Do Economists Make Markets? Hal Varian Does.

Wired has a feature about Hal Varian, a UC Berkeley professor and chief economist for Google. Varian joined Google in 2000 and determined that the AdWords auction system Google was planning was designed “perfectly.” Google then went ahead and launched the AdWords auctions to tremendous success. Since then, Google has gone auction-crazy, for example:

Google even uses auctions for internal operations, like allocating servers among its various business units. Since moving a product’s storage and computation to a new data center is disruptive, engineers often put it off. “I suggested we run an auction similar to what the airlines do when they oversell a flight. They keep offering bigger vouchers until enough customers give up their seats,” Varian says. “In our case, we offer more machines in exchange for moving to new servers. One group might do it for 50 new ones, another for 100, and another won’t move unless we give them 300. So we give them to the lowest bidder—they get their extra capacity, and we get computation shifted to the new data center.”

Markets vs. hierarchies? How about economist-made markets within hierarchies! Adwords itself is an interesting case I now want to know more about. What does it mean that every time a user searches an auction is held? Has Google managed to produce a system that actually has a market for every moment in time, a market for every desire?

Last, a bit about the spread of “Googlenomics”:

Since Google hired Varian, other companies, like Yahoo, have decided that they, too, must have a chief economist heading a division that scrutinizes auctions, dashboards, and econometric models to fine-tune their business plan. In 2007, Harvard economist Susan Athey was surprised to get a summons to Redmond to meet with Steve Ballmer. “That’s a call you take,” she says. Athey spent last year working in Microsoft’s Cambridge, Massachusetts, office.

Can the rest of the world be far behind? Although Eric Schmidt doesn’t think it will happen as quickly as some believe, he does think that Google-style auctions are applicable to all sorts of transactions. The solution to the glut in auto inventory? Put the entire supply of unsold cars up for bid. That’ll clear out the lot. Housing, too: “People use auctions now in cases of distress, like auctioning a house when there are no buyers,” Schmidt says. “But you can imagine a situation in which it was a normal and routine way of doing things.”

Sometimes I think that internet tycoons don’t fully understand how unique their products are, and I wonder if this is one of them. AdWords can have millions and millions of auctions per day because each auction is almost free, and because the product being sold is entirely electronic. Would the same kind of positive outcomes be possible from something like cars? What would that even mean? Are houses and cars and text ads similar enough? What will economist do to them going forward to make them more similar? Might they try and package them up as securities to sell and trade?

Oh wait, we kinda tried that one already…

Another Cause of the Mortgage Crisis: The Consumer Price Index!

One of my favorite things about reading a good book is rummaging through its citations to look for more good books. It’s like paleo-wikipedia. Today’s find, from Jerry Davis’s last chapter in Managed by the Markets, is this interesting article from Harper’s on manipulations of macroeconomic statistics by Kevin Phillips. Much of the piece recounts interesting and politically salient examples of how technical changes in the calculation of key macroeconomic indicators – GDP, CPI (which tries to measure inflation), and the unemployment rate – led to “polyanna creep”. That is, successive administrations pushed the statistics to always make the economy look better, such that compared to 25 years earlier, the statistics of the 2000s reported inflation and unemployment as being far lower than they otherwise would have been.

I have a lengthier take on the whole problem – which hopefully may someday be part of an article or dissertation chapter – involving the idea of technopolitics, and the problem with forgetting that statistics are always everywhere political tools and never technical measures of an objective underlying reality, but for this quick post I just want to highlight an interesting connection between measurements of inflation the mortgage crisis. So, story part I goes back to the Reagan administration and changes made in the CPI that helped lower interest rates:

In 1983, under the Reagan Administration, inflation was further finagled when the Bureau of Labor Statistics decided that housing, too, was overstating the Consumer Price Index; the BLS substituted an entirely different “Owner Equivalent Rent” measurement, based on what a homeowner might get for renting his or her house. This methodology, controversial at the time but still in place today, simply sidestepped what was happening in the real world of homeowner costs.

