The Austrian Economists

The Market Process at Work, Even in Hollywood

Forbes.com (and here) gives a ranking of the Hollywood stars that are overpaid. Yes, overpaid. The point Forbes tries to make is not a moral one. The problem is not that movie stars make thousands of times what the average worker makes in the US. Rather, the point is that some movie stars get paid way more than they should considering the income they generate with their movies. Why is that?

Russell Crowe for instance hasn’t had much success since Gladiator. His (last three) movies have generated an average of $5 in gross income for every dollar he has been paid. Nicole Kidman is another star who, in the last few years, has been in movies that haven’t attracted much crowd. She was recently paid around $15m for her role in Golden Compass. The movie cost $200 to make and so far has not delivered has much as one would hope for a movie in that category. Kidman has generated an average of $8 in gross income with her last three movies for every dollar she has been paid. The same is true of Jim Carey. In fact, Carey is the worst performers and has been earning $20m for movies that turned out to be complete stinkers like Fun with Dick and Jane. Will Ferrell, Jennifer Lopez, Adam Sandler, Cameron Diaz and others are also on the list. Other stars are much more profitable, Angelina Jolie has generated an average of $15 for every dollar she has been paid. She also gets paid less than Nicole Kidman, around $10m per movie. Jolie is 3 times more profitable than Crowe.

It is interesting to see how the market is adjusting. Clearly some stars get paid well after a huge blockbuster. Crowe got many offers and huge salaries after Gladiator (which cost $100m to make and earned $460m in box office sales alone). Sandler got many more offers after The Wedding Singer in 1998. He got paid $20m for Click, which earned $236m in box office sales. A name can have a lot of value and producers may be willing to pay for it. However, as the profitability of an actor goes down, so does the interest of producers. Carey is not being paid up front for his latest movie, Yes Man. Whether Crowe will be in the same boat depends on what an American Gangster does at the box office. Kidman and Lopez may also be confronted with the same problem very soon.

While there is perhaps a lag of a few movies before the returns on a name start to fall, it is clearly the case that appearing in profitable movies over and over again is not something easy to do. Having a name is not enough. One can rise to the summit of the profession and disappear from the headlights within a few years. No one can escape the diktat of the consumers has Mises used to say, not even movie stars. Movies have been made about this very theme. Sunset Boulevard is one that I remember.

Beyond reducing the stars’ salaries (which seems to be difficult for some reason), the market also reacted in another way. Judd Apatow, who has already made hundreds of millions (549 to be  exact) with Knocked Up and Superbad, makes movies on a shoe-string budget ($30m is not much in this industry). One way to cut costs is to employ no stars (not even former ones), and this is exactly what he is doing with his next movie, Walk Hard: The Dewey Cox Story. This is interesting because usually low-budget movies don’t generate much income because they are not widely distributed and don’t interest a vast amount of people. This is the case of “indie films” in the US. Judd Apatow has shown that one can combine the two: make low-budget movies that attract a huge crowd. He is a real entrepreneur. But will it last?

I want my ETV

Washington Post has an interesting article today on the rise of free online courses from the top universities in the world.

Individuals of my generation will remember the introduction of MTV.  And the article in the Post reminded me of the changes that took place due to MTV.  "Video Killed the Radio Star" -- right?!  Just think would Madonna or even Michael Jackson have become the cultural icon they did without music videos?

What might this say about the future of the college professor?  What skill set will the top professors exhibit?

Insightful Economist At Work

Two of the most insightful economist I have ever known are James Buchanan and my classmate and best buddy in graduate school David Prychitko.  When Buchanan won the Nobel Prize in 1986, the profile that was done on him focused on his farm in Blacksburg and his routine of chopping his own wood.

Prychitko can tear an argument apart faster than anyone can put one together.  He sees quickly through the junk and gets to the crux of the matter.  He was (is) a major critique of my efforts and though I would often get upset, I always learned from him and tried to make my argument better.  Though I am sure there are many instances where Dave is convinced I should have just given up rather than persist.  But like Buchanan, Prychitko likes to chop wood, and enjoy the outdoors and a good day of work in nature (especially the snow).  Buchanan and Prychitko enjoy work for contemplative reasons.

This got me thinking.  Should we ever trust an economist who has never worked with their hands?

The great basketball coach Pete Carril used to say that you can tell if you were going to get a good rebounder by how close he lived to a railroad track. The farther away, the less likely he would rebound aggressively.  NBA scouts used to say that nobody can make it the NBA if they grew up with a 2 car garage.  And, Phil Jackson tells the story that you used to have to sit in the back of a station wagon and if you couldn't open up both doors at the same time no coach would want you because you didn't have the appropriate arm length.  These are all empirical propositions that ring true, but of course there are great exceptions to them.

