Reports from the Man from Mars

One of the things that often strikes me when I read commentary from present-day economists is how frequently they resemble nothing so much as the hypothetical anthropological reports of the proverbial man from Mars. They’re devoid of actual insight into the conventional behavior of actual people in actual circumstances.

It wasn’t always that way. The early political economists viewed their field less as physics and more as moral philosophy. Adam Smith’s or David Ricardo’s writings are brim-full of observations about how real people behave and in reading them you can’t help but be struck by their wisdom, savvy, and, frequently, compassion.

I found Paul Krugman’s column this morning completely uninteresting but his blog post struck me as a report from the man from Mars. For example:

Is it at all reasonable to attribute high unemployment now to the need to shift the economy out of housing and cars?

OK, I actually haven’t taken cars into account; someone with more time can do that. But let’s look at the role of job losses in construction versus other sectors, since December 2007. It looks like this:

[graph illustrating more jobs lost in manufacturing and services than in construction]

If high unemployment were largely about shifting workers out of an overblown construction sector, wouldn’t you expect job losses to be concentrated in that sector? Wouldn’t you expect employment elsewhere to be, if anything, rising? In fact, however, the vast majority of job losses have occurred in parts of the economy with little direct connection to the housing bubble. Yes, as a percentage job losses have been much larger in construction; but nothing in Rajan’s argument explains why we shouldn’t be using policy in an attempt to prevent vast job losses in parts of the economy that aren’t overblown.

There are so many puzzling observations packed into a small space it’s hard to decompress them. By virtually every account we have come out of a bubble in which housing prices have risen beyond reason, as prices do in a bubble. An irrationally expected perpetual growth in housing prices coupled with a greedy and incompetent financial sector (whose incentives were also aligned perversely) allowed people to fund consumer spending far beyond what would otherwise have been expected by borrowing against the putative increased value of their houses. The boom boosted earnings and, consequently, wages in sectors from construction to retail to healthcare to government. Our society is so stratified and complex that we’re now in a mess that’s virtually impossible to untangle.

The point of this is that these various sectors of the economy are inter-connected. It’s a like a row of dominos. Anyone who’s seen such a thing knows that there’s no reason that the number of dominos that fall must be proportional to the number knocked over. You only need to knock over one domino to set off a chain reaction in which not only multiple other dominos will fall but multiple rows of dominos fall, tens or even hundreds of thousands in all.

Construction may have been the first domino but as a consequence of the nature of the bubble and the way our society works now we have excess capacity in sectors that range far beyond housing construction. Keeping resources tied up in these areas is like trapping a fly in amber. It may be interesting but it’s no longer a living fly.

Over the period of the last ten years government efforts at producing economic growth have unwisely been concentrated in boosting consumption. The “Bush tax cuts” are an egregious example but far from the only one, cf. “Cash for Clunkers”, the homebuyers tax credit, and so on. There is a fundamental rule of thumb among investors: you can’t re-inflate a bubble. But that’s what we’re trying to do.