But, as we know from (good citation needed), rental prices and home prices diverged fairly dramatically in the past few years. That’s one of the signs we missed in the whole housing price bubble. Because the house price wasn’t in the CPI any more, the measure was lower than it would have been and thus interest rates were lower, which in turn fueled the bubble, as Phillips notes (citing a law professor):

As Robert Hardaway, a professor at the University of Denver, pointed out last September [2007], the subprime lending crisis “can be directly traced back to the [1983] BLS decision to exclude the price of housing from the CPI. . . . With the illusion of low inflation inducing lenders to offer 6 percent loans, not only has speculation run rampant on the expectations of ever-rising home prices, but home buyers by the millions have been tricked into buying homes even though they only qualified for the teaser rates.”

The Embeddedness of Economic Action: Piracy Edition!

I don’t listen to NPR as often as I would like, in part because my commute is a 10 minute walk, but a friend today sent me an excellent bit from Planet Money. Yesterday’s podcast revisits piracy, and consists largely of a very funny story about how a pirate negotiator and a businessman hit it off after completing a negotiation for the release of some kidnapped employees. Here’s the story. I recommend it as an excellent example of the embeddedness of pirate action in social structure! (Of course, you’ll mostly get the economics angle involving information and bargaining, but that’s Planet Money for you.)

Jerry Davis is a Genius

… but not perhaps (or not only) for the reasons you might think. I’m currently reading his excellent new book, Managed by the Markets: How Finance Re-Shaped America. The book is something of a synthesis that tries to tell the story of the rise of finance in the past few decades and what Jerry calls “the portfolio society”. That is, a society “in which the investment idiom becomes the dominant way of understanding the individual’s place in society.” (p. 6) The book is fun, and well-written and seems to be aimed at a much wider audience than, say, readers of ASQ, but without sacrificing much depth. I predict it will do very well, and recommend it.

But none of this explains how Jerry is a genius. Rather, this quote from the acknowledgments does:

“All remaining errors are my own. In fact, for the more pedantic readers, I have purposely inserted a small handful of minor factual, grammatical, and spelling errors – its the least I could do to keep their interest up.” (p. xv)

With this one deft move, Jerry has now forced me (i.e. a pedantic reader) to look ever harder for small errors and be upset if I don’t find any. I don’t know if Jerry seriously introduced intentional typos – apart, perhaps, from the use of “its” in the above quote? – but now I have to assume he did. And every time I find one, rather than being upset at the general decline of editing skills in the world, I will now feel the slight tinge of conspiratorial victory. Well played, Davis. Well played.

A Serious Question About Agency Theory

If shareholders are “rationally ignorant” and thus don’t get involved in management decisions, how can financial markets (i.e. the place where shareholders buy and sell shares) capture all information? Maybe I’m trying to put two disparate things together, it’s been awhile since I read the agency theorists.

In a similar vein, I offer a Retro Quote of the Day:
“Although the evidence is not literally 100 percent in support of the efficient market hypothesis, no proposition in any of the sciences is better documented.” Michael Jensen (1988) “Takeovers: Their Causes and Consequences”, available from the SSRN here (and cited in Davis 2005).

I wonder what he’s saying now… Probably not quite what John Quiggin is saying.

The Boundaries of “Economic”

The New York Review of Books has an excellent review of Akerlof and Shiller’s recent book Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism here. As a warning, I have not yet read Animal Spirits. My favorite part of the review concerns Akerlof and Shiller’s treatment of economic vs. noneconomic motives (and rational vs. irrational responses). I’m going to quote a big section of the review because I think it says cleanly something I’ve been saying messily for years, and which I’ve been trying to find better ways to say. First, the review (by Benjamin Friedman) quotes the book at length:

Picture a square divided into four boxes, denoting motives that are economic or noneconomic and responses that are rational or irrational. The current model fills only the upper left-hand box; it answers the question: How does the economy behave if people only have economic motives, and if they respond to them rationally? But that leads immediately to three more questions, corresponding to the three blank boxes…. We believe that the answers to the most important questions regarding how the macroeconomy behaves and what we ought to do when it misbehaves lie largely (though not exclusively) within those three blank boxes.

