle tax rate and anything invested in the United States at the productive wealth rate. I personally hate this idea, but political efficacy demands some jingoistic compromises.

Next, there’s some argument about innovation and education reform, but I’m going to leave it alone because I seriously have no knowledge on this front and thus can’t engage.

More broadly, though, there seems in the introduction to be an unwillingness to make any argument about why economies should grow at all. Several times Glassman promises that essayists who will appear later in the book will make arguments about particular policies — usually getting out of the way of the market in some way — that promote growth, but there’s still something non-intuitive to me about why the market would on its own opt for more products next year than this year. Even if that were the case, there’s no explanation or even promise of an explanation about how this will make anyone’s life better. Percentage changes in total economic activity may not be linked to rising individual welfare, which the decoupling of economic growth and per capita income shows pretty clearly. From Glassman’s introduction, it appears that growth as such is good, and other good things are naturally supposed to follow.

That’s a weird tension. Somehow, Glassman managed to make it through the entire introduction without mentioning how growth was supposed to make anyone’s life better. The only particular argument about anything getting better in the introduction is debt reduction, the purpose of which seemed to be more growth, which I guess we’re supposed to ride gracefully into the sunset. To be fair, though, the book is a lot longer than the introduction, and the mechanism through which people’s lives improve through growth may be hidden somewhere else.

1 – His prediction, by the way, if we parse it from this quotation, is that it is possible that we will be within sight of a solution to the economic problem within a hundred years, but also possible that we may not be. Interpreting the quotation this way, we can say with Glassman that Keynes nailed it.

2 – It’s unclear what “putting the principles of the free market into practice” means or when we did so, or why we might “[lose] our way for good.” If the former Soviet states can transition to market economies, I don’t know why Glassman would posit a possibility of developing unrecoverably un-free markets. Oh well.

3 – Paulson, Snow, O’Neil, Summers, and Rubin (the five preceding Geithner) had backgrounds with Goldman Sachs, CSX, Alcoa/RAND, public service/academia, and Goldman Sachs, respectively, and Summers’s time in public service/academia, even as president of Harvard, was in large part a private industry/self-promotion tour.

4 – This might be Limbaugh-ian straw man-ing, but surely someone, somewhere still wants to believe in the trickle down argument.

All page numbers refer to:

Bush, George W., James K. Glassman, and Brendan Miniter. The 4% Solution: Unleashing the Economic Growth America Needs. New York: Crown Business, 2012.

Obligatory response to Aurora (Guest Post for Josh Divine)

(originally posted at The Divine Perspective)

The shooting that occurred at the premier of The Dark Knight Rises was a very sad event, and naturally the immediate response was policy. The twitterverse blew up almost immediately with calls for stiffer gun control, which was of course to be expected. On MSNBC, a survivor said her father, on discovering she’d survived, said he would have killed the shooter, giving a blunt articulation of what the anti-gun regulation lobby says should have happened. E.J. Dionne Jr. then decided to take the predictable liberal line: we need to talk about this and come up with a policy. All of this misses the boat.

In the first case, the link between gun control and decreased gun crimes is almost impossible to isolate. This NYT article following the 2008 ruling in District of Columbia v. Heller does a solid job covering the arguments for and against guns and the difficulty in making arguments out of the raw data available. This passage, in particular, is instructive:

According to the study, published last year in The Harvard Journal of Law and Public Policy, European nations with more guns had lower murder rates. As summarized in a brief filed by several criminologists and other scholars supporting the challenge to the Washington law, the seven nations with the most guns per capita had 1.2 murders annually for every 100,000 people. The rate in the nine nations with the fewest guns was 4.4.

Justice Breyer was skeptical about what these comparisons proved. “Which is the cause and which the effect?” he asked. “The proposition that strict gun laws cause crime is harder to accept than the proposition that strict gun laws in part grow out of the fact that a nation already has a higher crime rate.”

One study cited in the article showed a link between background checks and a decreased murder rate, but Colorado already requires vendors to perform background checks before transferring possession of firearms.

On the other side, no one was going to take down the shooter with a concealed handgun. I doubt many of the film’s attendees thought to bring their gas masks with them, so the tear gas the shooter threw before he started shooting would have decreased their ability to aim accurately. Second, reports have all emphasized that the shooter was covered head to toe in body armor, including a neck guard. The shooter was the only person who could breathe and the only person who could fire blind without worrying about hitting the wrong person since for him there were no wrong people.

