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2014 Hottest Year on Record

Profit Sharing on the Plantation and the Social Cost of Slavery

Following up on my previous post, the thought occurred to me:  what if someone proposed that instead of abolishing slavery (which would be detrimental to GDP growth), a system of profit-sharing should be introduced to enable the slaves to buy their freedom? The profit-sharing plan would be optimized by gradually ramping up the profit share over the span of, say, fifty years, given a discount rate of "x" determined by the projected GDP growth rate.

Then some Stanford researchers come along and point out that the social cost of slavery is actually six times as high as estimated by the standard models and that a much more stringent slavery mitigation policy is warranted.

Would it be too moralistic of me to point out that the quantitative casuistry is obscene? John Brown's body lies a mouldering in the grave.

Circular Social Cost of Carbon Reference

Frances Moore and Delavane Diaz's nature climate change letter, "Temperature impacts on economic growth warrant stringent mitigation policy" rightly points to the static nature of the standard assumptions of climate change Integrated Assessment Models, which capture only the transient effects of climate change on the economy. They point out that such assumptions leave total factor productivity (TFP) unchanged and thus ignore cumulative impacts on GDP growth rates.

They then go on to tweak the model to produce alternative estimates. They probably had to do this kind of thing to get any attention to their critique of the standard model. But the problem with the model is more fundamental than can be fixed by inputting better assumptions. The model is a colossal tinker-toy of indices, some of which are aggregates of disparate outputs expressed in money units and others of which are formulas that refer to the results of formulas that depend on the original formula's value: circular references.

Deeply embedded within the mare's nest of unacknowledged, unrecognized assumptions is an 86-year old "simplification" introduced to enable the calculation of otherwise indeterminate returns to factors of production. Eighty-six years is a long, long time in simplification shelf-lives but I suppose that if you don't know which direction your destination is, it doesn't matter how long it takes to get there. This missing link is "the economic effects of variations of hours of labour."

If we assume that there is some average length of the working day (week or year) that maximizes output, then variation above or below that optimum will reduce total output. Technological progress and changes in climate are also likely to effect the optimum length. Furthermore, changes in income effect preferences for leisure and consequently labour supply. It doesn't help that this indeterminate labour supply is both the denominator and an input into the numerator of the ratio that is supposed to determine the rate at which the ratio's numerator grows... Not to mention the social cost of labour.

It's a Rube Goldberg contraption with feedback loops.

Update: The "point" is that there is no basis for assuming that the given hours of labor maximize output. There is no basis for assuming  that the hours that maximize labor output would maximize utility of the workers. There is no basis for assuming that the hours that maximize output today would maximize output 50 years in the future or that the hours that maximize worker utility would maximize utility 50 years in the future. There are plenty of reasons for assuming that the answer to each of those questions is "indeterminate." In short, the interactions here are "so ramifying, involved and conjectural" as to render omniscience a prerequisite for making quantitative projections.

"F" is for Formula; "M" is for Magic

Formula n. 1. fixed form of words as definition; statement prescribed for use on ceremonial occasion; rule unintelligently followed; infant's food made up from recipe.

In Magic, Science and Religion, anthropologist Bronisław Malinowski discussed the interplay between the systematic rational knowledge and the magical pseudo-science of the Trobriand Islanders, observing that "even with all their systematic knowledge, methodically applied, they are still at the mercy of powerful and incalculable tides, sudden gales during the monsoon season and unknown reefs."

It is in dealing with these formidable uncertainties that magic comes into play. "Science," Malinowski explained, "is founded on the conviction that experience, effort, and reason are valid; magic on the belief that hope cannot fail nor desire deceive." In contrast to the reliance of science on "observation, fixed by reason," the domain of magical pseudo-science is "hedged round by observances, mysteries and taboos."

The "mainstream/heterodox" distinction in economics is otiose (and odious). The demarcation that matters is between observation of economic regularities, which is limited, and the proliferation and persistence of economic pseudo-science in the face of "powerful and incalculable tides" and "sudden gales." "Theorists have a natural urge toward precise and determinate theorems or laws," John Maurice Clark wrote 65 years ago. "But..." he continued:

"...the facts of economic life show little consideration for this urge, and remain, to a large extent, perversely and persistently indeterminate. This is the skeleton in the closet of economic theory. What is a proper attitude for a would-be science, forced to deal with such refractory material? One thing economists do is to construct hypothetical simplified 'models.' These can be used in two ways: as an approach to reality or as an escape from it. My problem is how to promote the first kind of use and set up safeguards against the second." 

Would Clark's attitude toward this "skeleton in the closet of economic theory" make him "heterodox"? How has the bureaucratically-imposed conventional cost-benefit analysis and the Kaldor-Hicks criterion that justifies it achieved its canonical status? How about the notion of shirking in New Keynesian models of sticky wages? The ritual invocation of the lump-of-labor fallacy claim? Ceteris paribus? General equilibrium?

The urge for formulas in economic analysis is strong, especially from official "deciders" who yearn for guidelines, criteria or rules-of-thumb that will immunize their decisions from criticism for favoritism, arbitrariness or bias (all the more convenient if favoritism and bias are non-transparently built-in to the formula!). In an article also published in 1950, Paul Samuelson wrote:

"Improved measurement of national income has been one of the outstanding features of recent progress in economics. But the theoretical interpretation of such aggregate data has been sadly neglected, so that we hardly know how to define real income even in simple cases where statistical data are perfect and where problems of capital formation and government expenditure do not arise."

In his article, Samuelson warned that "the last word on the subject will not be uttered for a long time." Not that anyone would still be listening when that proverbial "last word" (or even the next word) was uttered. Hedged in by observances of bureaucratic standards and procedures, mysteries of discounted net present value and taboos on interpersonal comparisons of utilities, the aggregate data of national income came to ritually stand in for its own interpretation.

Usage and custom have shifted the burden of proof from the believers in economic magic to the skeptics. Disproving the magic is impossible. As Malinowski explained:

First of all, magic is surrounded by strict conditions: exact remembrance of a spell, unimpeachable performance of the rite, unswerving adhesion to the taboos and observances which shackle the magician. If any one of these is neglected, failure of magic follows. And then, even if magic be done in the most perfect manner, its effects can be equally well undone: for against every magic there can be also counter-magic [ceteris paribus]. 

Report of Panel of Consultants on Secondary or Indirect Benefits of Water-Use Projects, Part III

Introduction to Part III of the panel of consultants' report:

Part III of the consultants' report, "Some principles, and some of their consequences," runs to nearly 10,000 words and, in effect, "buries the lede." Section eleven, the last section, states in its underlined, topic sentence:

"Qualitative factors would become increasingly important in proportion as computations of quantitative secondary benefits might be scaled down in the ways here suggested and might become dominantly important."

Indeed, the gist of the entire report may be summed up as that there is only a limited case for quantitative estimates. I have taken the liberty of editing the following "executive summary" of the panel's main argument:

We believe in the importance of secondary benefits, but find them so ramifying, involved and conjectural that the attempt to compute them as a national total, in dollar terms, by the methods of the Manual or any other methods that appear at present available, cannot properly be regarded as "measurement," though computations of pertinent items may be useful as guides to judgment in rating the importance of these benefits. 

Accordingly, we are able to "set forth a recommended basis for the evaluation of secondary benefits and costs" as directed in instruction (2) only on the assumption that "evaluation" can include, for important parts of these benefits and costs, ratings by the exercise of judgment which are not precise enough to justify regarding them as quantitative measurement.

This being the nature of our judgment, we are hardly in a position to recommend an alternative formula purporting to measure these secondary benefits. The inescapable difficulty, even for the quantitative differences, is that, for the ramifying secondary effects, accurate and definitive answers require omniscience. 

Democracy has to rely on technicians in matters inscrutable to the non-specialist, but preferably where the specialist is following a well-authenticated technique. In this case, the disagreements among the specialists are evidence that they do not possess such an authenticated technique, for the results of which a representative government can safely take their word. It needs to be able to tell what they are doing, and what their procedures mean. 

As to qualitative and intangible benefits and costs, our study has led us to look toward diminished reliance on quantitative computation and toward attaching greater relative importance to qualitative effects of the alterations in distribution of population, types of community, etc. We therefore suggest that these matters are worth increased attention and study, including sociological aspects. These are, of course, matters that can be described and appraised only by judgment.

By contrast, the thrust of Budget Circular A-47 was to mandate a quantitative formula that effectively excluded consideration of those "ramifying, involved and conjectural" secondary benefits "[u]ntil standards and procedures for measuring secondary benefits are approved by the Bureau of the Budget." Until when? Until never! The panel of consultants had concluded that evaluation of secondary benefits could not be "precise enough to justify regarding them as quantitative measurement."

Below is a summary of the eleven principles presented in Part III of the consultants report. The Scribd file that follows contains the full text of Part III:

1. Demand for the product is a prerequisite condition. 

2. Quantitative or tangible benefits constitute total differences in national real income, with and without the project. 

3. Increased national real income however caused, can be embodied in three and only three forms. 

4. For an increase of national real income, both increased supply and increased demand are necessary, and full national computations of the two should not be added.  

5. In a national with-and-without comparison, dollar-costs are important only insofar as they usefully represent the foregoing of primary and saleable products (for which their creator could collect a price) from alternative resource-uses that would otherwise have been made. 

6. The "stemming-from" hypothesis, crediting production of raw products with acting as a "trigger" and causing the chain of subsequent processes, has limited validity which does not warrant carrying the computation through to the ultimate consumer in all cases. 

