Catallaxy Files

Many people blame the global financial crisis on ‘free-market’ economics and the teachings of some economists. In particular the Chicago school has come in for some criticism. John Cassidy, for example, has a long piece in the New Yorker (subscription required) where he seems to lay the blame squarely at the feet of the Chicago school. Cassidy relies heavily on the opinions of Richard Posner. From the introduction

Earlier this year, Posner published “A Failure of Capitalism,” in which he argues that lax monetary policy and deregulation helped bring on the current slump. “We are learning from it that we need a more active and intelligent government to keep our model of a capitalist economy from running off the rails,” Posner writes. “The movement to deregulate the financial industry went too far by exaggerating the resilience–the self-healing powers–of laissez-faire capitalism.” Posner also accuses professional economists, including some of his Chicago colleagues, of being “asleep at the switch.”

I find the argument that ‘lax monetary policy and deregulation’ as some form of market failure somewhat surprising; I would categorise those as government failure. But moving right along (emphasis added)

… Ever since Milton Friedman, George Stigler, and others founded the Chicago School, in the nineteen-forties and fifties, one of its goals has been to displace Keynesianism, and it had largely succeeded. For three decades after the Second World War, economics was dominated by Keynesian ideas about how the government should use monetary and fiscal policy to prevent slumps. Since 1974, however, more than a dozen scholars associated with the U. of C. have been awarded the Nobel Memorial Prize in Economic Sciences; in the areas of regulation, trade, anti-trust law, taxes, interest rates, and welfare, Chicago thinking greatly influenced policymaking in the United States and many other parts of the world.

That is a testable hypothesis and John Taylor puts it to the test.

Consider, for example, measuring influence by the representation of members of a school in top economic positions in government where there is an opportunity to influence policy. And consider as a measure of an economist’s school, the university where he or she received the PhD. The data in the chart follows this approach. It shows the university PhD percentages of appointees to the President’s Council of Economics Advisers (CEA).

The blue line shows the percentage of presidential appointees to the CEA who have a PhD from Chicago. The red line shows the same for MIT or Harvard (Cambridge), one possible definition of an alternative to the Chicago school. The years from the creation of the CEA in 1946 until 1980 are shown along with each presidential term thereafter. Observe that the peak of the Chicago school influence was in the Reagan administration; it then dropped off markedly. In contrast Cambridge reached a low point of zero appointees to the CEA during the Reagan administration and then rose slightly to 20 percent in Bush 41, to 82 percent in Clinton, and to 100 percent in both Bush 43 and in Obama.

Blaming the financial crisis on the free-market influence of the Chicago school is certainly not consistent with these data. There were no Chicago PhDs on the President’s CEA leading up to or during the financial crisis. In contrast there was a great influx and then dominance of PhDs from Cambridge. And also notice that there were plenty of Chicago PhDs on the CEA at the time of the start of the Great Moderation—20 plus years of excellent economic performance. These data are more consistent with the view that the waning of the free-market Chicago school and the rise of interventionist alternatives was largely responsible for the crisis. But the main point is that there is no evidence here for blaming the influence of Chicago.

Of course, such measures are imperfect. Neither Milton Friedman nor Paul Samuelson served on the CEA, but their students did. And while PhDs from any insitution certainly do not fit in any one mold, the people who learned about rules versus discretion with Friedman likely had a different policy approach than people who learned about rules versus discretion with Samuelson. The data are robust when you look beyond the CEA to other top posts normally held by PhD economists. All assistant secretaries of Treasury for Economic Policy appointed during the Bush 43 and Obama Administrations had PhDs from Harvard. During the same period, all chief economists appointed to the IMF had PhDs from MIT, and, except for Don Kohn, who was promoted from within and Susan Bies who was appointed as a banker, all PhD economists appointed to the Federal Reserve Board were from Cambridge MA.

Taylor’s own PhD is from Stanford.

The AGW lobby would have us believe that the opportunity costs of their proposed policies are quite low. Just yesterday in a Financial Review op-ed John Quiggin wrote

No credible economist suggests the economic impact will be more than marginal.

Clive Hamilton describes the opportunity costs of AGW in a New Matilda piece (emphasis added, the Atkin paper is here)

I have often wanted to put the following question to sceptics like Don Aitkin: What if you are wrong? What sort of moral responsibility will the sceptics have if they succeed in their aim of stopping the world from taking action to reduce greenhouse gas emissions?

If scientific advances cause scientists to reject the conclusions of past IPCC reports and agree that there is nothing to be alarmed about, it will be mildly embarrassing for people like me; but not too much harm will have been done — according to all of the economic studies, the costs of reducing emissions are low.

But if Aitkin and his fellow sceptics were successful in stopping policies to cut emissions and the IPCC projections turn out to be correct, then environmental catastrophe will follow and millions of people will die. Do they lose sleep over this? Do they worry about how their grandchildren will see them? Or are they so consumed by their crusade that they know they will never be proven wrong?

Okay – so the stakes are (apparently) high. Notice the asymmetry in the opportunity cost; very little if the AGW lobby are wrong and very high if the AGW lobby are correct. Mind you those assessments of the relative costs comes from the AGW lobby itself.