Friedman then goes on to problematize this fourfould table*:

One of the inevitable difficulties with this kind of argument is that it depends so much on just how words are used. What is the difference between an economic and a noneconomic motive? If I buy a new car because I like its styling and good gas mileage, that’s presumably an economic motive. What if it’s a hybrid and part of my reason for buying it is that I value the “story” of my doing my bit to help slow global warming? If a business owner provides scholarships for his employees’ children, is his motive to treat them fairly for fairness’ sake or to foster their loyalty and thereby improve their productivity?

The answer, in the end, is that an “economic” motive is whatever economists include in their theories of how people behave. And since different economists are always proposing different theories, what constitutes an “economic” motive can differ from one theory, and one economist, to another. Since at any particular time there are dominant theories, there is some coherence to what people would understand as an “economic” motive; and so the point Akerlof and Shiller are trying to make here is far from empty. But it is more elusive than they suggest. The distinction between what’s “rational” and what’s not is, if anything, even more fraught. [Emphasis mine.]

If you’re Callon, that sounds a lot like “Economists frame the economic”. Alternatively, if you’re more into Gieryn, economist do boundary work around the economic. Either way, I think Friedman has given an excellent and jargon-free description of both the ways in which economists construct the economic and why challenging those constructions is meaningful even though they are, in some sense, arbitrary. In other words, just because “X is socially constructed” does not mean it’s pointless to argue that “A is X” or “A is not X”. Rather, that’s why such an argument is meaningful.

The question Friedman does not go on to ask – and which may be somewhat utopic to even bother pondering – is whether or not the categories of “economic” and “rational” have “shed more heat than light”. Fabio recently asked over at OrgTheory, are there other foundations for economics that might make more sense than the dominant model based on (rational, economic) choice. Perhaps another way of asking this question is, are there fruitful, alternative ways of conceptualizing what “economic” and “rational” mean? Or is there a way of getting at similar problems (of the distribution of scarce things, the dynamics of making and trading things, etc.) using a wholly different framework, that eschews “economic” and “rational” entirely? For example, I think the move to satisficing over maximizing (Fabio’s first suggestion) is a redefinition of rational but not of economic.

Alright, back to Polanyi…

* I wonder how many published papers and essays consist of making and then problematizing such tables. Many, if my theory classes are any guide.

Markets Are Politics vs. Markets Have Politics

A couple days ago, I stumbled upon an excellent article by economic sociologist and blogger Peter Levin about markets and culture. Levin digs into the contrast between the “markets have culture” and the “markets are culture” positions at the intersection of economic and cultural sociology. The debate had not made much sense to me when I first ran across it studying for prelims, but Levin’s explanation crystallized the differences and offered two nice paths to reconcile them. Briefly, Levin shows how one set of authors look at the way culture constitutes markets in the first place by fixing the kinds of objects and actors involved (through commodification, commensuration, etc.), while another set looks at the social and cultural influences within functioning, relatively stable markets (e.g. the Granovetterian tradition in economic sociology). The first shows how culture constitutes markets, the second shows how culture acts on existing markets in a complementary way to purely economic forces.

So what does this have to do with politics? I think we can usefully analogize the two. Authors looking at the intersection of political sociology and economic sociology have analyzed, on the one hand, how markets are politics, and, on the other, how markets have politics. The markets are politics approach you can associate with the like of Karl Polanyi, who shows that the constitution of markets is political all the way down. The economy is not, and can never be, disembedded from the social world in general, and from the state in particular. Laissez-faire was planned. Etc. The kind of politics referred to here is often macro, state-centered politics, but also can be the little, everyday sorts of politics you might associate with James Scott, or, even cooler, the subtle networks of power of Michel Foucault. Markets are politics because they act on our actions, defining our possibilities and our spaces of possible interaction. So the markets are politics approach covers the big P historical politics of states and the little p politics of the everyday. What’s missing is the middle level – overt, but not state-centered politics.

And that’s where the markets have politics approach comes in. This style, perhaps mostly cleanly seen in recent work on the intersections of social movements and markets such as Brayden King’s stuff, focuses on organized, public politics aimed at markets or market actors – a boycott, or a buycott, or a campaign to push for a certification like Fair Trade or Organic. The markets have politics approach looks at meso-level politics and how they influence markets.

What do you think?

