Krugman Doesn't Understand Micro

...or pretends not to.

"Yet textbook economics says that in a competitive economy, the contribution any individual (or for that matter any factor of production) makes to the economy at the margin is what that individual earns — period. What a worker contributes to GDP with an additional hour of work is that worker’s hourly wage, whether that hourly wage is $6 or $60,000 an hour. This in turn means that the effect on everyone else’s income if a worker chooses to work one hour less is precisely zero. If a hedge fund manager gets $60,000 an hour, and he works one hour less, he reduces GDP by $60,000 — but he also reduces his pay by $60,000, so the net effect on other peoples’ incomes is zip."
http://krugman.blogs.nytimes.com/2011/11/22/taxing-job-creators/

Further down he implies that this idea (that wage=value of marginal product) is some sort of bedrock principle of free-market economics.

Two problems with this:
1)Even if we were to use the perfect competition model that he's referring to (which I'm not sure any economists actually regard as an accurate description of reality), there is such a thing as consumer surplus. So, a producer does not capture all of the value that he creates.

2)There's no remotely good reason for free-market types to be wedded to the perfect competition model. It's easy to come up with sensible reasons why wage might not equal the value of marginal product. There could be transaction costs (e.g. maybe the worker will not search around until he finds someone who will pay him his marginal product. Maybe he ends the job search earlier and accepts a reasonably good wage that is lower than his marginal product.) One could also discuss the idea that some firms have market power (this can have some relation to the transaction cost idea mentioned above.) Lastly, whether we talk about perfect competition or not, there can be externalities. Does anyone really think Isaac Newton captured all the value he created? His wage was not billions or trillions of dollars.

Yglesias advocates price controls?

That's what it looks like. Read the last sentence.

Why when it comes to health care do policy analysts lose their minds? If prices are high, perhaps we should have more supply rather than the imposition of price controls. Also, when you subsidize demand, as we currently do, of course prices will be high.

Let's move to a different system.

Stephen Fry and Irony

I recently came across this clip in which Stephen Fry repeats the canard that Aristotle thought that flies only had 4 legs. And then Fry basically claims that the Western intellectual world was so unscientific at one point that no one bothered to count flies' legs and prove Aristotle wrong.

To anyone with an even weak b.s. detector, this claim about Aristotle and his followers is clearly very unlikely, and as it turns out, it is indeed untrue. The irony is that Fry is well-educated and probably considers himself pro-science and pro-empirical knowledge, yet when he comes across a ridiculous claim he seems not to have bothered to perform adequate fact-checking.

I don't want to pick on Fry too much. I think this is a common problem: even educated, enlightened people seem to rarely question the things they hear and attempt to think critically about things. I've long thought our supposedly "skeptical" society to be perhaps just as gullible as the "superstitious" society of the Middle Ages.

You might notice that famous scientists or economists or other intellectuals will routinely say crazy or outrageous things when they leave their own narrow specialization. Or perhaps they will be empiricists from 9 to 5, but when it comes to leisure time and their personal lives loose thinking sets in.

Instead of just ranting, I'll attempt an explanation:
a) Knowledge has become so technical and detailed that it is just too costly for us to be generally educated. We specialize more and, on most subjects, we leave the thinking to the experts. E.g. The scientist or historian or journalist will likely get his economics from his favorite newspaper columnist, assuming that this columnist will not lead him astray.
b) Government has become large and so it basically concerns itself with everything. Hence, almost any subject can be regarded as a political subject. This or that economist is defined by whether he is on the left or right, not by whether or not he is sensible. Even popes are described in this way.

Matt Yglesias's Odd Political Economy

Matt Yglesias often makes intelligent points, but this post might be too cute by a half. He says the goal of monetary policy in the last few years has been "has been to do just enough to stabilize financial asset prices without going far enough to produce catch-up growth in the labor market." This isn't so crazy, but then he goes on to say: "What’s more, from the point of view of capital maybe it’s better not to catch up. As long as growth is positive and unemployment isn’t rising then maintaining a large 8-9% of the labor force out of work could be a useful tool of wage restraint."