E.J. Dionne’s article means well, but who cares? He expresses outrage and a sense we ought to, you know, do something and makes some inane analogies. This is the critical passage:

First, the gun lobby goes straight to the exploitation argument — which is, of course, a big lie. You can see this because we never allow an assertion of this kind to stop conversation on other issues.

Nobody who points to the inadequacy of our flood-control policies or mistakes by the Army Corps of Engineers is accused of “exploiting” the victims of a deluge. Nobody who criticizes a botched response by the Federal Emergency Management Agency to a natural disaster is accused of “exploiting” the victims of a hurricane or a tornado. Nobody who lays part of the blame for an accident on insufficient regulation of, say, the airlines or coal mining is accused of “exploiting” the accident’s victims.

The difference, of course, between deluges, hurricanes, and tornadoes is that each of those is a consistent, predictable kind of disaster, while gun massacres are variable. Designing policies to stop the general case of gun massacres may not have any impact on stopping people like James Holmes, or the Virginia Tech shooter, or the Columbine shooter. Policy deals with general cases, big phenomena. This is something different.

It’d be nice to believe that we can use our political system to make the world more stable or make events like Friday’s make sense, but we’re not dealing with an institutional problem here. These mass shootings are still incredibly rare and, relative to yearly deaths, not all that significant – those killed in the Aurora shooting represent less than half a day’s quota for annual gun deaths in the U.S.

If we design a policy as a response, it shouldn’t be designed to stop gun deaths like those that happened in Aurora. Mass shootings are already rare enough by virtue of being mass shootings that we don’t have to design policy to stop them, and whatever policy we do design will be completely unable to predict the particulars of the next one. If we want to do something (!), we ought to focus on the other 729 730ths of gun deaths each year.

Policy designed to decrease the other 729 730ths of gun deaths each year may not work, but it would make much more sense than attempting to target the next disgruntled PhD. candidate with a shotgun and a penchant for designing booby traps.

All of the Bush Puns Have Been Taken

George Bush has a book coming out tomorrow. It outlines a plan of some kind for sustained 4% growth, which is tenuous from the outset. “We need a book outlining a plan for 4% growth” suggests that the reason we haven’t had sustained 4% growth is that we haven’t planned for 4% growth. Hey conservative friends, what do you call it when government chooses a policy set with specific growth, allocation, and composition targets? Nevermind, it’s not central planning if it’s “the market.” If you are a free marketeer, government planning to stay out of the way is probably a lot like this SMBC:

Government announcing “we’re staying out of the way for a bit” is analogous to a god’s abstaining from flooding everyone, blah blah blah, but government actually exists, etc., etc.¹

Anyway, that’s not really the point. The point is that sustaining 4% growth is an absurd target, and believing that fine tuning a few things and then watching the market work will provide it suggests a naivate about economics that should keep anyone from being allowed to publish a book in the first place.

We need to keep some perspective when we talk about growth. The New York Times article previewing the book points out that if the U.S. economy had grown by 4% annually since 1948, it would be 50% larger today than it actually is. Great. I’m not sure how that provides any perspective on what 4% growth means, since, you know, (1.04)^t isn’t something I can readily visualize or understand on an intuitive level relative to the growth that actually occurred, but whatever. I think this does provide some perspective though: In 2010 if the U.S. economy had grown by 4%, it would have grown by $577.8 billion (2010 dollars), or a bit more more than the 2010 GDP of Switzerland. The marginal economic activity from 2010 to 2011 –the growth, that is — would have been the 19th largest economy in the world.² Bush’s target basically says we want to increase our economic activity each year by a quantity greater than everything everyone in Switzerland did in 2010. What that means is the equivalent of adding the population of Switzerland in jobs (roughly 7.8 million people) annually… at or above $80,000 annual pay. We’re not “lowering corporate tax rates, shifting away from taxing income to taxing consumption and property, promoting innovation by letting professors keep gains from their research, expanding free-trade pacts with Japan and other countries, refocusing immigration policy to recruit more high-skill workers, and expanding the work force by lowering payroll taxes on employees with children” (from NYT again) from adding 7.8 million jobs at or above $80,000 a year every year. An alternative, of course, is that we could add some jobs and have wages keep up with productivity growth, but have you seen wage trends?³ They’re laughable, if you find sad things funny.