I wonder if my proposition about economists is similar.  Unless an economist has had to work with his hands on a farm or in a factory, he will find the seduction of "intellectual solutions" to alluring to resist.  It is a respect for work, personal responsibility, and faith in the wisdom of the common people to respond to incentives and better their lot in life that underlies a belief in the power of the free market economy to continually deliver better quality at a lower price to more of us.

From your study of the biography of economists who are the best examples of those who had to work hard with their hands during their formative years, and those immune from work?  And, where did they end up on the ideological spectrum of economists?

In Praise of Uncertainty?!

Tyler Cowen responds to a challenge from David Henderson and lists the policy questions that he is most uncertain about.

In the comment section some are expressing surprise and respect for Tyler's openness and non-dogmatism.

I want to make it perfectly clear that I have nothing but tremendous respect for Tyler and the quality of mind he possesses.  He is probably the closest thing to a genius I have closely interacted with among my contemporaries. Kenneth Boulding, Gordon Tullock and Jim Buchanan were my teachers, and Israel Kirzner was my mentor at NYU, Robert Conquest had the office next to mine and we spoke daily, and Vernon Smith was my colleague; and I did get to spend 2 weeks in close interaction with Robert Nozick once at a summer institute --- but none of these could be termed contemporaries, though I do believe they all exhibited the qualities of a true genius.  Tyler has a similar quality of mind --- though he is less focused than those guys (and perhaps that is at the end of the day a very important difference).

My first meeting with Tyler was at a distance --- he came down from Harvard to see Ludwig Lachmann give a seminar in early 1984.  The next day Tyler came into the office and there was an open desk in my office and Tyler sat in there waiting to meet with Rich Fink.  He was reading a novel and he was just turning the pages -- it turned out that was just the pace at which he read.  I was completely in awe.  And in some sense I still am in complete awe of him today.

But I also find some of his positions puzzling and frustrating.  This blog post is one of those instances.  Why?

For one, I think Tyler is being a bit disingenuous.  He doesn't really answer Henderson's challenge because in each of his answers he hints that he agrees with a certain general principle but uncertain about implementation issues.  What I would like him to clarify is where he would think libertarian/free market principles should be questioned.  Second, I would like him to clarify when the public choice qualifiers on implementation should be suspended and when they should be the main point of emphasis.  Third, I would like to know by what criteria he decides to not use market principles to implement market policies.  In other words, when is it the case that the transition to the market too important to be left to the market?

In contrast to Tyler, I tend to focus on the general principles of libertarianism and free market policy.  In fact, I find it frustrating when individuals try to say they are libertarians but they want to defend war and other government interventions.  Why not just say "I have libertarian sympathies, but I don't think they apply in this case.  Or, I used to be a libertarian, but now I am no longer persuaded by the libertarian argument."

I, on the other hand, find the utilitarian argument for libertarianism overwhelmingly persuasive and I find the moralistic reading of libertarian rights talk to be inspiring.  The hard questions are indeed in implementation, but the general principles are NOT for me uncertain.  Private property, freedom of trade, freedom of association, toleration and religious freedom, etc.  These are the goals that we strive to attain in practice, they should be the guide to our policy choices.  This is why I think Richard Epstein's Free Markets Under Seige is the best book on public policy in recent years ... for the simple reason that if we just pursued the low hanging fruit in public policy --- abolish price controls; eliminate trade restrictions; and open up market opportunities and introduce competition where there is currently privileged positions, etc.  If governments simply pursued the low hanging fruit in public policy, the lives of millions of individuals would be improved immensely.  The more complicated matters can be tackled later, not first.  What would Tyler disagree with in Epstein's presentation?  Is there uncertainty that African's would be better off if European agricultural policies were more free trade?  Is there uncertainty that rent controls in NYC cause problems in the housing market in the city?

So I remain committed to libertarian principles as outlined in works such as Mises's Liberalism and Rothbard's For a New Liberty.  I admit that there are hard cases, and there are problems of implementation.  But I don't see uncertainty on the general prinicples.  If that makes me dogmatic, well I would have to plead guilty --- I am dogmatic about what I am persuaded by reason and evidence to be the truth until that time when reason and evidence would persuade me to the opposite.  Perhaps I am deaf and blind, but I just haven't seen the evidence nor heard an argument that make me think that a free market economy and the decentralization of political power to the maximum would cause anything but great improvements in the lives of billions throughout the world.  Nothing uncertain about it, lets just move to it as quickly as we can!

