Home > Economics - General > Rational manias

Rational manias

July 20th, 2004

There’s a cottage industry within economics involving the production of historical arguments giving rational[1] explanations of seemingly irrational historical episodes, of which the most famous is probably the Dutch tulip boom/mania. This Slate article refers to the most recent example, a complex argument regarding changes in contract rules which seems plausible, but directly contradicts other explanations I’ve seen.

Once opened, questions like this are rarely closed. Still, articles of this kind seem a lot less interesting in 2004 than they did in, say, 1994. In 1994, the efficient markets hypothesis (the belief that asset markets invariably produce the best possible estimate of asset value based on all available information) was an open question, and the standard account of the Dutch tulip mania was evidence against it. In 2004, the falsity of the efficient markets hypothesis is clear to anyone open to being convinced by empirical evidence.

We have seen billion-dollar valuations placed on companies that proposed to home-deliver dogfood at prices lower than those charged in discount stores. We’ve seen unimportant subdivisions of profitable companies valued at more than the companies themselves. We’ve seen a dozen different companies simultaneously priced at levels that made sense only if they were each going to monopolise the industry in which they were competing. And don’t even get me started on the US dollar bubble (now burst) or the bond bubble (still inflating).

In summary, is contradicted by our own recent experience far more thoroughly than by anything that might or might not have happened in Amsterdam in the 1630s. Everybody who cared to look at the numbers coming out of markets in the late 1990s knew they were crazy, but it didn’t matter. Those who bet on an early return to sanity (George Soros for example) lost their money. The only sensible course was to withdraw to the sidelines and wait the madness out.

It’s true that dramatic episodes like the dotcom mania don’t happen all the time. But even one such episode, occurring in a well-developed and sophisticated financial market like that of the US in the late 1990s is sufficient to undermine the assumption that asset markets ever yield the best possible estimate of asset values, except by chance.

fn1. That is, explanations consistent with individual rationality as defined by economists

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  1. July 20th, 2004 at 05:38 | #1

    I presume you meant to link to the article?

  2. Fyodor
    July 20th, 2004 at 10:18 | #2

    JQ,

    I know you wear your politics on your sleeve, but you risk losing your reputation for intellectual rigour when you make statements like the following:

    “It’s true that dramatic episodes like the dotcom mania don’t happen all the time. But even one such episode, occurring in a well-developed and sophisticated financial market like that of the US in the late 1990s is sufficient to undermine the assumption that asset markets ever yield the best possible estimate of asset values, except by chance.”

    It reminds me of Churchill’s quip about democracy: the worst form of government, except for all the others.

    If you’re ready to propose a mechanism for price discovery that is more efficient than a well-run market, the world is keen to hear it. In the meantime, markets work pretty well, most of the time.

  3. July 20th, 2004 at 10:36 | #3

    Free market’s not necessarily the best solution ALL the time.

    When someone starts a speculative run on your currency (Asian currency crisis 1997), or your factory inputs (oil prices circa Gulf War II), or basic needs (beef, wheat, housing). Your life is going to be pretty miserable.

    Furthermore, when a speculative bubble bursts, there are pieces to be picked up by everyone, regardless of whether they took part in it or not (Great Depression 1930s).

    If the stock exchange can be programmed to prevent sharp downturns in prices, but an orderly market, why shouldn’t governments play a role in facilitating one by facilitating orderly growth of prices as well?

  4. Uncle Milton
    July 20th, 2004 at 10:52 | #4

    “markets work pretty well, most of the time”

    Quite possibly. But the efficient markets hypothesis says that financial markets work perfectly well, all of the time.

  5. July 20th, 2004 at 12:39 | #5

    And perfect competition says that there will never be any excess profits and price will always equal costs. It’s wrong. But that doesn’t mean it doesn’t hold useful insights and valuable lessons.

  6. tipper
    July 20th, 2004 at 13:16 | #6

    Uncle Milton wrote:

    “Quite possibly. But the efficient markets hypothesis says that financial markets work perfectly well, all of the time.”

    Uhmmm……… no it doesn’t.
    Wish that were so. The hypothesis tries to have a bob each way, or maybe three ways.
    A weak form, semistrong and strong.
    Most people when they refer to the hypothesis, refer to the semistrong not the strong form which includes insider information.
    On a more interesting topic, anyone know a good system for picking gee gees?
    I’ve been using a modified version of the EMH with average results.
    ‘Pose it’s better than losing.

