## The Market: As an Institution, Its Pros, and Its Cons

The Market as an Institution: “The Market” as an Institution:

• We start from what look like to us deep truths of human psychology

• People are acquisitive
• People engage in reciprocity—i.e., want to enter into reciprocal gift-exchange relationships
• In which they are neither cheaters nor saps
• With those they trust…
• We devised property as a way of constructing expectations of trust…

• We devised money as a substitute for trust…

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## Modes of Market Failure

At lunch last week Richard Thaler was skeptical that I had managed to identify ten different modes of market failure. I admit that this list has a little too much of the Borges-List Nature, but I do think it holds up. What do you think?: The Market Economy: Modes of Failure: Markets can go wrong—badly wrong. They can:

1. not fail, but be failed by governments, that do not properly structure and support them—or that break them via quotas, price floors/ceilings, etc....

2. be out-of-equilibrium...

3. possess actors have market power...

4. be afflicted—if that is the word—by non-rivalry (increasing returns to scale; natural monopolies)...

5. suffer externalities (in production and in consumption, positive and negative; closely related to non-excludibility)...

6. suffer from information lack or asymmetry...

7. suffer from maldistributions—for the market will only see you if you have a willingness to pay, which is predicated on an ability to pay…

8. suffer from non-excludability (public goods, etc.)...

9. suffer from miscalculations and behavioral biases...

10. suffer from failures of aggregate demand...

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## Talking Points and Snippets from Commonwealth Club January 25, 2019 Forecast Event

Forecasting: Because of the shutdown, we are flying much more blind than we would like to be. We are not getting the normal data flow. Thus there is more than the usual level of uncertainty. Given that:

• I believe there is something like an 80 percent probability that Europe is now in a small recession.
• The Chinese government continues to say that all is well.
• But somehow six percent fewer cars were bought in China in late 2018 than in late 2017.
• Over the past half century the reliable recession signal has been yield-curve inversion—since 1965 eight inversion signals: one false (1998), one near-recession (1966), and six recessions.
• There have been no recessions not signaled by a yield-curve inversion.
• The Federal Reserve currently plans are to invert the yield curve in June.
• Neither Steve Moore nor I understand why the Fed thinks that this is a good thing to do.

In the last yield-curve inversion, in 2006, they were worried about an inflationary spiral breaking out because of rising oil prices—they should not have been worrying about it, but they were. In the yield-curve inversion before that, in 2000, they were worried about the dot-com bubble. There is nothing like either of those going on now.

Some people think the Federal Reserve is about to back off. Some people think that this time really is different—that the bond market is spooking at shadows this time. Give each of these a 25% chance of being right, and you have to say that there is a 50% chance the U.S. will be in recession in a year and a half. We hope the recession, if it comes, will be a small one. We hope we will, somehow, dodge the bullet and not have a recession.

But, at least as I see it, that is the forecast: a 50% chance of 1.5%-2.5% growth over the next year and a half, and a 50% chance of negative growth.

If you want a more precise forecast, my advice is to consult your Magic-8 Ball.

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## The Economic Forecast: Commonwealth Club Non-Public Event Opening Statement

Because of the shutdown, we are flying much more blind than we would like to be. We are not getting the normal data flow. Thus there is more than the usual level of uncertainty.

Given that:

• I believe there is something like an 80 percent probability that Europe is now in a small recession.
• The Chinese government continues to say that all is well.
• But somehow six percent fewer cars were bought in China in late 2018 than in late 2017.
• Over the past half century the reliable recession signal has been yield-curve inversion—since 1965 eight inversion signals: one false (1998), one near-recession (1966), and six recessions.
• There have been no recessions not signaled by a yield-curve inversion.
• The Federal Reserve currently plans are to invert the yield curve in June.
• Neither Steve Moore nor I understand why the Fed thinks that this is a good thing to do.

Continue reading "The Economic Forecast: Commonwealth Club Non-Public Event Opening Statement" »

## Commonwealth Club Talking Points (January 25, 2019): Forecasting and Steve Moore Edition

The Shutdown: Let's review the bidding: Pelosi, Ryan, McCarthy, Schumer, McConnell, Trump reached a deal. Deal passes Senate unanimously. Trump watches "Fox and Friends". Trump announces he won't sign the deal. Paul Ryan—desperate not to embarrass Trump more—won't let the House vote on the deal. Ryan goes out and Pelosi gets in on January 4, and Pelosi passes the deal through the House. But because it is a new congressional session, the Senate's approval has expired. And McConnell—desperate not to embarrass Trump more—is now holding things up in the Senate.