The Gold Standard, the Great Depression, and Some Current Monetary Worries

Pete has called me out in the comments thread on his earlier post on the gold standard and the Great Depression.  I was going to post this there as a comment, but it's become long enough to be a post of its own.

It's been awhile since I read Temin and Eichengreen (but I AM planning to teach a Senior Seminar on the Great Depression in Spring 09, so maybe I better re-read them), so I don't want to comment on the details there.  However, the story of the gold inflow is right, as far as I know.  I recently read Meltzer's history of the Fed and I'm convinced by him that the gold/reserves were there for the using but that the Fed leadership was simply clueless in the 1929-33 period and beyond about what the nature of the situation was and what they should do about it.  Interestingly, many of those debates were theoretical - their indecision was the result of not knowing which variables mattered most.

I think Mark K's last comment is probably right:  none of this strikes me as *inconsistent* with what we might call the Austrian/monetarist/Rothbardian/Higgsian story (inflation, contraction, bad micro/trade policies, regime uncertainty/war-didn't-end-it).  The key points are these:

1. The post-WW I Gold Standard was not the "gold standard" or "free banking" system that any current Austrian would defend.  Trying to pin the problems of the 20s and 30s on the GS as talked about by Austrians or libertarians today is like dismissing free market health care reforms by blaming our current health care problems on our "free market" in health care.  The really-existing GS certainly contributed to the crash and deflation.

2. Aside from that, it's totally clear that the Fed mismanaged the situation it found itself in by 1929.  Almost everyone agrees this was government failure writ large.  The disagreement is the comparative institutional question of whether that failure is "reformable" or requires a regime change.  In either case though, the Austrian skepticism about central banks is in play.

What, then, explains the relative monetary stability of the last 20 or 25 years?  I think the answer is that we have a much more "competitive" international currency/money market that before, and that the competition among central banks keeps the major ones in check. It's kind of an international federalism argument. 

Obviously, there are still big risks here, especially if we see any continued trend toward larger central banks, as in Europe.  But with the near-zero transaction costs of currency substitution, any central bank that gets out of control is likely to be punished with much more effectiveness than in the past.

One worry is that even in this world, a monetary inflation that did not show up as significant price inflation due to a productivity increase that offset the upward pressure on prices would go unnoticed as the price level remains the official gauge of inflation. 

Another worry is that we'll see more sector-specific "booms" thanks to unwarranted credit expansion, possibly due to a regulatory intervention that distorts interest rates and the risk-return trade-offs in those sectors.  The S&L crisis might fit this story in some ways and so might the housing bubble. 

However, the bigger problem at the moment is the moral hazard issue the Fed has created via the housing market.  Jerry O'Driscoll has a nice piece in the November Freeman that makes the argument that the "Greenspan doctrine," whereby monetary policy makers cannot detect asset bubbles but can detect their collapse and should offset their fallout, led mortgage lenders to believe that their actions were risk-free because the Fed would inject funds to bail them out.  Well guess what we're seeing right now?  Having created this precedent, what is to stop other sectors from figuring their losses will get bailed out as well?  The result of this might well be both serious micro distortion directly and inflation more generally.  Both the gold standard and free banking would be unable to create this moral hazard problem.

Anyway, a few thoughts on a Saturday morning.

Making Poor Nations Rich

Is a new book available on economic development offering reasons as to why some countries are rich and others are poor, why some countries become rich when they were poor, and why other countries fail after having had some success. Peter Boettke, Christopher Coyne, Peter Leeson, and I have papers published in it. Contributors include Ayittey, Baumol, Beaulier, Dorn, Holcombe, Johansson, Lawson, Llosa, Olson, and Shah and Sane. It was edited by Benjamin Powell from Suffolk University. Making Poor Nations Rich mainly deals with the importance of entrepreneurship in economic development. It examines the institutional conditions for the emergence of entrepreneurship, as well as the cultural context, the evolution of beliefs, etc. The book is published by Stanford University Press and The Independent Institute. Deepak Lal wrote an excellent foreword in which he emphasizes the role of institutions and beliefs in development. Here are two interesting passages:

The globalization of capitalism has… been resisted by two groups—the cultural nationalists of the Third World and various dirigistes in all three worlds. The origins of this hatred of capitalism and its main agents—entrepreneurs—arise because the change in material beliefs associated with the eleventh century legal papal revolution was preceded an precipitated by an earlier papal family revolution in the sixth century by Pope Gregory the Great. This changed the West’s cosmological beliefs by promoting individualism, the independence of the young, and love marriages, as contrasted to the communalist values and arranged marriages that remain common to this day in the rest of Eurasia. (p. xiii)