How does "capital" benefit from high unemployment? There are some people who are primarily investing in bonds, or who have fixed incomes, and such people may like the idea of zero inflation or even deflation. Maybe lenders like this as well in some cases, though I'm not completely convinced. But generally, holders of financial assets, perhaps especially the wealthy among them, will be owners of stocks, real estate, etc. Why would such people oppose a little inflation? And why would a business owner want 8-9% unemployment, which is presumably coupled with unimpressive sales? I've never heard of someone who preferred a weak economy to a strong economy so that he could "restrain" wages. Basically, both employees and employers are fighting over the same pie (the revenue of their company), but presumably they want that pie to grow. Allowing the size of the pie to shrink or not to grow and then hoping you can consistently out-bargain your employees for a larger share of the pie does not seem like a reasonable or sustainable strategy for employers. Eventually, the employees leave.

Scott Sumner has a good take down of this sort of thinking.

Conservative Philosophers

Bryan Caplan asks: "Can you name a post-1900 conservative economist as well-known as Milton Friedman, or a post-1900 conservative philosopher as well-known as Robert Nozick?"

I don't know whether or not he means well-known inside academia or well-known in general. I'll assume he means in general. If we interpret the words conservative and philosopher somewhat broadly, then I'll throw these names out there:
Elizabeth Anscombe
Reinhold Niebuhr
John Courtney Murray
Jacques Maritain
Alasdair MacIntyre
Pope John Paul II
Joseph Cardinal Ratzinger
C.S. Lewis
G.K. Chesterton

As for conservative economists comparable in fame to Friedman, I'll throw in the towel. However, I will say that considered himself "a libertarian with a small 'l' and a Republican with a capital 'R.'" He also called himself a classical liberal. But these descriptions are not so different from what many contemporary conservatives would apply to themselves. And maintaining a long-term connection to the Republican Party, as Friedman did, is something many libertarians would find too distasteful to attempt.

Also, Hayek, though he denied being a conservative, actually was quite conservative in his philosophical views (e.g. a reluctance to tinker with institutions which had presumably evolved that way for a reason.)

Inflation Target

It's nice to see this. It's amazing that the Fed doesn't already have some sort of explicit target (inflation, price level, NGDP, whatever.) How can we know whether it is effective or not if we don't even know what it's goal is? If the Fed wants to create expectations of price stability, why not tell us what that means so that can know what we should be expecting? This could be one of those cases where being more mysterious gives one more prestige. But I think a predictable Fed is better than a prestigious Fed.

Our country desperately needs more intelligence in the debate over monetary policy. Once in a while, it's good to step back from the newspapers and talk shows and think deeply about these issues.

Contra John Cochrane on QEII

U.Chicago economist John Cochrane recently argued (in a Bloomberg article entitled "Is QE2 a Savior, Inflator, or a Dud?: Business Class") that the Fed is basically impotent, and the evidence for this is that: "QE2 doesn't seem to have lowered any interest rates." For students of Scott Sumner and Milton Friedman, interest rates are known to be quite misleading indicators. Also, interest rates are not the only way to measure the effectiveness of monetary policy. Why not look at inflation expectations themselves? After all, what is monetary policy about if not inflation expectations?

He does mention inflation expectations, but oddly he says: "Expected inflation could explain the sharp rise in long-term yields starting in November. But the rate for 10-year Treasury Inflation Protected Securities, or TIPS, rose in parallel, contradicting that interpretation." Why not look at the TIPS spreads? Look at graph of TIPS spreads above. You can see the 5 and 10-year TIPS spreads rose sharply from August 2010 to late April. Notice also that in that period the S&P rose as well (top graph.) I'm not an expert Fed watcher, but wasn't August around the time Bernanke signaled that he was open to more monetary expansion if needed? Could the decrease seen in both graphs since late April 2011 be partially due to market participants realizing that QEIII would not be coming any time soon?

I'm quite open to correction, but why doesn't Cochrane talk about the most relevant indicators, such as TIPS spreads?

(Sources: TIPS graph made using data from http://www.stlouisfed.org/ and S&P graph from Google Finance.)