This is where the naivate comes into play. It starts with the assumption that sustainable growth on a scale equal to the post-WWII era is possible. Low growth numbers sound awful, but the fact is that the U.S.’s growth numbers are compared to a much larger baseline than other countries’, partly because of decades of robust growth. Part of the answer to “Why aren’t we growing like we used to?” has to be “because we’re bigger now.” But then the other side of the argument is that a few market reforms will miraculously produce this 4% growth.⁴ Why should a “freer” market have goals in line with our 4% growth? Why should it prefer round numbers? Why should it prefer any number in particular? Particularly unconvincing is the argument that reduction of corporate tax rates will do anything significant other than increase dividends or increase executive pay. Businesses have 12.7 million unemployed people from which to choose, and they aren’t hiring in ways that don’t get taken out in the BLS’s massive summer seasonal adjustments, which suggests that it’s not the cost of labor that’s keeping them from hiring but rather labor demand.

The line from Brendan Miniter, editor of the book, that closes the NYT article explains a lot:

“We’re in an economy in transition,” said Brendan Miniter, who edited the book. “If we don’t set the target higher, if we just continue to stumble along, ultimately we’re going to pay a pretty stark price.”

The alternatives aren’t changing the growth target and stumbling along, and the link between not choosing a 4% growth target and “[paying] a pretty stark price” is tenuous as presented — what would happen if we targeted 3.8% growth? The point is that we could target any number of other things. We could limit executive salary + bonuses and ignore everyone who cries “You’re eliminating incentives for people even to try to make more than $10 million a year!” (Yes, that’s the point), try to make the U.S. a better place for everyone by democratizing access to a wide variety of benefits and damn the growth numbers, substantially increase top marginal tax rates and add a tax bracket to capture higher income groups and attempt to ensure a minimum standard of living rather than shrugging our collective shoulders at the plight of people in the resentment zone… None of these involve growth targets, but none of them are stumbling along either.

Schumpeter and Marx both argued that the endgame of capitalism involved the death of the entrepreneur and small capitalists and a concentration of market power in the hands of large businesses (Fusfeld 173). The problem here if you believe innovation is important is that big businesses, once they secure monopoly power, have almost no reason to innovate and zero interest in growth. None of the reforms suggested above have anything to do with halting or even slowing this trend, which means that even if 4% growth is sustainable for a short time, it cannot be in the long run.

1 – In this analogy, I’m a priest shouting “Anarchist!”

2 – I’m using the UN numbers because they’re in the first column. Feel free to use whichever column you like.

3 – Yeah, that article is from 2006. That doesn’t matter in terms of the actual argument, because wages have taken a beating in this recession.

4 – I’m sure the argument is more nuanced than this, but, you know, the book’s not out yet, so I’m giving myself a free pass on this simplification.

Fusfeld, Daniel. The Age of the Economist, 9e. Pearson Education, Inc.: 2002.

PS Planning to read the book and map out its more thought-out argument than what the NYT can publish in an advance summary. Count on it next week.

The Common Commenter Problem (Guest Post for Josh Divine)

(originally posted on The Divine Perspective)

Let’s start with this chart showing average weekly working hours for OECD countries from 2008:

There doesn’t seem to be anything controversial here. It’s OECD data, so it’s probably better reported than what you’d find from China or India. It includes 28 countries, which should give some perspective about… something. Whatever, perspective is always good, right? The chart also lists a source for its data, which is nice. The only place the authors could be accused of editorializing is where they say the chart “[shows] us which countries have their nose to the grindstone and which ones are more often found smelling the roses.” Really, authors? Which have their nose to the grindstone? Only the South Koreans? The South Koreans and the Greeks? The South Koreans, Greeks, Poles, Czechs, and Hungarians? Still, a little imprecision that doesn’t significantly affect the meaning of the chart is acceptable.