The socialist panaceas combined the rationalism of the Enlightenment with the critique of the Romantic revolt as represented in the writings of the young Marx and the Fabian socialism of the Webbs and William Morris in the United Kingdom. They offered a route whereby countries could try to modernize without losing their souls. With the death of the countries of “really existing socialism,” the harder socialist panaceas based on the plan were seen to be dead ends, but a softer version based on the desire to have “capitalism with a human face” still survives. (p. xiv)

Making Poor Nations Rich is a great book that anyone interested in the role of entrepreneurship in economic development should read. It includes some fundamental papers that have shaped the current discussions on the role of institutions and entrepreneurship (e.g. Baumol’s paper on the three types  of entrepreneurship). Benjamin Powell did a great job in putting all this together (with an introduction and his excellent paper on Ireland). Thanks Ben!

Did the Gold Standard Cause the Great Depression?

Let me make a confession, I am not a gold-bug, but my original introduction to economics was by someone who stressed the virtues of 'honest money' and I wrote an op-ed as a youngster advocating a return to a true gold-standard.  Now, I would simply argue that we should move toward a system of free banking.  My "market prediction" as opposed to theoretical necessity would be that some form of commodity-backed currency would emerge in the competition as the most 'trusted' money.  But it need not.

Still, as I read the various discussions about the Gold-Standard inspired by Ron Paul's political campaign, I am struck by the unwarranted attacks.  I know the arguments that people like Barry Eichengreen have made about the gold-standard and GD, but it is my understanding that the historical record is a bit more complicated.  Eichengreen is no doubt a first-rate economic historian, but the gold-standard that existed at the time he is talking about is not the historical gold-standard that advocates push for.  Eichengreen does for the gold-standard, what Stiglitz does for 'shock therapy' in East and Central Europe, or what Rodrik does for the 'Washington consensus' in the developing world.  Free market shock therapy didn't take place in the transition economies, it was a government administered and regulated 'market' economy that was instituted.  And similarly the developing world did not follow a path of fiscal and monetary responsibility, free trade, and low taxes and minimal regulation.  The transition has been slowest and the development the least in those countries that have failed to move toward a free market system.  It is government policies of regulation, taxation and restrictions on trade that cause the problems.  To give one example, when Argentina had its recent woes, the problems often got blamed on the currency board system it was operating under, but it wasn't the currency board that caused the problems, but the fiscal policies that eventually destroyed the currency board that caused the problems.

I really think the issue of understanding cause and consequence (and not confusing them) are critical in all these discussions.

I might be wrong on the Gold Standard and the Great Depression, but nothing I have read to date has convinced me on that.  The Great Depression was a consequence of (a) credit expansion to pay off war debts from WWI during the 1920s, (b) monetary contraction during the 1930s, (c) government microeconomic policies which completely curtailed the ability of market forces to adjust to the changing circumstances, and (d) government policies which eliminated the ability of individuals to realize gains from trade.  None of this is about the gold-standard.

The gold-standard is a serious check on government debasement of the currency.  This should be viewed as a GOOD THING to have done in the realm of public policy.  I am not saying it is the best way to do this, but that is its main strength as far as I am concerned.  Like the lock system on my car raises the costs of the car thief, a gold-standard raises the cost to government thievery of our wealth.  Unfortunately, it alone doesn't prevent government stealing anymore than door locks prevent car theft.  But we would have more theft if we left our doors open and our keys in the ignition.  Fiat currency is analogous to leaving the keys in the ignition with the door unlocked.

Does it make one a suspect economist to argue that government debasement of the currency is a problem?  Not any more than arguing that socialism doesn't work or macroeconomic policies will be counter-productive.  Perhaps you might be referred to as a 'market fundamentalist' in economics, but all that means is that you understand the basic principles of economics and BELIEVE them to be true based on logic and evidence.  As the old joke used to go, at Harvard we read the same books in economics that you guys read at Chicago, we just don't believe them.  Well, the market fundamentalist believes there are good reasons to believe them if you tell the complete story.

Of course, Austrians have some important nuanced points to make about dynamic adjustment, time, ignorance, uncertainty, and mutual dependence.  And these are extremely important points to insist on in the scientific and policy discussion, but at the moment there are even more basic issues that are missed and thus the discussion is confused.