From Pelosi and Schumer's standpoint, the big problem is this: they reach a new deal with Trump, Fox and Friends finds some reason to slag it, Trump backs out again.

The right, rational response to this situation is for Pelosi, McCarthy, Schumer, and McConnell to strike deals and then pass them with veto-proof majorities. But McCarthy and McConnell are too scared of Trump and not concerned enough about the well-being of the country to do that.

2.5 million people aren't getting their paychecks and 800,000 are getting very little work done. That's about a 0.5%—10 billion over the past month—hit to the economy. We won't see that because of oddities in the how the public sector is folded into official statistics, but it is there. Will there be a multiplier applied to it? In a year I will have the data so that then I will be able to look back and tell you. I cannot tell you now...

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## Be the Podcast You Want to See in the World!

The very sharp Arindrajit Dube was, as one does, procrastinating on twitter:

Arindrajit Dube: Somehow I find the econ podcast space is mostly occupied by ideological right wingers, as opposed to people interested in an open minded, evidence informed economics. Who am I missing?

And my instantaneous reaction was: BE THE PODCAST YOU WANT TO SEE IN THE WORLD!

Brad DeLong: Let's start a podcast!

Arindrajit Dube: Wait Brad, is this a serious offer? :-)...

And the public chimed in:

Suresh Naidu: Do it!
Matthew Yglesias: You guys should do this for real
Robert Waldmann: You really do have to do the podcast (or block me). I will tweet complaints until you do it.
Aaron Sojourner: It would be incredibly valuable service.
Erik: Do it!
Dr. A. Duus Pape: I'd subscribe in a heartbeat.

Arindrajit Dube: God damn it Brad now Matt Y is on board and I am seriously screwed...

So it looks like we may be doing this for real—once a week, half-hour chunks, starting out as amateur hour only. First topic: thinking about what marginal tax rates on the rich should be.

What say you all?

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Seems to me @biscuit_ersed and everybody else needs their first game-theory lecture to be (1) defect-defect as dominant-strategy Nash equilibrium in prisoner's dilemma, (2) the unraveling equilibrium in finite related prisoner's dilemma, and (3) this first prisoner's dilemma ever played: http://www.j-bradford-delong.net/economists/prisoners_dilemma.html https://twitter.com/biscuit_ersed/status/1084812993509105671...

## Trade and Distribution: A Multisector Stolper-Samuelson Finger Exercise: Hoisted from 2008

Hoisted from 2008: Trade and Distribution: A Multisector Stolper-Samuelson Finger Exercise: This argument of an inconsistency between free trade and the well-being of the majority of potential voters rests substantially on the two-factor example of the Stolper-Samuelson result. It does not fare too well when we generalize to a situation in which there are a number of different factors—even if the ownership of the abundant factors of production is very concentrated indeed... https://delong.typepad.com/stolper-samuelson_finger_exercise-1.pdf

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Richard Thaler: The Power of Nudges, for Good and Bad: "All nudging should be transparent and never misleading.... It should be as easy as possible to opt out.... There should be good reason to believe that the behavior being encouraged will improve the welfare of those being nudged.... Government teams in Britain and the United States that have focused on nudging have followed these guidelines scrupulously. But the private sector is another matter. In this domain, I see much more troubling behavior...

## Development and Security

Not what I said at the Blum Center Development Lunch today: more what I wish I had said—albeit it is still incoherent and disorganized:

Let me begin with three direct responses to points Michael Nacht made. Let me then try to—briefly—propose a framework, perhaps a framework for analysis, perhaps merely a framework for convincing people in the national security community that they should take issues of economic development seriously, and so give large grants so that the Berkeley development community can do more things—things closely related to what we would be doing anyway.