Gavin Kennedy on the Myth of Adam Smith’s Invisible Hand

Gavin Kennedy is a retired professor of business history and the history of economics and a prolific blogger. His central topic is Adam Smith’s “lost legacy”, on which he has written two books. His blog has recently focused on misuses of the metaphor of “the invisible hand”. In particular, Kennedy argues that this metaphor took on a life of its own in the mid-20th century that had little to do with Adam Smith’s original meaning. Smith used the metaphor 3 times, and only once in Wealth of Nations, and never expressed anything like a “theory” of the invisible hand. In Wealth of Nations, Smith used the metaphor to refer to

… degrees of caution about the risks associated with distant trade with the British colonies in North America, which incentivised some, but not all, merchants to act circumspectly in their preference for domestic projects, thereby unintentionally benefiting the domestic economy.

A far cry from the almost mystical force it later acquired. The quote above is from a paper Kennedy just published in the fun journal, Econ Journal Watch. The paper is Adam Smith and the Invisible Hand: From Metaphor to Myth. In the same issue, Daniel Klein dissents and argues for continued attempts to understand the invisible hand here.

Stand-Up Economist on the Financial Crisis

Yoram Bauman is a PhD Economist from UWashington, and the world’s only stand-up economist. I probably watch his bit on the “Principle of Economics, Translated” about once a month, and it has not yet gotten old. He just released a new clip on the Financial Crisis which is quite enjoyable:

I recommend it and everything else on his site.

Now, why isn’t there a stand-up sociologist? Is sociology just not as funny?

Econ 101: Hopelessly Outdated And All The Macro You Need To Know?

Gregory Clark, UC Davis economic historian and Atlantic blogger, wrote awhile back a very interesting post about the failures of the profession to predict the current downturn, and the irrelevance of most contemporary economic research to understanding the recession. In a sense, he’s arguing that economists have stopped studying the economy because they thought the problem was solved – the business cycle moderated, fiscal and monetary policy levers sufficiently understood to make another Great Depression* impossible. Here’s Clark’s assessment of the current debate:

The debate about the bank bailout, and the stimulus package, has all revolved around issues that are entirely at the level of Econ 1. What is the multiplier from government spending? Does government spending crowd out private spending? How quickly can you increase government spending? If you got a A in college in Econ 1 you are an expert in this debate: fully an equal of Summers and Geithner.

The bailout debate has also been conducted in terms that would be quite familiar to economists in the 1920s and 1930s. There has essentially been no advance in our knowledge in 80 years.

While I like the thrust of the comment (and given my own recent reading of 1930s economic writings I largely concur) I disagree slightly with the timeline. 80 years ago, in 1929, John Maynard Keynes had not yet published A Treatise on Money (1930), let alone The General Theory of Employment, Interest and Money (1936). Hicks’ famous interpretation of the General Theory, which set the stage for Samuelson’s text and the Econ 101 courses Clark refers to, was published in 1937. So, I think to be a bit more precise and a bit more charitable, we can say there has been very little advance in the terms of the debate in the last 70 years. Which is to say that we still think of the economy roughly how we did just after Keynes (but not much before him), and we still focus on the same metrics for success and the same big policy proposals. But is that the same thing as saying there has been no advance in our knowledge? Or just to say that the paradigm of economics (to abuse Kuhn for a moment, as so often happens) has not shifted as much as all the debates about monetarism, New Keynesianism or Real Business Cycle theory would suggest.

But back to the central claim Clark makes: has all of the macroeconomic research done in the last 70 years really provided us with nothing (or less than nothing in Eugene Fama’s case) helpful for a big crisis? Does Econ 101 give you all the macro you need to know for the current crisis, even though it’s all considered hopelessly outdated by graduate curricula standards? If so, why?

Clark connects the uselessness of contemporary macro to the Great Depression II: Electric Boogaloo to economics turn towards studying the apparently trivial, e.g. online dating. But that can’t be enough – PhD economists are still required to take a rigorous year of macroeconomics, at least, in basically every program. And every top department has plenty of people who are still studying the dynamics of economies, rather than specific markets.

Thoughts?

* I was sorely tempted to write “Great Bagel” there in honor of the West Wing but, of course, bagel stands in for the R-word not the D-word.