As Jim Buchanan always stressed to his students ... "it takes varied reiterations to force alien concepts upon reluctant minds."  Those of us who understand and believe in 'basic economics' (the wonderful phrase that Bruce Caldwell uses to describe Hayek's economics in Hayek's Challenge) have our work cut out for us to educate our students, the public, and to a considerable extent our peers who fall prey to Romantic notions of politics and scientistic notions of economics.  The alliance between statism and scientism is what Hayek had to fight against in his career, and the current manifestation of that alliance is what we must continue to fight against.  In our contemporary context it has shown itself in the scoffing at the 'old fashion' ideas of Ron Paul and the contempt of anyone who would be silly enough to believe in the old-wisdoms of the classical economists.

Why Lou Dobbs Doesn't Know What He Is Talking About?

A lot of nonsense is spoken about economic conditions.  Foreigners taking jobs, disappearing middle class, and claims that so-called free market policies make the rich richer and the poor pooer.  All nonsense.  Stephen Rose pushes for some good sense in the economic discussion among pundits and politicians.  I am not sure he will succeed, but he at least is trying.

A Blast From the Past

In doing some holiday cleaning yesterday, I came across the picture below.  Pete and I decided it was worth posting.  And with great trepidation, we'll leave comments open.

This is from grad school at GMU, at the Center for the Study of Market Processes colloquium, from the Fall of 1985 (my first semester).  For those interested, the guy in the background is Mike Becker (of whom I have lost track) and the woman is Nancy Mitchell Pfotenhauer who was starting her master's at GMU at that time and is now a frequent media commentator on women's issues from a conservative perspective.  Her ex-husband Dan Mitchell was also a GMU grad student then, and he worked at Heritage for a long time and is now at Cato and is widely cited on fiscal policy issues.

In thinking about it, I have no idea who took this picture.  And I also don't know what happened to the airplanes that matched those goggles!

Adverse Selection, Gresham's Law, and the Austrian School

I asked earlier why critics of Austrian economics tend to focus on the least charitable reading of the position held within the school.  But today I'd like to ask why the Austrian School of Economics often appeals to individuals who lack the intellectual prowess to make scientific contributions and the good sense to get along with others rather than antagonize them.

Adverse selection refers to processes where less than desirable characteristics (characters) are selected for rather than weeded out due to the incentives of the situation.  The classic example is health insurance and those of ill-health.  But the idea can be applied to a variety of circumstances where the incentives impact the population pool and skew the distribution of characteristics of that population.  Do the incentives within the Austrian school and its relationship to the larger community of professional economists --- lower barriers to entry at the level of technical capabilities within the Austrian school; the vast layman following; the close association with libertarianism; the everyman his own economists syndrom; etc. --- geneate a problem of adverse selection?

Gresham's Law refers to processes where under regulation of the exchange rate bad money will drive good money out of the market.  The key here is the regulation which provides a false exchange rate between say gold and silver.  If we apply the principle to economic argument, what we find is that under certain circumstances bad argument drives out good argument.  I would suggest that the internet represents that context.  Those who have a high opportunity cost of making economic argument are overtaken by those who have a lower opportunity cost.

Part of the rules we have asked commentators to follow on our blog is to set incentives such that higher quality economic argument is encouraged, rather than weeded out by less than serious economic argument.  However, individuals repeatedly fail to follow the rules.  They post anonymous comments, they make personal attacks, they go way off topic, and they make uninformed assertations about the ideas they are talking about and the positions that people supposedly hold. 

WHY?  Because it is cheap entertainment?!  Is this a case where Gresham's Law combines with Adverse Selection and destroys any chance for a decent set of ideas in economics to get advanced.

So I come back to my question I asked a few days ago --- does NIE or Public Choice or New Classical or Monetarism have the same problems?  I don't think so and I really wonder why.  I cannot figure this out.

We have critics who read the worst possible reading of the Austrians. And we have others who claim to be Austrians who are promoting the worst possible reading in the school.  Thus, these are mutually reinforcing to condem the Austrian school to a fate of non-influence.

On the other hand, charitable readings of the main insights of the Austrian school have influenced perhaps more Nobel Prize winning economists than any other contemporary source (e.g., Hayek's influence on thinkers such as Buchanan, Coase, Lucas, Phelps, North, Schelling, and Smith).

As we head into 2008 (more on that later this week), it is important for those of us who want to take the powerful insights of Mises-Hayek and develop them along with other ideas in modern political economy and push for better (not worse) argument, more sophisticated (not less) presentations, carefull (not careless) readings of others in the social sciences, and civil (not angry) enagement with our peers.  In short, we must break the mutually reinforcing 'mechanisms' of adverse selection and Gresham's law, and instead push for processes that will lead to better writing, more logical argument, deeper analysis of the empirical facts of the matter, and wider acceptance among professional peers.