With that said, somehow the commenters managed visceral reactions. “K” contributes “American says wtf? no way. I work twice that.” “not important” attempts to kick off conspiracy discussions with “they probably don’t want to put up china and india’s [sic.] numbers because it’ll just be ridiculous,” as if the OECD is sitting on the China and India data, terrified that someone might find out what they’re holding back. Mike cautions not to trust “any statistic you haven’t forged,” which is poetic, I think, and gives statisticians a better claim to material engagement with the world than they may have had previously. Most concerning is Teiosanu George’s comment: “Hmm…guess I am the one crazy working 70-80 hours per week. Or the rest of the world is lazy…”

What’s striking to me is that even those commenters who have beliefs that can be factually verified – “spanish: Sorry, it’s not correct. In Spain all workers work at least 1750 hours per year.” – are completely certain that they’re right and that the data are wrong. “Spanish” doesn’t even think the data are only a little wrong. If all workers worked at least 1,750 hours per year, that is to say if the least hours worked anyone worked were over 1,750, Spain’s average would be substantially higher than the 1,627 reported. And can Teiosanu George really believe that everyone who works fewer than 3,640 hours per year is lazy?

This common man problem is unique to the social sciences. No one, for instance, much cares if the common man has an opinion about whether the particle found Wednesday is “an impostor, a single particle or even the first of many particles yet to be discovered” (New York Times) because the common man has no idea what he’s talking about. Social scientists could make the same claim, but the common man has easier retorts available: “I’m not an economist, but I have a bank account and I live in the economy;” “I’m not a psychologist, but I’ve been around people my whole life;” “I’m not an English major, but I’ve read some books.”

I think the most problematic is the common man in economics. Rick Perry has a bachelors degree in animal science, but for some reason we had, for about two weeks, to take him seriously when he suggested that Ben Bernanke should be hanged. Ron Paul has an M.D. from Duke and is a Randian,¹ but we’re supposed to take him seriously as a debate opponent for Paul Krugman. Bernanke, by the way, is one of the best recession economists on the planet, and Krugman received the Nobel Memorial Prize in Economic Science in 2008 for his work in international macroeconomics. Both received tenure at Princeton, and while I’m skeptical about rankings in general, the evaluation process for tenure at the third-ranked economics program in the world is probably stringent.

But at least Perry and Paul aren’t wandering around with “Taxed Enough Already” signs. To these people, we ought collectively to pose a simple question: how do you know?²

It’s probably true that some of the people who post senseless comments below graphs have sensibilities similar to mine. I wish they would stop too. The economy is too big for someone who hasn’t seriously studied economics to understand intuitively, and don’t even ask about business experience.

Zizek tells a story about Niels Bohr in probably two-thirds of the books he’s published:

seeing a horse-shoe on his door, the surprised visitor said that he doesn’t believe in the superstition that it brings luck, to what Bohr snapped back: “I also do not believe in it; I have it there because I was told that it works also if one does not believe in it!” (from here)

The difference, of course, between the horse-shoe and the Federal Reserve is that while neither Niels Bohr’s nor anyone else’s beliefs affect the credibility of the horse-shoe, the fact that institutions like the Fed can change real conditions makes the hands-over-ears response even more problematic. It’s stupid, of course, to say that “The Fed doesn’t work because you don’t believe in it,” but we can say “The Fed is terrified to do anything because you don’t believe in it and because Marco Rubio has just enough clout somehow to ‘do something’ about the Fed if he doesn’t see results in two weeks, and then where will we be.”

1 – Economically, this basically means classical microeconomics without any nuance

2 – And then, of course, we could ask how much they think they’re being taxed currently, to hilariously inaccurate result (in Forbes, by the way, who lean right, so I’m totally not cherry-picking CNN articles about how uninformed the Tea Party is)

‘Merica

Since it was independence day yesterday, I thought I would try to do something patriotic, so here’s a dry look at central banking policy.

Louis-Philippe Rochon wrote a determined lit review of papers critiquing central bank policy objectives (“The more things change… inflation targeting and central bank policy,” Journal of Post Keynesian Economics, Summer 2006, vol. 28 no. 4). Early on he details the three constants in central bank policy-setting “irrespective of whether central banks are governed by monetarists, mark I and mark II, or by new Keynesians, mark I or mark II.” These are, in order:

1. “Some degree of price stability” is desirable
2. Inflation is an excess-demand phenomenon
3. Monetary policy is long-run neutral

His main focus is on the foibles of inflation targeting. It’s popular, he writes, due to “the fact that most mainstream authors consider inflation targeting an impressive success, although for them, success is defined exclusively in terms of a reduction in the rate of inflation.” He points out, though, that

the success of inflation targeting is usually measured in terms of its impact on inflation rates, with little or no consideration for real factors or other economic policy goals, such as the reduction of unemployment and poverty as well as the maximization of output. Yet inflation was on a downward trend years before any inflation targeting strategies were adopted, thereby seriously undermining the notion that inflation targeting strategies had anything to do with lowering inflation.