This brings me to a very carefully worded op-ed published in both the Age and SMH by Tim Wallace. He is having a go at Christopher Monckton. In particular this point

Christopher Monckton’s rhetorical tilts against wind turbines might be regarded as humorously quixotic, but his spinning of deeply flawed American and European biofuel policies into a blanket denuciation of all climate change action, accusing “environmental extremists” of “eagerly” starving to death millions of the world’s poor, is no laughing matter. At best this argument is recklessly simplistic; at worst it is deliberately disingenuous.

This might lead the reader to believe that Monckton is incorrect in linking climate change policy to starvation. Apparently he has made the argument for some time – as have others. As Wallace admits the so-called ‘biofuels genocide’ argument has an excellent pedigree (emphasis added).

Monckton is not the first person to link biofuels to genocide (Fidel Castro, for example, did so in April 2007) or to call using food for fuel a crime against humanity (the UN special rapporteur on the right to food, Jean Ziegler, called it such in October 2007). In Monckton’s own nation, Guardian columnist George Monbiot warned as early as 2004 that biofuels could lead to humanitarian and environmental disaster.

“Every potential solution must be handled carefully,” said Al Gore, the man climate sceptics most love to hate, at the first Biofuels Congress of the Americas held in Buenos Aires in May 2007. The twin dangers of biofuel production if not pursued carefully, he said, were further deforestation and the driving up of food prices. Greenpeace, the Worldwide Fund for Nature, Friends of the Earth, the Sierra Club and so on are all in furious agreement: food crops should not be used to fuel vehicles.

I’m not sure if Fidel Castro fits into that group, but the Age did publish an op-ed from him just last month.

So far, so good. It seems there might be something in the argument about the AGW scare leading to food shortages. But then Wallace does something very interesting (emphasis added).

That the diversion of food crops to biofuel production has been the main contributor the doubling of staple food prices in recent years need not be disputed, though Monckton’s crediting that rise to “a sharp drop in world food production, caused by suddenly taking millions of acres of land out of growing food for people who need it” is a less than accurate representation of the document he cites as his reference.

Wallace then goes onto imply that Monckton’s argument is inconsistent with a World Bank publication that Monckton quotes. Wallace doesn’t tell us what that document is, but he gives enough clues to track it down (or, at least, I have tracked down a document based on his clues).

An internal World Bank working paper was leaked to the Guardian newspaper in 2008 that indicated that biofuel production was responsible for the bulk of rising food prices.

This document is marked ‘Draft, not for citation or circulation’. The subsequent ‘official’ World Bank copy is here. A critique of the paper can be found here. The World Bank have another paper on their website that makes the same points.

Increased bio-fuel production has contributed to the rise in food prices. Concerns over oil prices, energy security and climate change have prompted governments to take a more proactive stance towards encouraging production and use of bio-fuels. This has led to increased demand for bio-fuel raw materials, such as wheat, soy, maize and palm oil, and increased competition for cropland. Almost all of the increase in global maize production from 2004 to 2007 (the period when grain prices rose sharply) went for bio-fuels production in the U.S., while existing stocks were depleted by an increase in global consumption for other uses. Other developments, such as droughts in Australia and poor crops in the E.U. and Ukraine in 2006 and 2007, were largely offset by good crops and increased exports in other countries and would not, on their own, have had a significant impact on prices. Only a relatively small share of the increase in food production prices (around 15%) is due directly to higher energy and fertilizer costs.

There can be little doubt that the World Bank believes that demand for biofuels has caused the bulk of the increase in food prices.

How does Wallace describe the World Bank position?

It attributed 70-75 per cent of price rises to biofuel-driven demand “and the related consequences of low grain stocks, large land use shifts, speculative activity and export bans”. It identifies US and European Union subsidies, mandates and import tariffs to promote domestic biofuel production as the main problem.

As if they were somehow separate from the increased demand for biofuels. But that is not how the World Bank describe it.

the most important factor was the large increase in biofuels production in the U.S. and the EU. Without these increases, global wheat and maize stocks would not have declined appreciably, oilseed prices would not have tripled, and price increases due to other factors, such as droughts, would have been more moderate. Recent export bans and speculative activities would probably not have occurred because they were largely responses to rising prices.

So Wallace is creating a bit of a straw man here. Where Wallace is correct is in arguing that the agricultural policies of the EU and the US are economically irresponsible. We know that and this is a point well worth repeating. So too are Australian quarantine policies – they are a disgraceful impediment to free trade in agricultural goods.

The other straw man worth noting is the entire premise for the op-ed. I saw Monckton making the biofuel – food trade-off argument here (at 5:40 minutes into the debate). I didn’t see him referring to either ‘extremists’ or ‘eagerly’ starving people to death; I did see him saying that it was a disgrace, and David Koch agreeing that it was a disgrace. At best Wallace can argue that Monckton hasn’t described the mechanism whereby biofuels have crowded out food production and reduced food security, but when everyone agrees that this is what has happened it is a bit rich to attack Monckton’s description of the argument and somehow imply that it isn’t happening. More importantly it shows that there are very real costs associated with the AGW lobby being wrong.