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Note to Self: Books for Econ 210a: Introduction to Economic History (Spring 2019)

## Blum Hall B100: Plaza Level: 2 PM: Bill Janeway: The Digital Revolution and the State: The Great Reversal

Bill Janeway: Doing Capitalism in the Innovation Economy 2.0 https://books.google.com/books?isbn=1108471277: "The innovation economy begins with discovery and culminates in speculation. Over some 250 years, economic growth has been driven by successive processes of trial and error: upstream exercises in research and invention and downstream experiments in exploiting the new economic space opened by innovation...

...Drawing on his professional experiences, William H. Janeway provides an accessible pathway for readers to appreciate the dynamics of the innovation economy. He combines personal reflections from a career spanning forty years in venture capital, with the development of an original theory of the role of asset bubbles in financing technological innovation and of the role of the state in playing an enabling role in the innovation process. Today, with the state frozen as an economic actor and access to the public equity markets only open to a minority, the innovation economy is stalled; learning the lessons from this book will contribute to its renewal...

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The first write-up of the Prisoner's (or is it Prisoners'?) Dilemma: Merrill Flood (1958): Some Experimental Games: "Summary: Two players non-cooperatively choose rows and columns of their payoff matrices in a series of 100 plays of a non-constant sum game. The purpose of this experimental game is to determine which of several theories best describes their behavior. The players, being familiar with zero-sum game theory, happen to choose a poor solution for their non-constant-sum game...

## Prisoner's Dilemma, or Prisoners' Dilemma?: Hoisted from the Archives

Hoisted from the Archives: Prisoner's Dilemma: An extended passage from William Poundstone's (1992) marvelous book Prisoner's Dilemma (New York: Doubleday: 038541580X) https://books.google.com/books?isbn=0307763781. Economists will find it hilarious and thought-provoking. Others will probably find it bizarre and weird. It comes from pp.106-118.

Flood and Dresher devised a simple game where [the Nash equilibrium wasn't such a good outcome for the players].... The researchers wondered if real people playing the game--especially, people who had never heard of Nash or equilibrium points--would be drawn mysteriously to the equilibrium strategy. Flood and Dresher doubted it.

The two researchers ran an experiment that very afternoon. They recruited two friends as guinea pigs, Armen Alchian of UCLA ("AA" below), and RAND's John D. Williams ("JW"). The game was presented purely as a payoff table. The payoffs were:

 (AA's payoff, JW's payoff) JW's Strategy 1 [Defect] JW's Strategy 2 [Cooperate] AA's Strategy 1 [Cooperate] (-1, 2) (1/2, 1) AA's Strategy 2 [Defect] (0, 1/2) (1, -1)

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## The Appalachian and Other Trails

https://www.icloud.com/keynote/0HORQ6Ql3Ejvf5PSeGJkEXOyQ

Let's consider the United States in the time of major westward expansion and "Amerindian removal": the century 1760 to 1860 before the Civil War. We have U.S. output-per-worker growth then at about 1.0% per year, in contrast to British output-per-worker growth at about 0.5% per year. We have the U.S. population and labor force growing at 2.5% per year, from 2.5 to 30 million. Our conclusion:

An America penned behind the Appalachians would probably have seen its living standards and productivity levels not growing at 1% per year from 1760 to 1860 but shrinking. For the $\gamma = 3.0$ benchmark case, living standards and productivity levels would have shrunk at a pace of -0.325% per year had population growth been the historical 3% per year.

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Over on EconSpark, I think this is wrong: Ben Bernanke: How Important Was The Financial Panic As A Cause Of The Great Recession?: "The collapse of the housing bubble was certainly a primary cause of the Great Recession.  The unwinding of the bubble (1) depressed aggregate demand through its adverse effects on consumer wealth and residential construction, and (2) triggered a financial panic...

The unwinding of the bubble set the table for the financial panic, but it did not trigger it. The bubble had already been unwound before the panic. The triggers of the panic lay elsewhere: in the events in financial markets that produced a sudden, discontinuous boost in the demand for safe assets. One picture I have always found very illuminating is this one:

## Is There Any Reason to Fear Low Interest Rates?

Paul Krugman tells us: Paul Krugman: @paulkrugman: "The American Economic Association has a new discussion forum set up by Olivier Blanchard. First up is the question of whether low interest rates are leading to excessive risk-taking https://www.aeaweb.org/forum/311/have-low-interest-rates-led-to-excessive-risk-taking..." So I mossed on over and left three comments: one on the forum, one on secular stagnation, and one on whether there is any reason to fear low interest rates:

Is There Any Reason to Fear Low Interest Rates?: Have low interest rates led to excessive risk taking?: I suspect that the right way to make the accurate point that this line of discussion is hunting for is to focus not on the amount of risk but on, rather, who is bearing the risk...

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Larry Summers: The Five Best Books on Globalization: "The Economic Consequences of the Peace https://books.google.com/books?id=AX1EAAAAIAAJ, by John Maynard Keynes; Manias, Panics, and Crashes https://books.google.com/books?isbn=0230365353, by Charles Kindleberger; Globalization and Its Discontents https://books.google.com/books?isbn=0393071073, by Joseph E Stiglitz; Why Globalization Works https://books.google.com/books?isbn=0300102526, by Martin Wolf; and _The Great Convergence https://books.google.com/books?isbn=0674972686, by Richard Baldwin...

This line of work has become popular, and is very interesting. But I always find myself having a hard time evaluating it, and am puzzled as to how to think about it: Yuriy Gorodnichenko, Debora Revoltella, Jan Svejnar, Christoph Weiss: Dispersion in productivity among European firms: "This column uses firm-level data from all EU countries to explore how the dispersion of resources affects macroeconomic performance...

Perhaps the biggest hole in growth economics is its inability to properly wrestle with the problem of how to build and entertain the communities of engineering practice that have the externalities that fuel so much of economic growth. The 2% per year rate of growth of labor efficiency seen over the past century comes from somewhere, after all. If it comes from activities like R&D and science that together consume 2% of national income, that is a 60%/year net rate of return on such activities. We badly need to understand more about them: Pierre Azoulay, Erica Fuchs, Anna Goldstein, Michael Kearney: Funding Breakthrough Research: Promises and Challenges of the "ARPA Model": "The Advanced Research Projects Agency (ARPA) model for research funding has... spread...

If those of us on the left and center are ever going to restart a technocratic debate with those on the right, it will be because thinking on the right becomes dominated by people link Brink Lindsey and his posse, rather then the current crew who are haplessly triangulating between their funders and their political masters: Brink Lindsey: [Welcome to capturedeconomy.com(https://capturedeconomy.com/welcome-to-capturedeconomy-com/): "WA new website dedicated to the problems of 'regulatory capture' and 'rent-seeking'—economist-speak for the pursuit of profits through politics...

## Friedrich Engels (1843): Outlines of a Critique of Political Economy: Weekend Reading

Friedrich Engels (1843): Outlines of a Critique of Political Economy: "The eighteenth century, the century of revolution, also revolutionised economics. But... all the revolutions of this century were one-sided and bogged down in antitheses...

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## Hoisted from teh Archives: Joseph Schumpeter on "Liquidationism"

Today's Economic History: Joseph Schumpeter on "Liquidationism": "Three things strike me while rereading Schumpeter's 1934 "Depressions" (and also his 1927 Explanation of the Business Cycle):

1. How much smarter Schumpeter is than our modern liquidationists and austerians--he says a great many true things in and amongst the chaff, which is created by his fundamentally mistaken belief that structural adjustment must be triggered by a downturn and a wave of bankruptcies that releases resources into unemployment. How much more fun and useful it would be right now to be debating a Schumpeter right now than the ideologues calling for, say, more austerity for and more unemployment in Greece!

2. How very strange it is for Schumpeter to be laying out his depressions-cause-structural-change-and-growth theory of business cycles at the very same moment that he is also laying out his entrepreneurs-disrupt-the-circular-flow-and-cause-structural-change-and-growth-theory of enterprise. It is, of course, the second that is correct: Growth comes from entrepreneurs pulling resources into the sectors, enterprises, products, and production methods of the future. It does not come from depressions pushing resources into unemployment. Indeed, as Keynes noted, times of depression and fear of future depression are powerful brakes halting Schumpeterian entrepreneurship: "If effective demand is deficient... the individual enterpriser... is operating with the odds loaded against him. The game of hazard which he plays is furnished with many zeros.... Hitherto the increment of the world’s wealth has fallen short of the aggregate of positive individual savings; and the difference has been made up by the losses of those whose courage and initiative have not been supplemented by exceptional skill or unusual good fortune. But if effective demand is adequate, average skill and average good fortune will be enough..."