  7. PK
    July 20th, 2004 at 13:49 | #7

    Fyodor is right. Very few people say the free-market is perfect. Just that historical evidence shows it’s much better than the alternatives.

    Here we are in the West, living as well as humans ever have, thanks largely to the free market. It works! The evidence is all about us.

    If lefties like John were honest, they’d start from the position of admitting that fact, then stating why we should fix something that doesn’t appear to be broken and has, by historical measures, exceeded all expectations. Who would have believed 100 years ago that the average Australian/American/Western European would be living the way they do today?

    In response to Chui. Your examples were certainly very unpleasant. They are, however, minor compared to what socialism has wrought on populations.

    Put up or shut-up free-market critics. Your standard alternatives have been miserable failures in almost every real-world experiment. Come up with something new, or quit your pointless sniping.

  8. July 20th, 2004 at 16:36 | #8

    To the barricades PK!

    Let us lay down our lives for the profit of the owners of the means of production!

    You have nothing to lose but your safety net!

  9. kyan gadac
    July 20th, 2004 at 16:45 | #9

    IMHO the examples of free market failure suggest there are two distinct causes.

    One is a failure to deal with non-elastic supplies which leads to rapid inflation e.g. oil prices, drought induced food shortages. For me the important concept here is the idea of reproductive goods. Reproductive goods differ from productive goods in being time-compulsory rather than time voluntary. Food resources, hospitals, police etc. are time compulsory – the service/goods must be available at the time of demand. N.B. this is not an either/or distinction, oil, for instance, can be replaced as a source of energy but only when new/old technology is available – also oil used for heating (Say in North America) is a much more time compulsory resource than oil used for transport.

    The other aspect of free market failure is the failure of information inherent in booms/manias. Here the information (this is crazy) is available but not heeded. The players have blinkers on. Since this is inherent in horse racing as well as stock trading the nature of the signals that need to get through to people is what matters.

    For instance, the housing bubble of recent years is driven by people getting on the bandwagon – having rational expectations that prices will keep going up – until interest rates rise. But the latter signal is highly imperfect (have rates risen enough?) so officials such as economists, housing industry leaders etc. trumpet their concerns to get through to people in an attempt to cool the market.

    But as this example illustrates it is the collective blinkering, that leads people to think that one horse will always win, that is the real problem.

    The solution to this is the banning or the making difficult of various forms of speculation. We ban pokies but allow people to bet on horses because the latter is less addictive.

    So there are two ways of making a free market less prone to failure. One is to be prepared to intervene in the case of reproductive(non – eleastic) shortages/gluts. (But when? how?)

    The other is to seek ways to remove the blinkers from people’s eyes when a bubble is forming. Making the buy/sell process less efficient as prices start to rise e.g. capital gains taxes. Other suggestions?

  10. Matt
    July 20th, 2004 at 17:28 | #10

    To PK’s comment about free markets providing the best living standards ever, isn’t it true that there’s been more socialist/govt intervention in the economy since WWII than was usual before?
    As I see it we’re somewhere in the middle at the moment and deciding whether to stay put or move towards either free markets or greater govt regulation. Over the last 20/30 years we’ve moved towards free markets, but I’m not sure there’s overwhelming support to go forward in that direction. Even with that move we’re fairly well regulated now compared to other eras.

  11. July 20th, 2004 at 17:56 | #11

    i agree with john that markets are far from efficient. markets are groups of people, and people are far from rational. even people who command a lot of capital are far from rational (or well informed for that matter).

    the good thing about markets is that eventually the bubbles burst.

    the bad thing about these bubbles bursting is that the wrong people often get hurt. if your superannuation was wiped out in the dotcom crash, you would be pretty annoyed. the real problem is not that the bubble burst, but that certain people have control of other peoples money. too bad if you invested in an overpriced dogfood share, i have no sympathy.

    governments are like markets, in that the population can vote out the government or stage a revolt.

    the question is which of these correction mechanisms is better for certain things.

    reading between the lines, i think the implication of john’s article is an attack on markets, possibly in favour of a more command economy. as others point out, the real question is not whether markets fail (of course they do) but whether for certain parts of the economy (stock market?) the government could do a more efficient job.

    personally i feel there are huge inefficiencies in the stock market. imagine all these financiers in their billion dollar companies, and fancy offices in skyscrapers, and all they do is shift money around and cream off the top. they dont do anything “real”. billions of dollars are wasted paying these people.

    if government were given control of capital, there probably would be billions of dollars wasted as well.

    i guess the real problem is that people dont know, or care that a portion of their money in managed funds goes to paying people to do a bad job of managing their money.

    even in my own case i havent got around to seeing where all my different bits of super are invested, and whether im getting robbed blind by these funds.