Rather, he argues, that if central banks want to have any effect on the inflation rate, they “must raise interest rates repeatedly until the economy finally collapses,” which is probably not preferable to high inflation, but who knows? Maybe it is. His main point is that central banks, despite their hidebound commitment to inflation targeting, “are not efficient in fighting inflation, and as a consequence, inflation targeting strategies may do more harm to the economy.”

Fortunately, there are significant reasons to believe that some central banks at least are neither so hidebound nor so doctrinally simple as Rochon warns. Galbraith tells a hilarious history of the Federal Reserve’s policy changes since the 1960s in an essay called “Endogenous doctrine, or, why is monetary policy in America so much better than in Europe?” (I promised patriotism!; Journal of Post Keynesian Economics, vol. 28 no. 3). Not only has the Fed not been totally committed to any particular goal; it has at different times moved the same tools in opposite directions to achieve the same goals.

The Fed reacted to the early 1970s oil shocks with tight money policy, or high borrowing rates for banks. What followed was relatively high inflation and high unemployment, so tight money as a rule died. From 1979 to 1982, the Fed followed monetarist doctrine and a stable rate of growth in the money supply — Friedman knew best, after all, unless you buy that Volcker “never believed monetarist doctrine but only used it as a cover for anti-inflationary shock therapy” —  until that became inconvenient, at which point interest rates crashed and the Fed had swung all the way back to easy money. Monetarism’s only survivor was the non-accelerating inflation rate of unemployment (NAIRU), but that would die soon.

Alan Greenspan had a problem in 1987. Domestic expansion couldn’t continue as long as defaulted foreign loans were holding down commercial banks, but academic economists were “preoccupied with the NAIRU and the phobia of runaway inflation.” Greenspan ignored them and made “unlimited liquidity” available, averting one crisis. Then, in 1991, he attempted to increase demand for credit by decreasing short term interest rates. This failed. Banks recapitalized instead. In 1994, he raised interest rates, which had the effect that lowering interest rates was supposed to because banks had to return to commercial investment to return to more comfortable profit margins. That shouldn’t have happened, but it did, and the 1990s expansion was under way.

The climate of the 1990s, the ensuing crash, and then the early 2000s all required new explanations, finally culminating in a return to the natural rate of interest, even though “no new research of any kind justified its revival [from its death in the 1960s], and no empirical research had established the inflationary threshold implicit in any actual numerical value of the rate of interest.”

Galbraith’s history sounds like a critique. It isn’t. Instead, he highlights doctrinal inconsistency in the Fed’s history — to provide an elastic currency in 1913, consumer power in 1944, full employment and price stability in 1978, and a general rule of “one disaster per doctrine” — to make a point about the salient difference between the Federal Reserve and the European Central Bank. The ECB

has a rigid mandate, doctrinaire in the precise sense: price stability through monetary control. By design, it is constitution bound to the economic ideas predominant in Europe at the moment the monetary union was created; it is therefore unable to adjust when circumstances and beliefs change.

The Federal Reserve, in contrast, changes its goals frequently, as has been seen above. Galbraith writes:

While academic economists… may decry their own irrelevance, one cannot say they did not deserve it. It is impossible to identify any predominant doctrine of the past 30 years whose consistent application over this time would have yielded better results. Given this unhappy fact, the ability of the Federal Reserve to discard flawed and failed doctrines has to be regarded as a distinct institutional virtue. It might be better still if it did not adopt those doctrines in the first place — but once cannot have everything.

I suppose what I’m being patriotic about is that we crafted such a bizarre institution in the first place. In a sense, the Fed is perfectly post-modern, able to shift with the prevailing economic episteme of whatever crisis it’s faced with and to discard its former facts and tools as if they never had any value. I’ll light a day-late firework to that.