Wednesday, November 25, 2015

Questioning the Credibility Revolution

If you follow the econonomics blogosphere, you've likely heard a lot about the "credibility revolution." The "credbility" part has to do with the supposed superiority of randomized control trials and quasi-experimental design over traditional models. The "revolution" part has to do with the suggestion that these models should replace, to some degree, theory in determining causality. One popular book, Angrist & Pischke's "Mostly Harmless Econometrics," discusses these methods quite clearly. I've used it a few times as a reference and found it quite helpful.

Of course, this revolution is very important for agricultural economists. We spend a lot of time using empirical methods to examine microeconomic problems. An open mind and critical eye are, I think, important for evaluating the usefulness of these newly-popular methods.

As the title suggests, I'm skeptical of the "revolution" part and somewhat skeptical of the "credibility" part. Experimental methods are nice as far as they go, but the use of experiments (broadly speaking) is more problematic in the social sciences than in the natural sciences. This is especially important if we are going to rely on the data to determine causality for us, rather than relying on sound theory. Further, some people seem to think these methods are the only way to do empirical microeconomics. In this post I'll draw from a few sources to make the arguments that 1) there are some important limitations to these quasi-experimental methods, 2) we shouldn't replace sound theory with data analysis, and 3) the "old" empirical models are just as useful as they always have been.

Saturday, November 21, 2015

Roman Frydman on the New Rational Expectations Hypothesis

While reading a post at the Coordination Problem blog, I came across this interview of Roman Frydman (NYU economist) by Lynn Parramore at the Institute for New Economic Thinking. The interview was very interesting and I thought I'd share some of my favorite bits. The whole thing is worth reading.

LP: It seems obvious that both fundamentals and psychology matter. Why haven’t economists developed an approach to modeling stock-price movements that incorporates both?

RF: It took a while to realize that the reason is relatively straightforward. Economists have relied on models that assume away unforeseeable change. As different as they are, rational expectations and behavioral-finance models represent the market with what mathematicians call a probability distribution – a rule that specifies in advance the chances of absolutely everything that will ever happen.

In a world in which nothing unforeseen ever happened, rational individuals could compute precisely whatever they had to know about the future to make profit-maximizing decisions. Presuming that they do not fully rely on such computations and resort to psychology would mean that they forego profit opportunities.

Wednesday, November 18, 2015

Whither the Young Farmer?

Much is made about the average age of the American farmer. USDA Secretary Vilsack was once quoted as saying, "We have an aging farming population. If left unchecked, this could threaten our ability to produce the food we need – and also result in the loss of tens of thousands of acres of working lands that we rely on to clean our air and water." That's serious stuff, but a more careful analysis reveals that the situation isn't so dire after all.

Analysis by Carl Zulauf indicates that farmers are aging no faster than the general public. Additionally, we would expect, he says, that farmers would be older than the average business owner because modern agriculture is so capital intensive. Todd Kuethe breaks down farmer age by number of farms, acreage, and income, and notes that

The largest share of the income of the sector is captured managers between the age of 45 and 64. Just over half of Illinois' primary farm operators are between ages 45 and 64 (51.5%). This group, however, represents 60% of Illinois' agricultural land and 62.9% of the state's farm income.
Zulauf's observation that capital intensive industries are likely to have older sole proprietors on average is especially interesting given the current land price environment. As Brent Gloy and David Widmar note, land values are currently quite high, but a combination of low returns and rising interest rates could pave the way for a downward correction in land values. I made a similar argument about land values in Texas last October. The potential for a decline in land values may open up opportunities for younger farmers to buy in.

Another potential driver of the increasing age of the average farmer is increased regulation. As I've documented in the past, regulation by the EPA has increased almost continuously over the last 4 decades. Now more than ever farmers are burdened by the cost of regulation by the EPA. This increased regulatory cost creates economies of scale which might serve to hinder entry into the industry.

There are likely many causes of the increase in the average age of the American farmer, but it seems the worst thing that will happen is consolidation. If land values correct and young farmers are able to maintain access to credit, the trend of the aging farmer may at the very least slow down.

Sunday, November 15, 2015

Phishing for Reviews

I've read several reviews of Akerlof and Shiller's new book "Phishing for Phools." The book is largely about the ways in which businesses trick people into buying things they "shouldn't." Below I provide some key quotes from 2 positive and 1 negative reviews of the book, followed by two short, negative reviews of the summary article Shiller wrote for the New York Times. Since even the positive reviews say the book lacks depth, I think the New York Times summary is probably a reasonable proxy for the book itself, at least in terms of its primary arguments.

I've not read the book, but based on the breadth of topics covered, it may be good to have as a reference for behavioral economics articles.

