Category Archives: book review

Picking on Piketty!

So like many other fellow bloggers, amateur economists, savant economists, and Nobel laureate Paul Krugman, I have my copy of Capital. This time the author is Thomas Piketty and not Mr. Marx though. I am yet to read the book- not sure if I will ever get to it amidst semester ending, grading and fulfilling research requirements. So I wanted to get a quick take on what macroeconomists have to say about the book. Not surprisingly, Steve Williamson had a post- but he was yet to read the book. So I guess we will have to wait for his critical comments or not as he is more into figuring out what Fed should be doing! Meanwhile this following comment by Tony on Steve’s post provides a good critical view:

Piketty’s book does not contain explicit references (to the best of my knowledge) to the two-decade-old body of work on macroeconomics and inequality beginning with Huggett and Aiyagari. Neither does the book’s online appendix, but if you follow the links provided in this appendix to other papers that Piketty and co-authors have written you will find references to some of this work. (That does not count as a citation in my book but it shows at least that Piketty is evidently aware of some of this work.) But for reasons that are unclear to me Piketty does not seem persuaded by papers like Castaneda, Diaz-Gimenez, and Rios-Rull (JPE, 2003) which match most of the facts about U.S. income and wealth inequality with parameters calibrated more-or-less reasonably. Instead in his book (which I have still not yet finished) and in a very recent paper (April 2014) with Zucman he seems to favor fairly mechanical models with multiplicative shocks to individual wealth accumulation. These models generate power laws for the upper tails with coefficients that evidently depend on the now-infamous “r-g” (i.e., the difference between the interest rate and the growth rate). But he does not make much of an attempt to calibrate them as do Benhabib et al (Econometrica et al, 2011). My overall impression so far is that Piketty does not really engage the existing literature on income and wealth inequality. Maybe this is because he focuses almost exclusively on the upper upper right tail of the wealth distribution (not just the top 1% but the top 0.1%). Krusell and Smith and Castaneda et al and others do a pretty good job of matching the top 1% but perhaps (and I am not sure about this) less well on the top 0.1%. But then in his book he makes bizarre statements like “the profession [has an] undue enthusiasm for simplistic mathematical models based on so-called representative agents”. He knows this is not true! (He was even a discussant for Quadrini and Rios-Rull’s forthcoming chapter on “Inequality in Macroeconomics” in the Handbook of Income Distribution.) Inexcusable.

There is also this article from 2012 on VOX that might interest you. And as the famous econblogger Noah Smith once tweeted: stop spelling Piketty as Picketty 😉

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What macro do we teach at the Principles level?

Every time I take a look at the principles level texts, it turns out to be a thoroughly entertaining experience! I usually look at how the authors have dealt with business cycles and more often than not the treatment turns out to be biased. For example take a look at this passage (pp. 273) from Hall and Libermann’s principles text. It looks at changes in labor demand as a cause of business cycles:

A Change in Productivity? One possibility is that the labor demand curve shifts leftward because workers have become less productive and therefore less valuable to firms. This might happen if there were a sudden decrease in the capital stock, so that each worker had less equipment to work with. Or it might happen if workers suddenly forgot how to do things— how to operate a computer or use a screwdriver or fix an oil rig. Short of a major war that destroys plant and equipment, or an epidemic of amnesia, it is highly unlikely that workers would become less productive so suddenly. Thus, a sudden change in productivity is an unlikely explanation for recessions. What about booms? Could they be explained by a sudden increase in productivity, causing the labor demand curve to shift rightward? Again, not likely. Even though it is true that the capital stock grows over time and workers continually gain new skills— and that both of these movements shift the labor demand curve to the right— such shifts take place at a glacial pace. Compared to the amount of machinery already in place, and to the knowledge and skills that the labor force already has, annual increments in physical capital or knowledge are simply too small to have much of an impact on labor demand.

So in making fun of the RBC school or the classical model, they totally forget to mention oil price shocks, creative destruction because of technological changes, weather shocks in developing countries, etc. According to the discussion that follows, business cycles are caused by sudden autonomous miscalculations of demand on the part of producers coupled with herd behavior or changes in spending coupled with malfunctioning credit markets or people keeping unspent money under the mattress!

Dismissing changes in labor supply as a reason for business fluctuations, they say the following:

One way the classical model might explain a recession is through a shift in the labor supply curve. Figure 3 shows how this would work. If the labor supply curve shifted to the left, the equilibrium would move up and to the left along the labor demand curve, from point E to point G. The level of employment would fall, and output would fall with it. This explanation of recessions has almost no support among economists. First, ­remember that the labor supply schedule tells us, at each real wage rate, the number of people who would like to work. This number reflects millions of families’ preferences about working in the market rather than pursuing other activities, such as ­taking care of children, going to school, or enjoying leisure time.  A leftward shift in labor sup-ply would mean that fewer people want to work at any given wage— that preferences have changed toward these other, non work activities. But in reality, preferences tend to change very slowly, and certainly not rapidly enough to explain recessions.

Now here the treatment is somewhat reasonable. However, there is no mention of preferences for work and leisure over time and how they could affect the labor supply curve or the fact that every time there is a recession, graduate enrollment goes up or government policies like welfare programs could affect unemployment duration (The Redistribution Recession story!).

Now I am sure Robert E Hall knows better than that.  For example look at this paper where he talks about preference shifts as causing changes in employment.  So instead of taking sides with one model why not present alternative explanations of an economic phenomenon?  Yes, the economy could be hit by real shocks or aggregate demand shocks or a combination of both or one turning into another. It is important to emphasize this to foster critical thinking and developing a balanced perspective.  When it comes to lack of a balanced perspective, most macro-principles texts are to be blamed and not just the one mentioned above. Thankfully, though, the textbook I use fares better and I kind of feel proud for not bombarding students with only one version of the story.

PS: Came across one more Principles of Macroeconomics that has a balanced treatment: Macroeconomics: Theory through Applications by Russell Cooper and A Andrew John published by Flatworld Knowledge.

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A Splendid Exchange

This book by William Berstein is a must read for all those who are interested in the politics and economics of trade. The Economist carried a good review of the book. I could not agree more with their assessment of Bernstein’s book. It indeed is a fascinating read and leaves you much wiser than before. Having said this, I would like to jot down certain points of criticism.

Along with providing evidence for our eternal urge to truck and barter, the book also brings to light the frequent human desire to consume at whatever cost it takes. It is an important lesson to learn that trade has shaped the world and we all have immensely benefited from it. However, we should not lose sight of the extent to which greedy nations and corporations will go to enjoy the goodies of trade. Wiping out a complete island for nutmeg by the Dutch or the atrocities committed by the Portuguese in the Indian Ocean is a case in point.

The author thus, fails to note that not all exchange can be called as trade, at least by today’s textbook definition. If the Portuguese, Dutch or the English seized political control in order to secure supplies that cannot be termed as beneficial trade.

Even though the book successfully tells the story of how trade shaped the world, it tells the story primarily from western point of view. So much so that at times I felt the title should have been how trade shaped the “Western” world. The story of how centuries of trade affected the economies of China & India gets at best an incidental description. This is in spite of the fact that the silk route and the spice route originated in these countries. Of course one could argue that it is the story for atleast two additional books!

In spite of these lacunae, I think the book does a pretty good job of putting history of trade in perspective.

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Fast Food Nation!

I have to admit that I stumbled on this book just recently, though it was published in 2001. But it is so disturbing that I had to write something about it. Eric Schlosser does a wonderful job in bringing out the implications of the way we eat food today in US. It is not only the story of the quality of food, but it is also one of the unfettered greed of giant corporations and hence of the murky side of market forces.

It gives a lot of other information along with the story of greedy corporations determining what you eat and how will it be made. For example, I did not know that one of the American car companies bought the rail network in the west and destroyed it completely to create demand for their cars. These companies were later tried for monopolistic practices but the damage was already done. It was also interesting to know how various corporations use the state to grow. For example, many franchisees of a well known fast food chain have been developed through concessional state financing meant for small business development. Corporations have threatened to leave a particular state and bargained for reduction in taxes. They have lobbied for least regulations by financing election campaigns and in the process have taken consumers for a ride.

If all this is not enough, some of them have been regularly hiring illegal immigrants as they are cheaper than US citizens. They also do not have any legal standing and hence the hiring companies do not have to worry about insurance and other legal benefits. Much of the description of how they handle the poor immigrants reminds us of barbaric industrial towns of Europe from the earlier times that reeked of anarchy, disease and filth. It is hard to believe that a significant number of workers here in US have to face such hardships amidst all the glitter and sanitized psycho babble of violation of human rights in the rest of the world.

Even more disgusting are the details of how the meat packing industry functions. The scale and speed with which it currently functions is overwhelming and I leave it to the readers to discover the details. Suffice here to note that the meat packing industry not only has resisted any food safety regulation up till now but is also responsible for mindless perversions and meddling with course of nature. Cattle which is by nature is meant to be herbivorous has been fed for decades with dead cattle, cats, dogs, horses, pigs and chicken. Even chicken is fed with dead cattle and of course dead chicken.

I do not have enough scientific knowledge to comment on the biological and environmental implications of these actions, but it certainly does not feel right. At least I know for sure that our bodies are designed to digest certain types of food and that’s certainly the case with animals. In a normal course will a dog or chicken eat beef? Will a cow eat a horse or a pig? More importantly will a cow eat cow or chicken eat chicken? If this is taken to its logical end will we ever consider it normal to eat dead humans? I am inclined to answer in negative but you are entitled to your opinion. At least after reading the description of what all goes in that burger patty, I am happy to recommend a glass of orange juice for lunch. With it you will only starve for a while but definitely not die!

The development of American capitalism thus raises far more fundamental questions than just the selfishness of corporations as evident in the brutal denial of basic human courtesy to fellow human beings. Corporations built to serve human beings seem to have grown so larger than life that they deem some human beings completely expendable. And this disease is spreading to other countries as well, as these corporations open shops there and more and more people around the world yearn for a fast life style.

What do I say more here? Read it for yourself. After all some body aptly said- read and be wiser!

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The Red Book!

History provides ample evidence that red books are important and this one certainly fits the bill. It is one of its kind and in some sense a handbook of a revolution. Yes guys, I am indeed talking about Ljunqvist & Sargent’s (L-S) excursions in recursion!

However, its still a graduate text and hence by definition a badly written text. This fact has always puzzled me. We have fabulous books at the undergraduate level and I agree that they talk a lot. But sometimes stories are important and in subjects like economics, even more so. So what happens when the same author writes a graduate text? Does he not have the right incentives to write an equally accessible text? Or the only thing advanced about the advanced subject matter is the terseness and technique? Probably its the mix of the two factors.

The market is not that big for a graduate text and hence the returns only justify a minimal effort. However, if you read L-S you will find that some chapters are extremely well written. For example the initial chapter on Search theory as well as the one on Asset pricing read very well than other chapters. Coincidently, these chapters come somewhat straight away from Sargent’s earlier book on Dynamic Macroeconomic Theory!

Apart form frequent changes in notation, there are some other glaring examples of poor instructional design. For example, the material in the chapter on economic growth has no relation with the problems at the end of the chapter. What do you think is the reason? They come from completely different sets of authors! So if you are hoping to get some idea about how to solve the problems by reading the chapter, forget it. You might be better off reading the solutions directly.

Well, no point in complaining too much. We don’t have much choice when it comes to a PhD level Macro text based on microfoundations. Hence, even when we know that almost all monopolies suck, we have to patiently wait for a miracle in terms of a better competitor!

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Steve Williamson’s Macroeconomics

I have to admit that this indeed is a fabulous undergraduate macro text. As claimed it does reflect the current practice of macroeconomics or at least the most influential one. However, the following is worthwhile to note:

  1. The most common example given by almost all advocates of RBC theory of business cycles of a shock to total productivity, the oil price shock of 1970, is also present in this book. While it is true that with an exception of one, all the recessions in US have been preceded by a sharp rise in energy prices, this should work as a change in relative price of an input and hence a movement along the production function and not as a shift in it. However, even if we accept that the increase in energy prices does work as a productivity shock we cannot ignore the fact that most of the empirical studies place the contribution of energy prices to business cycles between 8 t 18 %, which is not a very significant, let alone a major one! ( Stadler 1994). This is not withstanding the fact that for technology shocks themselves to contribute to cycles, they should contribute at laest 78% to the shocks according to Aiyagari (1994).
  2. I still have difficult time understanding why various authors motivate the study of endogenous growth by mentioning the failure of Solow model’s prediction about convergence of growth rates across countries, but failing to mention that Robert Solow himself never intended his model to be used in that way, Easterly (2001, pp.55). Solow wrote his model on the backdrop of what is called as capital fundamentalism, a belief which postulates economic growth as a function of availability of machines per worker. He intended to show that this belief is wrong and hence capital accumulation does not cause growth in Solow model but some exogenous factor called technology does. The insight comes from the simple yet powerful logic of diminishing returns to a factor. When applied to cross country comparison of growth rates, economists extended the logic of the Solow model by assuming that, at least in principle, all countries have access to the same technology. Then, the only reason that countries, for example the tropics, did not catch up with the developed countries was lack of capital. But again the problem with this conclusion is that capital is not a very sizable factor in production. Therefore, if one wants to explain the differences in growth rates on the basis of availability of capital, then the conclusions are obviously absurd. As per the calculations of Lucas mentioned in Easterly (2001), each US worker for e.g. will have to have 900 times more machines than each Indian worker in order to explain the differences in their standard of living and thats clearly not the case.

All said and done, this book does a good job in presenting macro in a much clean and consistent way and avoids giving the feeling to the reader which, I got as an undergrad, that macro is a series of disconnected models with no relation to the micro behavior.

References:

Aiyagari R S (1994), On the Contribution of Technology Shocks to Business Cycles, Federal Reserve Bank of Minneapolis Quarterly Review, Vol. 18, No.1, pp.22-34.

Easterly William (2001), The Elusive Quest for Growth, The MIT Press.

Stadler George W (1994), Real Business Cycles, Journal of Economic Literature, Vol. XXXII, pp. 1750-1783.

Williamson Stephen D (2007), Macroeconomics, Third Edition, Pearson.

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Freakonomics

For those bedazzled by the wit and word of Steven Levitt, please read this equally entertaining and illuminating review by none other than Ariel Rubinstein.

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