7. One important effect of a successful project may be to raise the marginal productivity of resources in the economy or avoid a reduction but we know no present means of reducing this to calculation, beyond what is already represented in primary benefits. 

8. Allowance for calling unused resources into use needs different treatment for original investment and for subsequent operation. 

9. Local gains need not all be regarded as mere transfers, cancelling out from the national point of view. 

10. Determination of the proper scope of projects should be governed by the principle of equal productivities of marginal increments. 

11. Qualitative factors would become increasingly important in proportion as computations of quantitative secondary benefits might be scaled down in the ways here suggested and might become dominantly important.

Part III

Below are links to Parts I and II of the report:

Part IA. Instructions of Michael W. Straus, Commissioner, Bureau of Reclamation, to Panel of Consultants on Secondary or Indirect Benefits

Part IB. Summary Response to the Commissioner's Instructions

Part IIA. Conclusions and Recommendations: Introduction

Part IIB Conclusions and Recommendations: Summary of Principal Recommendations

Dynamic Scouring

Mark Thoma and Edward Kleinbard both have op-eds about Republican proposals for "dynamic scoring" of tax cut legislation. It would be helpful to point out that dynamic scoring is a euphemism for "secondary and indirect benefits" -- particularly those arising from what is known as the Keynesian multiplier.

Sandwichman has been documenting the controversy over secondary and indirect benefits in the early 1950s that eventually resulted in their virtual exclusion from standard cost-benefit analysis, as per Bureau of the Budget Circular A-47. Implementing dynamic scoring for tax cuts would, in effect, declare "multipliers for me but no multiplier for thee."

As the panel of consultant's report from 1952 outlined in excruciating detail, there are limits to the usefulness and transparency of incorporating secondary and indirect benefits in a quantitative cost benefit analysis. There are also huge pitfalls in disregarding these difficult or impossible to quantify outcomes. Familiarity with the panel's discussion could inform deliberation over the dynamic scoring proposal.

I have so far posted Parts I and II of the report. I have scanned in and proof read Part III but its considerable length poses some formatting challenges for posting on the blog.

Part IA. Instructions of Michael W. Straus, Commissioner, Bureau of Reclamation, to Panel of Consultants on Secondary or Indirect Benefits

Part IB. Summary Response to the Commissioner's Instructions

Part IIA. Conclusions and Recommendations: Introduction

Part IIB Conclusions and Recommendations: Summary of Principal Recommendations

Part III. Several Principles, and Some of Their Consequences

About that memo, Professor Summers...

Let this be the year when we put a proper price on carbon is the theme and headline of an op-ed by Lawrence Summers at the Financial Times. There is indeed a compelling case for a carbon tax, as Summers argues. The case could be even more compelling were it not for the persistence of an "impeccable economic logic" that never was.

That  "impeccable logic" made a cameo appearance in an infamous World Bank memo that went out over Summers's signature some 23 years ago: "the economic logic behind dumping a load of toxic waste in the lowest wage country is impeccable." Take it as given that Summers did not write the memo, that the infamous passage was taken out of context and that the intention of the author, Lant Pritchett, was ironic and not making a serious proposal.

And yet... Satire has an object. The full memo is a chapter-by-chapter commentary on the outline for the 1992 World Bank publication, "Global Economic Prospects and the Developing Countries." Chapter 3 of the outline was presumably the target of the infamous excerpt. Note that chapter 3 in the final version is titled "Interlinkages, human capital and export competitiveness" and has nothing to say about pollution. In fact, the entire document has nothing to say about pollution.

Where is the rest of the infamous memo? Pages one and five of the original memo are posted on the internet but searching phrases from those pages turns up nothing. Daniel Hausman and Michael McPherson used the provocative toxic waste passage as exhibit "A" in their Economic Analysis, Moral Philosophy and Public Policy. But they are silent on the broader context of the full memo and the Global Economic Prospects outline.

Hausman and McPherson do, however, delve into the matter of cost-benefit analysis, which they conclude "is not a scientifically valid or value-neutral procedure for social decision making." This is sort of the argument I have been making here but not entirely. My argument, though, is that the "economic logic" is extraordinarily "peccable" -- its logical fallacy concealed behind an impenetrable veil of incongruity.

Whether conventional cost-benefit analysis is merely "not scientifically valid or value neutral" or is downright incongruous and "unacceptable nonsense," the Interagency Working Group on Social Cost of Carbon relied on it in 2010 to estimate the social cost of carbon to be $21 per ton of CO2 (in 2007 dollars). If Summers is serious about "letting this be the year when we put a proper price on carbon," perhaps he could nudge things along a bit by showing that the "impeccable economic logic" of not doing so is an abysmal sham and a swindle.