  12. PK
    July 20th, 2004 at 17:56 | #12

    And over the past 20/30 years living standards have doubled Matt. There was no guarantee that that would occur, yet it did. This isn’t theory, it’s reality, apparent to anyone who cares to open their eyes.

    There’s also a pretty good argument to be made that the free market was responsible for lifting living standards before that even despite increased govt intervention. If you weigh down a horse and it still runs (albeit slower), are you crediting the weight with making it run?

    Dave Tiley’s comments are exactly what I was talking about. Sniping with no viable proven alternative. Any idiot can do that.

    His comments also bear a striking resemblance to those made by the architects of the USSR. What a great idea that turned out to be.

  13. PK
    July 20th, 2004 at 18:06 | #13

    In reply to c8to, who seems to be examining the argument rather than taking a side. This isn’t a rebuttal, just my clarification of some points.

    You seem to be saying people have more control over governments than free enterprise (correct me if I’m wrong). I don’t see how this pans out. You can vote for one of two pretty similar parties once every three years. That’s not much control.

    If you’re not happy with what private financiers are doing with your money, you can take it from them any time. If the Australian market is overvalued (in your opinion), put your money in Japan, or in cash, or in US bonds, or spend it on a new car etc, etc, etc. In the private world, your control is virtually limitless. Give the government your money and your say over what’s done with it is virtually non-existent.

  14. Harry Clarke
    July 20th, 2004 at 18:06 | #14

    I think a sensible view of asset markets is that they are often efficient but they do have speculative bubbles which eventually do self-correct. If this sounds like a weasily piece of evasion let me summarise what Burton Malkiel author of A Random Walk Down Wall Street (one of the best books on investment advice ever written) suggests as an investment philosophy.

    As a reflection of market efficient try to buy low-fee mutual funds that sell at a discount to their asset backing (there are some rational reasons for the discount!). Also as a reflection of market efficiency trade your stocks as infrequently as possible.

    If you must pick individual stocks ‘Buy stocks with the kinds of stories of anticipated growth on which investors can build castles in the air’. This reflects the reality of bubbles.

    The latest edition of Malkiel (2003) has a couple of chapters on bubbles that are useful. He links bubbles to criminal behaviour and fraud, an important connection. His comments on the pricing of speculative dotcoms are probably even more scathing than John Quiggin’s remarks but he certainly isn’t giving up on private capital markets.

  15. John Quiggin
    July 20th, 2004 at 18:07 | #15

    PK if by “capitalism”, you mean the class of economic systems that has prevailed in OECD countries since WWII, then I’m in favour of one variant of capitalism and you’re in favour of another. If you mean “a society with much less government intervention than today’s”, then the historical record of capitalism pre-WWII gives you little support.

    As for your claim that:

    “There’s also a pretty good argument to be made that the free market was responsible for lifting living standards before that even despite increased govt intervention. If you weigh down a horse and it still runs (albeit slower), are you crediting the weight with making it run?”

    there’s an equally good, or bad, argument to be made that communism would have worked if it had only been persisted with long enough.

    Both arguments share the property of being entirely untestable, but comforting to a particular class of ideologue.

  16. PK
    July 20th, 2004 at 18:07 | #16

    In reply to c8to, who seems to be examining the argument rather than taking a side. This isn’t a rebuttal, just my clarification of some points.

    You seem to be saying people have more control over governments than free enterprise (correct me if I’m wrong). I don’t see how this pans out. You can vote for one of two pretty similar parties once every three years. That’s not much control.

    If you’re not happy with what private financiers are doing with your money, you can take it from them any time. If the Australian market is overvalued (in your opinion), put your money in Japan, or in cash, or in US bonds, or spend it on a new car etc, etc, etc. In the private world, your control is virtually limitless. Give the government your money and your say over what’s done with it is virtually non-existent.

  17. PK
    July 20th, 2004 at 18:11 | #17

    “there’s an equally good, or bad, argument to be made that communism would have worked if it had only been persisted with long enough. ”

    Can you name a single case where it did? How many generations would we have to wait? The poor Cubans are still marking the days.

    There’s a long list of examples of free-markets growing more quickly with less government regulation.

    You’re right that it’s not cut and dry, but the evidence is pretty suggestive.

  18. PK
    July 20th, 2004 at 18:20 | #18

    “PK if by “capitalism”, you mean the class of economic systems that has prevailed in OECD countries since WWII, then I’m in favour of one variant of capitalism and you’re in favour of another. ”

    I didn’t actually use the word capitalism, but am broadly in agreement with this. If you’re in favour of an economy consisting largely of the free-market (a point on which you’re not always clear), but with some govt intervention. Then we’re in broad agreement. It’s the mix rather than the model that we probably differ upon.

    However, you often give the impression that the free-market is wrong or bad. If you believe this, then I assume you would relegate it to a minor role. If that’s the case, then there is little historical evidence anywhere to support your position.

  19. John Quiggin
    July 20th, 2004 at 19:29 | #19

    PK, the experience of the 20th century as a whole suggests that the optimal mix of public and private shares in GDP is about 50-50 (if you want a broad range, somewhere between 30-70 and 70-30) and that the optimal public share has risen gradually over time.

    During the 1980s and 1990s, policy debate was dominated by the claim that a radical reduction in the role of the state, and a corresponding expansion in the role of the market, was desirable. The efficient markets hypothesis was one of the intellectual props of this claim. I reject the claim, and argue that its intellectual basis is inconsistent with observed experience.

  20. July 20th, 2004 at 19:30 | #20

    PK – I was trying for a bit of gentle comedy based on your last rhetorical paragraph. A sort of faux-Leninist sendup. With something of a serious point beneath the joke – that the universe you paint is a bit manichean. You versus evil, sniping socialists.

  21. tipper
    July 21st, 2004 at 02:07 | #21

    David
    Would this be why socialism is evil?
    A diseased ideology from a diseased mind.

  22. tipper
    July 21st, 2004 at 02:19 | #22

    John
    Seeing that I’m not an economist, surely you are not trying to confuse me, by equating GDP with markets.
    The EMH has everything to do with markets but has little relevance to GDP.
    How can you have a “market” for public services, unless you privatise them and subject them to the rigours of the market?

  23. jo
    July 21st, 2004 at 03:36 | #23

    Mark Twain wrote that everyone talks about the weather but nobody does anything about it. When, in 1996, Alan Greenspan commented on the “temperature” of the market with his “irrational exuberance” speach, he likewise did nothing about it and the mania took another six years to blow off. If markets follow certain laws, then why are they so unpredictable? Like chaotic weather systems, markets are far from equilibrium, and are subject to mathematically based metaphores such as “the butterfly effect”, where a small event can, through positive feedback, become amplified. In the case of markets, both greed and fear have the potential to blow. Would a command economy eliminate the dangers? Possibly, but at what cost? What if we decided to “do something” about the inherent unpredictability of the weather?

  24. kyan gadac
    July 21st, 2004 at 05:18 | #24

    I’d beg to differ with Tipper about GDP as a useful measure. The gross in GDP implies work value for a year and is thus, relatively independent of profits and capital so the comparision is based on wages and prices which is not unreasonable.

    But I’m wondering at the straw men here – the free market is a game with rules, or at least meta-rules about honesty and timeliness and oppressive conduct. Surely PK et al aren’t arguing that fraud should be allowed.

    I would argue that the Trade Practices Act of 1974(?) contributed greatly to the operation of the Free Market in Australia. Because it set out the rules. Which gave people confidence, which, as everybody knows, is the sine qua non, of a free market!

    If we avoid thinking of the free market (or private share of GDP or whatever) as some kind of morally dubious entity then the balance of public versus private can be examined in completely different light.

    Firstly, public sector work is dominated by a reproductive constraints. (1) it is cyclical (2) it is time compulsory (3) it is necessarily social as opposed to socially necessary. The last is a difference in valuing. The original observation is Mary O’Brien (The Politics of Reproduction).

    The police, schools, welfare, army, weather forecasters, hospitals etc. that are the primary source of government funding are so because of these constraints and differences from a productive system.

    This difference is nothing more than the observation in group dynamics that groups require maintenance as well as goals and nothing less than the observation that reproduction is work centered specifically around women.

    This does not mean that productive work need suffer nor is it in competition with it. They are different dimensions of the same problem.

    It has been observed time and time again that small changes in the position of women can make a huge difference in the long run from the Grameen Bank in Bangladesh to child endowment payments to Aboriginal women.

    On the flip side the equal wage decisions for Aboriginal workers did not depopulate the country towns and places of Aboriginal people but it did impoverish them relative to European standards. The reason they survived was because the reproductive economy of women was so tied to their own place and was strong enough to survive.

    In a real sense, amongst Noongar people, matriarchal traditions(language to describe relationships) have outsurvived patriarchal ones. A failure to appreciate the significance of this is the main reason that throwing money at Aboriginal Communities doesn’t work – it’s usually given to the men.

    The reason why no one is describing an alternative to capitalism/socialism is that no one is asking the right people – women. Or if they’re asking then they’re not listening. (Sorry that’s a bit imflammatory:-)

    As to the inherent unpredictablility of markets this is no more of an obstacle to understanding and making predictions about long term trends than are predictions about climate change. If you accept the maths behind climate change then you are bound to accept maths about the ‘physics’ of the free market. i.e. the money supply, exchange rates etc. etc.

    Of course, if you don’t accept the predictions about climate change….

  25. Fyodor
    July 21st, 2004 at 10:07 | #25

    JQ,

    Could you provide some evidence for your claim that:

    “…the experience of the 20th century as a whole suggests that the optimal mix of public and private shares in GDP is about 50-50 (if you want a broad range, somewhere between 30-70 and 70-30) and that the optimal public share has risen gradually over time.”

    I think it’s a very hard argument to justify – as it would be to state that an unfettered free-market would be “optimal”. Your statement above also contradict your earlier point, that:

    “…even one such episode, occurring in a well-developed and sophisticated financial market like that of the US in the late 1990s is sufficient to undermine the assumption that asset markets ever yield the best possible estimate of asset values, except by chance.”

    If you accept that an optimal mix of private/public participation in the economy has at least 30% private participation, don’t you also have to accept that markets get it right, a lot of the time?

    I also think we need to clarify what we mean when we say “optimal”. Is our goal to maximise the size of the economic pie, or to make sure everyone gets an equal slice, or can we achieve both goals?

    Personally, I believe a capitalist economy based on well-regulated (i.e. with a significant government presence, rule-of-law, etc.) markets is the best way to create wealth, but this has the inevitable side-effect of creating wealth inequality. I can live with that, however, if most people achieve ever-improving living standards. Fortunately this is the case with every well-run capitalist economy, and emphatically not the case for societies that use non-market mechanisms for distributing resources.

  26. John Quiggin
    July 21st, 2004 at 10:21 | #26

    Fyodor, there’s a big difference between

    “The market estimate is always and everywhere the best possible estimate of asset values, and hence the best possible guide to resource allocation” (the EMH claim)
    and
    “The market estimate is, much of the time but not always, the best available estimate of asset values, and hence the most appropriate mechanism for resource allocation” (the mixed economy claim)

    Faced with this choice, not that many people will defend EMH. But lots of people make arguments within the context of the mixed economy that depend implicitly on EMH.

  27. July 21st, 2004 at 11:16 | #27

    Capitalism is a funny word. Too ambiguous. Not to mention that it was coined by Marx as an insult.

    I believe Q would be best described as a social democrat – as distinct from a liberal democrat (such as myself) and distinct from a democratic socialist (what the greens say they want), stalinist socialist (what the greens would turn out like), communist and anarcho-syndicalist (effectively the same and internally inconsistent).

    I think that we currently live in a social democracy, and it is pretty good. Certainly better than all the other options with the word ‘social’ in it. It basically accepts a market starting point – and just bastardises it according to certain political priorities.

    Social democracy is good, and has taken our economy forward. I just think that liberal democracy could be better.

    The changes of recent decades have just re-fashioned our social democracy. Tweak a tax rate here… change a regulation there… but no fundamental shift. John Quiggin and John Howard are both social democrats… but for different reasons and with different areas of emphasis.

  28. PK
    July 21st, 2004 at 13:03 | #28

    “I reject the claim, and argue that its intellectual basis is inconsistent with observed experience.”

    I’m not sure that it does. In the main three developed countries where these policies were implemented (Aus/UK/US), living standards effectively doubled. There was nothing inevitable about this and it followed a long period of economic stagnation.

    I think it’s reached a point now where opponents of these policies (such as yourself) need to admit that they haven’t been an absolute disaster. Since they’ve been implemented, the population in all three countries has become substantially better off.

    Perhaps things may have been even better if your preferred policies were implemented. They weren’t doing too well during the 70s though.

  29. John Quiggin
    July 21st, 2004 at 13:21 | #29

    What time periods are you referring to here, PK? The highest rate of GDP growth in all these countries was in the period 1945-70.

    The deceleration is particularly marked in relation to wages in the US, which are more relevant to living standards for most people than GDP per person. Real wages in the US have barely changed since 1970, particularly for workers with high-school education or less.

  30. Geoff Robinson
    July 21st, 2004 at 13:32 | #30

    A strong case can be made that Soviet economic planning from the late 1920s to the 1960s underpinned exceptionally high rates of economic growth compared to what would have occured in a market economy (see Robert Allen’s Farm to Factory published by Princeton last year). The economic history of the Soviet Union cannot simply be dismissed as an economic failure. What went wrong from the late 1960s is a complex question and there is a strong argument it was an inevitable result of the socialist system beyond a certain level of maturity, nevertheless it’s explanation requires analysis rather than slogans. Economic history is more than last year’s Fin Review editorial.

  31. Tony Healy
    July 21st, 2004 at 14:06 | #31

    I often wonder whether the important factor in the success of Western economies is democracy rather than capitalism. Democracy helps prevent the worst excesses of exploitation that lead to inefficiencies, whether in centrally governed or market economies.

    Capitalism in the reformed USSR at one stage seemed to consist of a lot of sleazy night club owners.

  32. July 21st, 2004 at 15:02 | #32

    PK, i agree, im actually economically right.

    i have posted some thoughts in response at my weblog:

    http://badanalysis.com/blog

    (damn, i came off sounding like a leftie.)

  33. Fyodor
    July 21st, 2004 at 15:34 | #33

    JQ,

    You seem determined to resist the argument that markets get prices (i.e. observed exchange rates for good traded between buyers and sellers, as opposed to “value”, which is a subjective concept) right MOST of the time.

    The fact that markets don’t work 100% perfectly 100% of the time may not support the strong form of the EMH , but a lot of economic assumptions never get met in real life. Moreover, on pragmatic grounds the success of markets in pricing goods and services is damn good going, and you have yet to suggest credible alternatives that work as well, MOST of the time. Markets work.

    Taking your subsequent post, I’d like to see the data series you refer to when you state that American’s real wages have not increased since 1970, and whether you have adjusted for the effect of stagflation in the 1970s. What were the results looking at real wages from, say, 1980 to today? This may be a loopy suggestion, but I dare say most Americans think they’re better off now than they were in 1970.

    Geoff Robinson notes the rapid economic growth of the Soviet Union, and it’s undoubtedly true that real economic growth was significant. Unfortunately, the data is notoriously unreliable, and we don’t know how quickly the economies involved would have grown under a capitalist system. Russia went through an industrial revolution in a short space of time, and it’s not suprising that the application of Western technology and exploitation of Russia’s vast natural resources should yield economic growth. What we can’t really prove is whether Russia would have grown faster under a capitalist system.

    Given the extent to which the Soviet Union proved unable, from the 1960s on, to meet the consumer demands of its populace, maintain technological parity with the West and renew its infrastructure, I’m guessing that it would have done better under capitalism, but no doubt there are plenty of lefties out there who believe that those old blokes in the Politburo would have lifted their game if they’d just been given a bit more time than 30-odd years. You only have to look at China since 1980 to realise the power of markets and capitalism.

  34. PK
    July 21st, 2004 at 15:48 | #34

    “The highest rate of GDP growth in all these countries was in the period 1945-70.”

    So all we have to do is have another world war and then we can happily increase growth levels as we recover from it? Since the period you’re referring to was extraordinary compared to the environment we currently live in and can expect to in the future, the comparison is somewhat irrelevant.

    ‘Economies much better off twenty five years after the war than immediately following it!’ Not a very convincing headline, is it?

    “Real wages in the US have barely changed since 1970, particularly for workers with high-school education or less.”

    This is a bit of cherry-picking the data to fit your prejudice John. Are you seriously suggesting that most Americans aren’t better off now than they were then?

    This particular bit of data choice is also somewhat misleading, as price of most goods has fallen at the same time, thanks largely to free trade.

  35. PK
    July 21st, 2004 at 16:00 | #35

    Oops. Missed the Real in your sentence. Please be charitable and ignore the last para.

  36. John Quiggin
    July 21st, 2004 at 16:44 | #36

    As regards US real wages, just do a Google on something like “US real wages 1970″ and see if I’m cherrypicking. This was the
    first link I found that had relevant data

    It’s up to 1999. Real wages grew during the boom that ended in 2001, and have been pretty much stagnant since then.

    As regards Fyodor’s suggestion, the peak for real wages was actually around 1980.

    Note that these are averages for wage employees and that the situation is worse for those with high-school only.

    Against this, the value of health benefits has risen, for those workers who have them (a shrinking group).

  37. Fyodor
    July 21st, 2004 at 17:45 | #37

    JQ,

    I think that data may be bogus. I went to the US Government Bureau of Labor Statistics, at the following website:

    http://www.bls.gov/ncs/ect/sp/ecbl0014.pdf

    It’s a Sep-2000 report entitled “Employment Cost Indexes, 1975-1999″. It’s a 165 page PDF document (sorry), but p.16 has a table showing that blue collar workers experienced a 208% increase in real total compensation from 1980 to 1999, or a real increase of 3.7% p.a. Moreover, every class of worker – management, blue-collar, manufacturing, service, etc. – has experienced a substantial increase in real compensation over similar periods.

    I can’t reconcile that with your statement or your data. It doesn’t make intuitive sense either.

  38. John Quiggin
    July 21st, 2004 at 18:10 | #38

    Fyodor, I think you’re confusing reals and nominals. I quote from your source (p8)

    “Over the entire September 1975-December 1999 period,
    the constant-dollar ECI increased by 2.5 percent. ECI wages
    and salaries rose 216 percent, while consumer prices increased
    208 percent over the same period.”

  39. Fyodor
    July 21st, 2004 at 18:35 | #39

    JQ,

    You’re quite right – apologies, I was too hasty in posting. The chart on the same page also suggests, however, that spells of inflation in 1978-1981 and 1987-1991 are what dragged down real wages growth.

    Data notwithstanding, it doesn’t seem intuitively correct that Americans (and I mean the typical worker, not Wall Street cats) have not progressed in economic terms since 1970, although I suppose the analysis doesn’t include asset appreciation/wealth effects (which would favour the wealthy rather than poor).

  40. July 21st, 2004 at 18:56 | #40

    i think 1970 was the pinnacle of human history…if only i were 23 back then…

    at any rate, maybe what your thinking of fyodor is that the average american has more stuff now…but this might be the contribution of women to the workforce. so real wages may have declined but family incomes have increased due to intensification.

    (no gain as far as im concerned, unless you count the increased opportunity for women to enter the workforce, which is a positive. however, if real wages have declined, its actually become necessary that they do so aswell)

    50 years ago and probably still 30 years ago there was mainly a sole breadwinner per family.

  41. derida derider
    July 21st, 2004 at 19:02 | #41

    Fyodor, read closely – that is nominal wages, not real, you are quoting. Given that US prices grew by 209% over the same period, (use the CPI calculator here), average real blue-collar wages fell very slightly. And don’t forget that with a skewed (lognormal) wage distribution increases in wage inequality must mean that the average grows faster than the median – and its the median that represents the ‘typical’ experience.

    Also, real wages are generally believed to have fallen in the US in the 1970s – so John’s claim about overall movements in real median unskilled wages since 1970 (rather than your choice of 1980) is more likely to be right than not (assuming you trust the US CPI – but that’s a whole different story).

  42. John Quiggin
    July 21st, 2004 at 19:25 | #42

    The behaviour of US wages presents a puzzle on many levels. Stay tuned for a big post on this as soon as I get time.

  43. PK
    July 21st, 2004 at 20:14 | #43

    JQ

    You’re cherry-picking by selecting one piece of data out of many that could support your position. You are trying to draw the argument into focussing on that one piece of data at the exclusion of all else.

    Are you’re asserting that:
    a) The average American is not substantially better off than they were in 1980 and;
    b) real wage growth is the most important measure of economic well-being?

    If so, I’d like to see you go on record with these assertions. They are contrary to what’s generally believed both inside and outside your profession.

    If you feel that these assertions are correct, you should go into print as I’m sure a lot of people would be interested in that viewpoint.

    My original argument was that the economic policies you oppose do not appear to have done any harm to the developed country populations that lived under them. In fact, in those countries, the average person appears much better off.

    Are you saying that this is generally wrong?

  44. John Quiggin
    July 21st, 2004 at 21:09 | #44

    PK, perhaps you could take up my earlier invitation to say what policies you are talking about.

    Since turnabout is fair play, I’ll go first. In OECD countries since 1945, people have (to greater or lesser degrees at different times and places) lived under, and benefited from policies such as old age pensions, unemployment benefits, publicly-funded education and health, union-friendly labour laws, environmental and anti-discrimination regulation, progressive income taxes and so on. I support all of the above.

    Of course, you can assert, and I can’t easily disprove, the counterfactual claim that things would have been even better in the absence of these policies. But the same will apply in reverse when you present your list.

  45. PK
    July 22nd, 2004 at 11:09 | #45

    John, I’m responding to your previous comment…

    “During the 1980s and 1990s, policy debate was dominated by the claim that a radical reduction in the role of the state, and a corresponding expansion in the role of the market, was desirable.”

    In the countries where this was attempted, little harm seems to have been done.

    I generally agree with your list of what government should supply, although in many cases I think it’s currently overdone.

  46. Tom Davies
    July 22nd, 2004 at 13:20 | #46

    It seems to me that the interesting question is: How do you tell when a regulatory approach to pricing something is better than a market approach, and what are the costs of getting it wrong?

    For instance, the dot com boom wasted a lot of capital on business which were unlikely to work. But should there be some government body which somehow caps share prices at some lowish p/e? Some successful businesses would be starved of capital, and the freedom to invest one’s money as one sees fit would be infringed.

    It seems hard to imagine the cure not being worse than the disease.

  47. July 22nd, 2004 at 15:50 | #47

    davies hits the nail on the head.

    the alternative to pricing stuff by the market is to have a government body sit down and decide on the price, and you can almost guarantee price by commitee would be even more irrational than the market. (plus youd have no choice to opt out)

    thus, the fact that markets are irrational doesnt alone sway anything in favour of the government, as i point out at my blog.

    on the separate issue of private versus public services, there are again two issues:

    1) redistribution of wealth

    2) natural monopolies

    wealth redistribution is best achieved by taxation and directly giving the money to people, instead of services.

    in cases of natural monopoly (land lines, water, energy, rail), theres no room for competition, so its inefficient whether its provided for by government or by government ordained private monopoly.

    in a government run service, if theres profit to be made the taxpayer gets a return, whereas privatisation just enriches the share holders, or some other lucky bastard who managed to sway the government and get the contract. so government provided services are (probably) better in a natural monopoly.

    however, this is not an argument against privatisation of things where competition exists and is viable, like education and health (which should be voucher schemes redeemable at private institutions)

  48. tipper
    July 22nd, 2004 at 16:19 | #48

    No worder I get a headache reading JQ sometimes.
    I innocently assumed that the topic was EMH. Now EMH is not a hard concept to understand, once it’s pointed out to you (A bit like the Emperors lack of clothing)
    The Efficient Market Hypothesis states that at any given time, security prices fully reflect all available information. Most people who buy and sell securities (shares in particular), do so under the assumption that the securities they are buying are worth more than the price that they are paying, while securities that they are selling are worth less than the selling price. But if markets are efficient and current prices fully reflect all information, then buying and selling securities in an attempt to outperform the market will effectively be a game of chance rather than skill.
    That’s it!
    Not about Private V. Public ownership, or if the author of statistics about the Soviet Union was Baghdad Bob.
    Or at least, that’s my understanding of it.

  49. July 22nd, 2004 at 19:07 | #49

    markets are only efficient if theres people in them who think they aren’t efficient (i.e they can make money out of the inefficiencies…thus closing them)

    but youre right, public versus private is a separate issue as i point out, but that doesnt mean a thread shouldnt get sidetracked productively.

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