I posted a link to Bryan Caplan’s paper on Behavioral Economics and the Welfare State. Many of the comments I got from economists were predictable:

  1. Where is the formal model and existence proofs?
  2. Where is the data analysis?
  3. How is this a paper?
  4. Do you mean to tell me this is publishable?

I too was shocked initially by these features or lack thereof. However, that’s part of what made the paper compelling.

Some papers get a wonderful data set, perform magnificent identification and get a result that really changes your mind about something you care about. Most don’t.

Most are cases that are of very narrow interest or do a 90% good job at the ID but leave enough doors open that you are not really sure if  the result is meaningful or not.

On the other hand, one could as Bryan and his co-author did, attack an important question, string together some non-obvious points and in my case leave the reader thinking about whether he or she should reexamine an import view.

The profession should rightly celebrate the first kind of paper. However, what about the relative worth of the second and the third?

I submit that bringing up arguments that use the economic way of thinking matter. This is true even if the argument is not definitive, has no mathematical proof behind it and marshals no data.

Let me give a more timely example. We are now engaged in a debate over the nature of recessions and how the government should respond. There are obviously lots of models and empirical studies, none of them perfect.

However, more than any other analysis the baby-sitting coop story made me a confident Keynesian. Before then I could parrot the New Keynesian models and understood that this was more or less what a smart economist was supposed to say.

However, I didn’t know how to counter the logic of Laizze Faire except to say, “well there are sticky prices and an Euler equation and so the household will adjust consumption . . . “  This is compelling to virtually no one – not even, on a deep level, to myself.

When it really came down to it, I would have been left with “Great Depression! Want it to happen again? No? Then we need to spend more money or cut taxes! Why? Because I am very smart and I have a whiteboard. Do you have a whiteboard?”

However, a simple story about baby-sitting and it all fell into place. Paul Krugman has retold the story many times. Its about a baby-sitting co-op that uses scrip to track how many times a couple has sat for other members of the co-op and thus how many times someone should sit for them.

Because of some mismanagement in the handling of scrip the co-op at one point went into recession. There weren’t any fewer people who could babysit and there weren’t any fewer opportunities for couples to go out. The real baby-sitting economy hadn’t changed.

Bad policies by the co-op leaders reduced the number of scrip per couple. And, for lack of scrip no one went out. And because no one went out, no one sat. And because no one sat, no one got any scrip. And, since no one got any scrip, no one could go out . . .

Excess demand for financial assets led to a collapse in the demand for real good and services. Something that seemed extremely complicated was elucidated by a simple story.

Years ago that story was printed in an economics journal. I read it in the Slate.com archives.

As I have mentioned before I started warning of a Japanese style scenario in early 2008, not because of a formal model, but because of that baby-sitting story.

You see, the investment banks were like a baby-sitting couple who by borrowing and lending script and carefully tracking dining out patterns with fancy computer models had assured everyone that any couple, at any time, could find a baby-sitter whether they had physical scrip or not. Just come to us, and we’ll make it happen. No scrip down as it were.

That system was about to collapse and when that happened the demand for physical scrip was going to skyrocket. If you believed the original baby-sitting story that meant a recession of epic proportions. We were going to need a lot more scrip and the Fed didn’t seem to get that.

Nor, I should mention, did may people familiar with mainstream macro-economics. Its not that you couldn’t have gotten that result out of the math models. Its that you wouldn’t have known where to look.

You would have thought about wealth effects and the distributional impact of housing. Willem Buiter, a very smart man, insisted there would be no recession because the decline in the price of houses made homeowners poorer but homebuyers richer. This does somewhere between little and nothing to the representative agents Euler equation. However, Buiter failed to consider the simple lesson of the baby-sitting economy.

Buiter, forgot about scrip.