Non-conformism in academia

In economics, there is the mainstream and various heterodox fractions that do not identify with the mainstream or each other. Too many, the heterodox seem like annoying and useless chatter. But they fulfill an important role, which is to keep those in the mainstream on their toes. This is part of the scientific process: challenge long and widely held views to check whether they are still valid. And even if the challenge is wrong, it makes those in the mainstream think about the axioms the build their theories on.

Vela Velupillai makes the case that dissenters are typically silenced by the mainstream, but may prevail in the long-run, citing many examples of mathematical economics, in particular the work of Pietro Sraffa. And this is really what tenure is good for: a dissenter will have much trouble publishing but may ultimately still contribute a lot to scientific advances.

We are in times were dissenters seems to have a more receptive audience. Indeed, the current crisis is seen by some as a failure of Economics, thus it is easy to criticize it. But it also highlights that dissenting can be very distracting if it is poorly focused, uniformed and populist. In this regard the recent dissenting by Colander, Krugman and Stiglitz has, I think been counterproductive, as I have occasionally discussed here. It is good to criticize the fundamental assumptions of the mainstream. It is better, but not necessary to offer alternatives. But it is counterproductive to dissent on the basis of a old read of the literature, and a literature that has in the meanwhile evolved to address these supposedly new criticisms.

Heterodox Economics has thus gained a fresh wind, simply because it is different from the mainstream. But what does it have to offer? Peter Skott, a heterodox economist himself, argues that it is still far from being an viable alternative. While heterodox approaches usually reject microeconomic foundations in macroeconomics, they should not throw out the baby with the bath water, i.e., ignore microeconomics altogether. And while the heterodox analysis for income distribution has focused on the labor income share, the large changes in income inequality happened within labor income. Finally, the heterodox literature is just as guilty of ignoring many of the suddenly relevant intricacies of the world of finance.

There is still a lot of work to do, and instead of pursuing an excess of mutual accusations and claiming Economics is useless, it seems much more appropriate to put more resources into making it better, heterodox or mainstream. After all, medical research was not defunded when the HIV/AIDS epidemic made ravages.

Adaptive versus rational expectations

There was a time where macroeconomics was ruled by adaptive (or backward-looking) expectations, like the much-ridiculed chartists. Then there was a revolution and rational (typically forward-looking) expectations were widely adopted, realizing that people are not stupid and will try to use the available information, including what other agents may do, to figure out what the future holds. Rationality, and in particular rational expectations, has recently come under attack because models failed to predict recent bubbles and crashes. I think this is mistaken, as detailed on several occasions on this blog.

Gregory Chow, however, longs for a return to adaptive expectations for three other reasons. The first is that it is empirically more plausible. Exhibit A is a regression of the stock prices of 50 blue chips in Taiwan on current dividends and past dividend growth. Despite a lowly R2 of 0.111, the fact that the coefficient on dividend growth is positive and significant is taken as evidence of adaptive expectations. I do not find this convincing, as a similar result could emerge with rational expectations if the dividend growth process is persistent.

The second reason is that "there is no reason to believe that the expected values [computed from an econometric model of the rational expectations] will have a sum, after discounting, which equals the actual current price." I think the underlying reasoning is that a statistician can only use a linear combination of past observations, thus economic agents will, too, and this all looks like adaptive expectations. But economic agents, and nowadays statisticians, are more sophisticated than that, and a gigantic literature in finance has shown that, for example, non-linearities and endogenous volatility, too name a few, are important. Even though statisticians have become much more sophisticated, they are still running behind economic agents and are far removed from being linearly backward-looking.

The third reason is that macroeconomists started using rational expectations simply because it was required to deal with the Lucas Critique, empirical evidence be damned. While I can be sympathetic to the argument that rational expectations was adopted without much direct empirical evidence, I also believe that economic agents do try and avoid systematic mistakes and that their expectations contain at least some rationality. And as much literature has shown, a modicum of rationality can bring markets darn close to prices that look like perfectly rational ones.

Politicians and leisure

When you think about leisure in the utility function, for most applications you need to take a stand on some properties: is the income effect larger than the substitution effect? Is leisure a normal good in the first place? Convincing empirical evidence is surprisingly difficult to find: read the endless debate between microeconomists and macroeconomists about the size of the wage elasticity. This may be an aggregation issue, but maybe we are lacking a clear natural experiment.

Naci Mocan and Duha Altindag report on an interesting change in the way members are paid in the European parliament. Whereas previously they were compensated at wildly different levels by there home countries, since July 2009 they get money according to a uniform rule: 38.5% of a European judge's salary as a base, plus a per diem when present. Mocan and Altindag then use the difference between and with the previous schemes to highlight that an increase in the base reduces attendance (yes, the income effect! Leisure is normal!) and an increase in the per diem increases attendance (the substitution effect is larger than the income effect). Politicians are rational after all.

Emotions in economic interactions

How do you get people to cooperate. By increasing utility, of course, but that is difficult to measure, obviously, and there may some components beyond rationality in emotional contexts. However, we have some interesting ways to get some neurological hints about positive and negative emotions by measuring the conductance of skin. This may help to explain why people are sometimes willing to hurt themselves in order to punish others.

Mateus Joffily, David Masclet, Charles Noussair and Marie-Claire Villeval conduct an experiment where cooperation, free-riding and punishment can happen. They measure skin conductance to reveal the intensity of emotions and let players reveal whether their emotions are positive or negative. Cooperation and punishment of free-riding elicit positive emotions, the latter indicating that emotions can override self-interest. That is also because punishment relieves some of the negative emotions from observing free-riding. And one does not like being punished, which lends one to cooperate more in the future. Finally, people like being in a set-up where sanctions are possible, in particular because it allows a virtuous circle of emotions that reinforce each other and lead to more cooperation.