Like David Brooks, Jim Manzi has some wrong ideas about how economics works.
Manzi begins with the standard critique
In practice, the problem of excessive abstraction by economic theory that Brooks identifies becomes increasingly severe as we try to evaluate the effects of proposed interventions and programs over years and decades, rather than months and quarters.
First, this is backwards. With cyclical policy its generally speaking easier to access the effect of interventions over longer and longer horizons because the economy increasingly resembles a frictionless market as you extend time in to the future.
For example, if you asked what effect would properly done fiscal stimulus today have on the economy 20 years from now, the fairly easy and straight forward answer is, none.
Stimulus is not central planning or industrial policy. It should have no lasting effects. If it does, then you did it wrong. What’s more difficult is the short run.
Manzi continues mixes monetary and industrial policy. He says
Consider the role of very low interest rates in stimulating economic growth in the software industry where I work. Easy monetary policy, along with various other forms of stimulus, has at least in part, likely worked as advertised; it has likely stimulated some extremely-difficult-to-quantify general economic growth, which has in turn created demand for enterprise software, among many other things. And low interest rates probably have resulted in certain additional development projects within large companies being greenlighted because they face a lower discount rate. In fact, many traditional large enterprise software companies have built large cash hoards. But they are mostly using them to finance acquisitions, not to expand capacity and increase aggregate output. Why this is so turns out to be important for understanding the potential effects of this policy on the industry.
A good central banker has absolutely no interest in what the effect of this policy is on your industry. That is your problem as a manager.
The idea is that in a market economy, someone, somewhere, will find a way to capitalize on increasing demand. It may be the software industry, it may be the restaurant industry, it may be traditional manufacturing. In our experience, traditional manufacturing moves the most in response to cyclical forces, but we are not picking winners here.
We are trusting that in a market someone, somewhere will find a product that they can sell if demand is high.
He goes on to confuse two-party transactions with economy wide effects
One major effect of a Fed policy of easy money, then, is that large software companies can go borrow lots of money cheaply, and then use this acquire entrepreneurial companies that usually require more equity financing rather than debt financing. This does not add capacity to world, but simply transfers management control over some very important assets from entrepreneurs to incumbents.
That single transaction does not, but it is a part of chain that does. The money flows from the incumbent to former entrepreneurs. One potential effect is that the entrepreneurs have a sudden wealth effect which they can use either to purchase more consumption, invest in new companies they might want to start or hoard as low return cash.
If they choose the later they will face the same incentives that pushed the large company to acquire the smaller one.
Another potential effect, is that likely the incumbent is doing this because its increasing its internal return on assets. This means that while the incumbent formerly was simply a cash cow building up ever higher cash reserves, it now has a new department which can use that cash effectively.
Note, that the viability of the paragraph I just wrote depends on a breakdown of Modigliani-Miller. That is, an explicit recognition that some important conjectures may not hold.
Still another potential effect is that upon seeing the wave of buy-ups new companies start-up with the thought that they don’t have to dethrone the incumbent, they simply have to be threatening enough or creative enough to be bought out. This soaks up capacity.
Again, the goal is not to get the software incumbents or entrepreneurs to do anything in particular. It is to change the general set of incentives in the economy and assume that someone will respond.
Manzi asks again
Will this lead to higher or lower economic output in 2015, 2020 and 2030? I don’t know. But then again, neither does anybody else.
There might be some minor knock-on effects because you are dealing with the high growth software industry but the standard answer should be the same. It will have no effect on economic output by 2030.
He goes on to critique the model and again mix stimulus with industrial policy
Where is any of this complexity captured in econometric models that purport to explain how fiscal deficits, interest rates and quantitative easing are driving everything from car dealerships to television broadcasters to consumers of dog food, all of whom face their own unique dynamics? But without it, I doubt the ability of any model to forecast the long-run impacts of a multi-trillion dollar program to intervene in the economy in the name of creating self-sustaining growth in the long -term. All I can say with confidence is that if you believe as I do that a good rough rule-of-thumb is that “over any sustained period markets supported by an appropriate culture will do a better job than politicians in allocating resources to generate high economic growth,” then at some point, the distortions created by such a policy would likely outweigh any benefits it can create.
This complexity is captured in most models that have a no-arbitrage condition. That is the model implicitly assumes that if there is a clear way to make profit some entrepreneur will take it. The model assumes that if product A is better than product B then the consumer will buy it. It makes no assumptions about how this profit will be made or which products the consumers will choose.
Indeed, its faith in the web of interconnections that leads economists to say, market participants will arbitrage away the internal difficulties leaving us with a black-box in which stimulus comes goes in one side and production comes out of the other.
Its not the belief that we can understand all the frictions that leads to the simplest models but the belief that we can’t but the market participants can.
Most importantly, however, there is no “no policy” option.
One cannot have “no monetary policy.” Policy must either be tight or loose. Interest rates in every period must be something and that something is determined by what the Fed chooses. Even if we returned to a gold standard, the policy would be that the Fed prints money until the price of gold has reached a certain level and then stops. That’s still a policy.
So, it is not as if the Fed for example is saying – look we have digested the intricacies of business better than the market participants and have decided that you are doing the wrong thing and need to be adjusted.
No, the Fed says, by necessity we have a policy. Is this policy helping or hurting based on the broad set of incentives we know this policy has?
A similar situation happens with taxes. The federal government is going to have some tax policy. Even if the policy were to eliminate all taxes, that itself would be a policy and would have consequences.
Thus, the question facing the government is whether or not the tax policy is helping or hurting? Would lower taxes, which are akin to looser money, encourage or discourage business activity.
Likewise the government will have some deficit policy. Even running a balanced budget is itself a policy. For example running a balanced budget would make tax hike during a recession almost inevitable. Is this a good idea?
Again, we can’t have no policy. We have to have some policy and the question is, is the policy helpful or not.
What we are expressly not doing is industrial policy. That is, we are not saying – look corporation should really be doing X and we are going to make them do it regardless of the private sector incentives.
We are saying corporations are responding to the incentive structure we as public institutions inevitably create and we wondering how can this structure be as supportive of growth as possible.
Manzi end with
Despite confident assertions by academicians, the Law of Unintended Consequences remains in force.
That law sounds like something Manzi picked up from an academician.