Positive Reviews
The Economist:
You Have Been Warned: Two heavyweights show how markets can turn against the unsuspecting
Economic models tend to assume that people are informed about the decisions they make; in the jargon consumers have “perfect information”. This supposedly enables consumers to make markets work to their advantage. But Robert Shiller of Yale University and George Akerlof of Georgetown University argue instead that this assumption is false. There are plenty of market equilibria, the authors find, where one party is being deceived, or “phished”. You may think you are doing well out of markets; you may behave quite rationally; but in fact you are being taken for a “phool”.
The London School of Economics and Political Science - Review of Books:
Book Review: Phishing for Phools
... Nobel Prize winners George A. Akerlof and Robert J. Shiller deliver a timely and much-needed plea against the free market dogma that surprisingly seems to have outlived the financial crisis. According to the two authors, big corporations take advantage of the ‘stories we tell ourselves’ and of our ‘monkey-on-our-shoulder tastes’. Our propensity to make choices according to multiple cognitive and psychological biases makes us easy targets for the phishermen. If one sentence could epitomise their thesis, it would be Jean-Paul Sartre’s’ famous saying: ‘We are what we make of what people want to turn us into.’

Negative Reviews
Arnold Kling (author, blogger, former Fannie Mae economist):
Phools and Their Money
Overall, I do not think that the authors chose well in starting with the Cinnabon example. They do not make the case that people who buy cinnamon rolls are doing something that those consumers would rather not be doing. Instead, it just seems that such consumers are doing something that Akerlof and Shiller find reprehensible. They need to come up with an objective way of making the distinction between satisfying consumer wants and manipulating consumers. It is demagogic to rely on one person's disgust at another person's consumption of fatty foods.
Michael Makovi (recent graduate in economics, Loyola University - New Orleans):
Do Capitalists Manipulate, Deceive, and Cheat?
But government regulation is not an infallible deus ex machina. The question is not whether the market fails, but whether the government is more likely than the market itself to correct those failures. Economist Harold Demsetz coined the term “nirvana fallacy” to make this point: it is not enough to find flaws in the real world; one must prove that some feasible alternative is likely to be less flawed. James Buchanan, one of the fathers of public choice economics, compared advocates of government regulation to the judges of a singing contest who, after hearing an imperfect performance from the first contestant, immediately award the second contestant, reasoning that he must be better.

Peter Klein (Baylor University professor of entrepreneurship):
George Akerlof, Meet Oliver Williamson
Shiller's worldview features a caricature understanding of free markets along with a naive and uncomprehending model of government regulation. I suppose we can blame the Times's editorial team, not Shiller, for the headline "Faith in an Unregulated Free Market? Don’t Fall for It." But it nicely illustrates the Shiller crowd's view that support for free markets is based on faith, rather than two centuries of reason and evidence. You might think that Shiller's coauthor George Akerlof could walk down the hall and speak to his UC Berkeley colleague and fellow Nobel Laureate Oliver Williamson for a better understanding of how markets work. Williamson, of course, is famous for explaining how market actors protect themselves against opportunistic behavior from other market actors through contracts, joint ownership of assets, reputation, exchange of "hostages," and similar practices. It is markets, not government, that enable cooperation and joint production in the face of information and incentive problems.
Relevant Farmer Hayek Posts
The Nirvana Approach in Ag Economics - Contributions of E.C. Pasour

Blackboard Theory Versus the Reality of Markets

Economics in TWO Lessons?!

Demsetz on Comparative Institutions

Friday, November 13, 2015

Crop Insurance Spending Myopia

In the last couple of weeks there's been a lot of focus inside the beltway on crop insurance. First, a 2-year budget deal between Republicans and Democrats planned to cut $3 billion from the crop insurance program. The deal would boost total spending by $80 billion (not including off-budget items) over 2 years. The $3 billion has since been restored to crop insurance in this bill.

More recently another bill called the "Assisting Family Farmers through Insurance Reform (AFFIRM) Act," has been proposed in both the Senate and House. The bill would cut $24.4 billion over 10 years from the crop insurance program by 1) capping RMA's premium share at $40,000, 2) eliminating RMA's share of the premium for all farmers with adjusted gross income over $250,000, 3) retaining the $3 billion cut to insurance providers, 4) reducing the commission paid to insurance salespeople, and 5) eliminating the Harvest Price Option.

The AFFIRM Act is, of course, being sold as a fiscally-conservative measure, but numbers can be deceiving. "Billion" is a big word, but context is important. 

I want to be clear here that I'm not advocating any cuts to or expansions of federal spending, I just want to bring some data to bear on the conversation.

Saturday, November 7, 2015

Ideology, Evidence, or Approach: What Drives Economists Beliefs?

Mark Thoma's recent Fiscal Times column presents two possible explanations for the beliefs of economists: ideology and evidence. While these may be important for an individual economist, I think an important third factor is the approach we take or what Arnold Kling calls "interpretive framework." The approach you take to a question might be related to your ideology (causing some to confuse the two) and it certainly affects the way you interpret evidence. All of the facts we observe are interpreted. The approach we take in economics determines, at least to some degree, how we interpret facts.

Conveniently, Thoma's article provides some opportunities to juxtapose the influences of approach, ideology, and evidence on our beliefs. In the first paragraph of Thoma's piece he says: