Friday, August 14, 2015

Summers and the nature of policy advice

Larry Summers has a fascinating editorial in the Financial Times titled "Corporate long-termism is no panacea — but it is a start" You really should read the whole thing and come back for commentary.

The three paragraphs in the heart of the editorial are a tour de force:
Businesses will raise wages to a point where the cost is just balanced by the reduced bill for recruiting and motivating workers. At that point, a further increase in wages does not appreciably change their total costs but higher wages certainly makes their workers better off. So there is a strong case for robust minimum wages.
Never mind centuries of supply and demand, centuries of experience with minimum wages and other price controls, or even the current controversies. Never mind that who works for what business and how many do so is a little bit endogenous. Larry has a new and very clever theory about monopsonistic wage setting in the presence of recruitment and motivation costs.  (One that apparently only holds at the lower end of the wage scale where minimum wages bite?)

There is also a strong reason for regulating aspects of pay. Usually competition drives desirable economic arrangements. But not always — especially when there is a risk of a race to the bottom. A company that tries to stand out by offering especially attractive family leave benefits, or job security, or egalitarian wage structures faces the prospect of attracting a disproportionately risk-averse work force. So there is an argument for using mandates to level the playing field.
Once again, bravo. Larry has a new and very clever theory about companies attracting a too-risk-averse pool of workers when they offer benefits instead of pay. (Why are they offering benefits instead of pay? How does this paragraph, in which workers move from job to job, fit with the last one, about bilateral bargaining between fixed workers and firms? ) And an optimal pay mandate can just offset this distortion and give firms the proper pool of risk aversion in its workforce. (Why are excessively risk averse employees a problem? Where do the risk neutral go to work? Why does this not just lead to a different profile of pay vs. benefits to clear the market by risk aversion? )
Profit sharing, too, is an area where there are demonstrable benefits in terms of increased productivity — but an individual company that stands out by offering it may encounter difficulties in recruitment because workers are too risk averse. So there is a strong case for tax incentives to spur profit sharing.
Ditto. "may encounter" is a "strong case" for "tax incentives?"

Ignore my whining, though, and admire the prose. One, two, three, policies enshrined as economic fallacies in Econ 101 classes, are stunningly overturned by clever new theories in three short paragraphs.

My thought: is this really a good way for economists to help to advance public policy?

Larry is the Smartest Guy In The Room.  I mean that, and I mean it as a compliment. I've seen him in action at conferences and other meetings, and his performances are breathtaking. You can see that bravura here. If you have a policy in mind, Larry can come up with three theories to justify it in half an hour, all novel, all clever, all plausible.

But is this at all a service? We all know the elephant (or perhaps I should say donkey) in the room: these are all proposals Mrs. Clinton is making on the campaign trail. For totally different reasons, of course.

Does it really do lots of good to reverse-engineer clever new theories to justify old policies that happen to be politically hot at the moment? And to ignore all the old arguments over those old policies?

Larry's column is great advice for Harvard graduate students. Here are three great thesis topics. Work them out, see if the theory actually holds together (my questions need answering), see if there is a hope of support in the data. You'll have a great thesis.

But is this reverse-engineering great advice for the country?  Shouldn't economics act a little more like science, and keep our clever new ideas as clever new ideas until they have at least some certified theoretical coherence and empirical support?


I was also a bit annoyed by the classic missing subject and passive voice that pervades economic policy writing. Just who is going to do all these great things and how?

In this case it's more striking because the prose denies the obvious implicit subject -- the Federal Government. No, it's all going to happen
...not through government actions but through mandates or incentives to change business decision-making." 
And later,
So the idea of achieving reform through altered business behaviour, rather than government programmes, is appealing....
That's important, because of the obvious objection: If these clever new market failures exist, do government bureaucrats have any hope of measuring the distortions well enough to craft a policy? If pay mandates are not about giving one group with political access more pay than others, but to carefully offset an incentive to attract too many high-risk-aversion employees, does the current Department of Labor have a hope of getting it just right?

No, obviously. So it would help a lot if this were not a plea for a hopeless dirigisme. And by using the passive voice with no subject, and explicitly denying this is about government, Larry is trying to overcome that obvious hole in these ideas.

But just who other than the government is going to mandate  mandates, incentivize incentives, alter behaviors, impose "robust minimum wages," enact the "tax incentives to spur profit sharing" do the "regulating aspects of pay" and so on? Is Mrs. Clinton no longer running to be head of a government, but some sort of improve-business do-good website?

The last paragraph attempts an answer
The real need is for a cadre of trusted, tough-minded investors in any given company who can credibly commit to support strong management teams and to provide assurances to a broader investment community so that productive investments are made. Accomplishing that, while maintaining market discipline, is the crucial challenge.
Where is this cadre (!) of investors going to come from? How are they going to take over capital markets? How are these Wise People going to impose the long list of things Larry recommends that only governments can do, including minimum wages, tax incentives, and pay regulation? Just who if not the government is this "crucial challenge" for?

Surely this isn't a pean to the wonders of private equity (Bain capital), who can take companies off the short-termist stock market? Neither Harvard's nor Chicago's endowment managers did a great job of being "long-term" investors, both selling madly in 2008, to say nothing of taking little stance on minimum wages, tax incentives, pay regulation, and so forth. This is not a Summers criticism: university presidents do not direct endowment policy. But if university endowments are not the cadre of wise investors, who are? If (explicitly) not a plea for government intervention, is it a plea for alien invasion or divine intervention?

This part is just inconsistent in a very uncharacteristic way. There is a political discourse that wants to pretend there is a "government lite," that will just nudge us here and there. Unwittingly, perhaps, Larry has set forth quite clearly how empty that promise is.  But why he wants to make this obviously weak argument  I do not understand.

Similarly, the first paragraph is
There are not many wholly new areas to open up in economic policy. But in recent months there has been a wave of innovative proposals directed at improving economic performance in general, and middle-class incomes in particular...
Larry himself provides the counterexample to the idea that corporate short-termism is a "wholly new area"
A generation ago, the Japanese keiretsu system of cross ownership of corporate shares — which insulated corporate managements from share price pressure — was seen as a strength.
What's new, of course, is that the Clinton campaign has taken on these very old ideas.

Why go to such lengths to hide the subject of all these policy entreaties -- very much regulation by the Federal Government -- and pretend the final conclusion is to document a need for a new cadre of investors to parachute in from Mars and take over markets? Why ignore the elephant and donkey in the room when analyzing policy proposals by candidates?


  1. The point about benefits attracting an undesirable risk pool has been made before by Summers in a 1989 AER article:,
    so it's not really that new.

    1. Thanks. But an old paper that didn't really catch on seems even less promising as the single basis for a long-debated policy.

    2. That's not AER, it's AER P&P.

  2. What troubles me about neo-Keynesians is not so much that they have a definite clear-cut ideology that I dislike, but that they have too little ideology. They’re too good at rationalizing anything. So if I’m worried about anything, it’s that economics as a kind of independent force won’t really be operating in this administration. These guys have enough talent to put a kind of semi-respectable economic rationale on whatever the hell the politicians come up with. I don’t see a neoKeynesian agenda on policy issues.

    Robert Lucas (1993),

    1. I forgot the quotation marks in the above citation, sorry.

  3. Thanks for making sense of this; the article seems more of a job application than any kind of coherent analysis of economic policy proposals-- and as you make clear, especially disappointing for someone as bright as Summers. In the first paragraph you cite, for him to ignore labor/capital substitution ($15 fast food minimum wage rules may only lead to self service kiosks) just seems lazy, and it just continues from there...

  4. Larry Summers is the smartest guy in the room in the same sense that Johnny Cochran was the smartest guy in the room at the OJ Simpson trial. Intelligence without wisdom degenerates into sophistry in Summers' case.

    I think you nailed the essence of this essay: Summers simultaneously rejects and embraces government interference. He implies that there is some coercive force that can enforce "mandates or incentives" other than "government programmes". What non-governmental force would that be? Where else would one find the power to enact such sweeping "mandates and incentives"?

    The solution offered is as old as Plato - philosopher kings:

    "The real need is for a cadre of trusted, tough-minded investors in any given company who can credibly commit to support strong management teams and to provide assurances to a broader investment community so that productive investments are made."

    I wouldn't be surprised in the least to learn that Summers considers himself to be among the select few capable of guiding us through the wilderness to the Land of Milk and Honey.

