Sunday, 21 September 2014

Two-Handed Economists

"A sign of a good economist is he or she always has two hands" says John Cochrane. Truth is, there is more to that statements than commonly thought and it is one of the things most forgotten in the economics profession. More often than not, when an economist is asked to provide an opinion on a subject, the assurance of absolute knowledge in his or her words is staggering. It is as if God Himself has come down to earth and bestowed that person with the impeccable ability of perfect foresight. In addition, the economist was also granted with the ability of saying that everybody who disagrees with him is just plain ignorant.

The problem most economists commonly ignore (maybe due to biases than other things) is that there are actually two sides in everything, from the plainest decision to the most intrigue problem the economy faces. The smart thing would be to recognise both but choose the one with less downside. For example, when the Federal Reserve chose to boost the economy by promoting programmes such as the TARP and large-scale QE they were faced with two options: do nothing and watch the whole economy collapse or do something and risk being told off for inducing moral hazard. Obviously the latter was the worse of two evils. (In case you were wondering, even with the total collapse of the economy the top 1% would still be the top 1%; the inequality would have just been greater- see the certainty I was talking about before?).

Take another example: what do you think about the government spending more than now? Most who say that this is a good idea are in danger of being labelled as communists while those who say that it is bad are about to be called Austrians. The problem here is that the question is very vague: when, for example would be a good clarification. In times of crises those labelled Keynesians would respond. But again, it depends on where you spend it and how constrained you are. Greece, Italy, Cyprus and Portugal cannot increase government spending as they are too indebted for that. In addition, moral hazard comes in again. If I am due to spend every time things go bad, why shouldn't everyone just be risky? Again, the lesser of two evils is the wisest choice here.

Probably all issues could be benefited from a two-handedness approach. Even extreme ones such as cartel formation. We all know that cartels are bad, simple because they tend to charge higher prices. Suppose now that we have a situation where a cartel is formed in an industry. In the case where no cartel exists, every firm competes by price and the lowest bidder wins. But in the case where the cartel exists, the firms agree that one of them would win each time and place higher prices. Is this bad for the state? Obviously. Is this bad for the economy? Well, it depends. If, as usual we have returns to scale, it would mean that less people are employed in a single firm than in two similar firms. In this case, the lowest bidder would get all the auctions and everyone else would be left off the market. But, at the same time more unemployment would occur than if all firms were operating as one firm needs less than all the workers! 

As the reader may observe, there is no clear-cut answer to a question. Even in this most extreme of cases such as the one where cartels are involved, what would you prefer if you were a policymaker during a crisis and unemployment was already sky high? High morals and high unemployment with less spending or lower morals and lower unemployment with more spending? My answer is simple: it depends.

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