3. How Schumpeter genuinely seems to have no clue at all that the business cycle is a feature of a monetary economy--how very badly indeed he needed to learn, and how he never did learn, what Nick Rowe and company teach today about the effects of monetary stringency on economic coordination.

4. And, finally, how absolutely bonkers liquidationism and austerianism remain...

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## Tail Risks

Tail risks. Can we afford right now to think about tail risks? Probably not: right now what were our tail risks have become head risks, and given them and our day jobs we are all fully absorbed. But if we are going to be spending even a little time thinking about tail risks, the big worry has to be that something happens to cause the Global North to stop investing, as it did in 2008-2009.

Cast your minds back to ten years and two months ago. Back then people were patting themselves on the back; The United States had wound down from its over-the-top overcommitment to housing construction, and had done so without a recession. The Federal Reserve had handled the unpleasantness of mortage-firm, structured-product, and Bear-Stearns bankruptcy. In doing so the Federal Reserve had effectively guaranteed the unsecured debt of every systemically-important commercial and investment bank in and out of New York. The forecast—at least among those who were not close students of Hyman Minsky, an who had not paid attention to Paul Krugman's The Return of Depression Economics—was for at most a small recession, with the balance of risks such that the major risk to the economy—at least in the minds of the Federal Reserve's Open Market Committee—was an increase in core inflation.

## Weekend Reading: Robert Allen on Japan

Weekend Reading: On Japan: Robert Allen** (2013) Global Economic History: A Very Short Introduction (Very Short Introductions) (Oxford: Oxford University Press: ) https://books.google.com/books?isbn=0199596654: On Japan: "Japan is a particularly interesting case, for it was the first Asian country to catch up with the West...

As Michael Kades writes, “the stakes are much higher than an ideological battle or technical adjustments to a legal regime” here. We need to understand how anti-trust practice affects the degree of monopoly in the United States and Hal monopoly effects equitable growth and societal well being. We do not. I think that attempting to understand these two issues is the most important analytic issue for policy relevant economic research in the United States today: Michael Kades: Why market competition matters to equitable growth: "At first glance, competition in the U.S. economy may seem far afield of the topic of equitable growth.... What could antitrust enforcement have to do with maintaining a healthy economy?...

## Big Questions for Left Opposition Social Scientists: Cedarbrook Notes

Cedarbrook Notes: Occupy had zero impact on austerity budgets. Mont Pelerin was not important because they gathered by a lake, sang “kumbaya”, and felt a sense of solidarity. We should not pretend defeats were victories.

What can we do? I think there are three levels that we ought to be operating on—all, right now, understanding the world rather than trying to change it: understanding policies, understanding mobilizations, and understanding utopia:

• The first is understanding the effects of policies: the policies adopted between 1980 and 2007 did not have the results that their advocates expected nor the results that their critics expected. We really do need to figure out how to understand what the social world is rather than what the models—both pro and con—in use during the neoliberal era said the social world was.

• The second is understanding the vicissitude of mobilization. The standard political center-left plans to promote full employment, progressive taxation and social insurance, upward mobility, and infrastructure and public services—equitable growth—all these are things that should meet with near-universal applause. By contrast, con-game kleptocracy in the interest of plutocracy should not get 60 million votes. Fascism—the belief that you need a strong leader who is a bully, because he is your bully, and he will bully your enemies, who may be corporations, foreigners, people who look or think differently, and who are always the rootless cosmopolites—should not be attractive to a 21st-century electorate on any level. Yet, somehow, it, terrifyingly, is. The same social-science models that failed to adequately track the effects of neoliberal policies failed to predict the seductive attractiveness of 21st century neo-fascism. Thus we have two different levels at which we need to understand the societal world: the effects of neoliberal policies, and the possibilities for mobilization.

• The third is the question of what our Utopia is. How will our different view of the social world change our goals for a good society? Our utopia will almost surely still include full employment, progressive taxation and social insurance, upward mobility, and lots of infrastructure. But it will also include other and deeper objectives—objectives that have not been on the New Deal and social democratic bucket lists.

These three tracks all need to be pushed forward. But they also very much need to be three tracks. And they need to be three different tracks.