  5. John,

    This struck me:

    "A company that tries to stand out by offering especially attractive family leave benefits, or job security, or egalitarian wage structures faces the prospect of attracting a disproportionately risk-averse work force. So there is an argument for using mandates to level the playing field."

    I disagree - There is an argument for using incentives to level the playing field. No sense using mandates where incentives can do the trick.

    Also, which way should the playing field be leveled - government mandate eliminates family leave benefits, job security, and egalitarian wage structures? I suspect Larry believes the opposite, but it is kind of funny that he leaves it to the reader to decide.

  6. Stupidity being safely excluded in the Summers case, leaves only deliberate obfuscation as an alternative, so the next question is, cui bono? Suspecting the man himself of thinking of his own interest only is failing to envision the vast multitudes expected to revel in whatever that siren passive voice is describing. Example, from today's news on German scam on carbon taxes:

    Abolishing that carbon tax would eliminate that particular fraud - and I've never seen a tax-by-tax comparison matching revenues of a tax to its fully costed expense.

  7. Isn't the minimum wage point just that if the firm is at its optimum trade-off for wages then by the envelope theorem the efficiency losses of moving the wage around are second-order, while the transfer gains are first-order? (This argument of course only works for small minimum wage increases...).

  8. When it comes to labor economics, I don't think Larry Summers is the smartest guy in the room. That honor goes to David Card . Seriously, empirical work on labor force supply and demand very clearly shows that labor is not like refrigerators, airline tickets, video games, or smart phones.

  9. Larry Summers is breath-taking is his expansive view of government intrusion into free markets, and into labor markets. I disagree with him.

    But then, the U.S. agriculture sector is heavily subsidized, protected and regulated, at county, state and federal levels. The farm sector is often lionized, especially in Red States, and right-wing circles. We have the best farmers in the world--so everyone says. Our food costs in relation to income are the lowest. In fact, Rural America is heavily subsidized by Metropolitan America, and no one condemns that situation.

    But imagine if for the last 100 years we had free markets in our farm sector and now a Larry Summers came along and called for extensive, even pervasive regulations, subsidies and protectionism. People would say Summers was wrong, had bad ideas.

    My conclusion is that few really believe in free markets. They believe in partisan politics hidden behind economic jargon.

    Where is the outcry against agriculture controls and subsidies? Against licensing lawyers? Against criminalizing high-rise condos in single-family detached neighborhoods?

    But let someone say a higher minimum wage is a good idea....

    So, does statism work?

  10. Larry Summers might be the smartest guy in the room, but he's no Richard Feynman. Feynman complained that the social sciences have no laws and therefore little hope of really knowing things.

    Unlike most of the social sciences, economics has laws: self interest, and rational expectations, however imprecise. Larry Summers harms economics as a discipline with his column. To overthrow Econ 101 with "clever new theories", without any evidence or empirical discovery, is like an eminent physicist throwing out the conservation of energy and the second law of thermodynamics because it fits with the political zeitgeist. Carl Sagan taught us that extraordinary claims require extraordinary evidence. Either economics is a science, with actual laws and empirical evidence, which can helps us understand reality and separate ideas, or it's just a form of religious belief.

    Larry Summers would do well to follow how science actually proceeds lest he further harms economics by promoting it as a lawless discipline of bulverism, run by the authority of "top men".

  11. "Once again, bravo. Larry has a new and very clever theory about companies attracting a too-risk-averse pool of workers when they offer benefits instead of pay"

    This is really new? I always understood, for example, that the reason that companies only offer one or two weeks vacation for new hires (and max at 4 weeks for senior employees) is that they don't want to attract employees who are especially interested in leisure opportunities. University tenure operates on the same principle -- the only way it can work to offer senior faculty ample opportunities to coast is that the publish-or-perish tenure process filters out natural slackers in the first place. On the other side of the coin, one of the problems with K12 education is that one of the big benefits is summers off, and that's not a recipe for attracting the most ambitious and hard-working candidates.

  12. When laypeople read a serious economist such as Summers or Krugman ignore econ 101 that small business owners, middle class workers, educated people with little finance expertise, know to be written solely as a political theory /idea ,we simply deem the profession to be kooky. Guys like Summers and Krugman come across as economists who regret they never held public office.


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