Who Are US Policy Elites?

It is ten hour drive each way from my home in Virginia to the GENCON gaming convention I attended last week.  Those hours driving were more fun than the convention, because I spent them talking to the smart polymath Bill Dickens.  I’d love more long car trips like that.

Here are two related things Bill told me:

  1. Bill learned to fly planes from the CEO of a well-known successful tech company, a man who was forced out by VCs when his company went public.  This wasn’t a tech person replaced by a management person; this CEO had been doing a fine job managing employees, suppliers, customers, etc.  The VCs told him he was pushed out to make room for someone “better known to Wall Street.”  It seems they wanted a CEO with more social connections to the investment bankers that the company needed to impress.  Such bankers would induce less investment in a company managed by someone who wasn’t in their social circle.
  2. For the last few decades academic macroeconomic journals have been dominated by models that do not support the actual US policies used to deal with this latest economic downturn.  Alex Tabarrok confirms this, citing John Cochrane:

    Modern economics gives very little reason to believe that fiscal stimulus will do much to raise output or lower unemployment. … The basic Keynesian analysis of this question is simply wrong. Professional economists abandoned it 30 years ago. …  It has not appeared in graduate programmes or professional journals since.

    Instead of following the dominant academic theories, however, both a Republican and a Democratic president, and Congress, have empowered folks well connected to the elite US banking social circle.  (Paulson, for example, was CEO of Goldman Sachs.  Neither he nor Geithner held any academic position, and both went to Dartmouth.)  And their main priority in spending trillions has been to save those banks from bankruptcy.

Recall also that college students make more money by going to “elite” colleges, but not because students at those colleges have higher test scores:

Students who attended colleges with higher average SAT scores do not earn more than other students who were accepted and rejected by comparable schools but attended a college with a lower average SAT score.  However the Barron’s rating of school selectivity and the tuition charged by the school are significantly related to the students’ subsequent earnings.

So it seems the US has a finance and policy elite defined by college ties and related social connections, an elite with a strong sense that only people in their circle can really be trusted, and that their institutions must be saved at all cost at taxpayer expense if necessary.  These beliefs might be correct, but it is disturbing to realize they might well persist and be reinforced even if they were incorrect, especially if such elites thought that insiders who trust outsiders too much also could not be trusted.

Added:  Bill comments:

I think you (through Cochrane) use a bit of slight of hand. Keynesian theory is, overwhelmingly, what we teach undergraduates and IS-LM theory is still the way most people I know think about policy.  DSGE theory isn’t ready for prime time and most economists know it.  Central banks do use DSGE models, but they also use more traditional models as well and ultimately rely on the judgment of their monetary policy committees. Still, a neat post.

More added:  TGGP points us to this:

In his book, A History of Macroeconomic Policy in the United States, Wood argues that U.S. fiscal and monetary policy have been remarkably consistent over the decades and largely uninfluenced by macroeconomic theory. Economists have rationalized more than influenced policy.

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  • http://www.hopeanon.typepad.com Hopefully Anonymous

    Interesting. A disconnect between goldman sachs type economic policy elites and the consensus of macroeconomic academic experts is news to me, but interesting information.
    I think you’re implying that there’s classic regulatory capture, and that policy is being deformed away from the recommendations of more neutral experts towards the narrow interests of Goldman Sachs and company by regulators who have a special affinity for Goldman Sachs and some of its cohorts.
    That seems separable from a theory that they naively think that “what’s good for goldman sachs is good for america” and don’t trust academic macroeconomist consensus because those academics are outside their banker social circle.

  • http://andrewkemendo.blogspot.com Andrew Kemendo

    I am fairly confident that the average policy maker has little to no background in economics and finance. I am sure of this because I have seen the debates on the floor of both house and senate and all but one or two members have a significant grasp on monetary policy – let alone macroeconomics or price theory.

    Why should they? Their constituents don’t know enough about how economies and policy to realize that they should look for these things in a representative. As a result, it never even comes into the debate. Just look at what happens when economics is attempted to be discussed by candidates: Ross Perot and his graphs and charts and Ron Paul and his monetary policy. Laughing stocks.

    The policy makers and the academics have, in practice, wholly different philosophies and goals; so it is not surprising that they would not collaborate.

    • http://shagbark.livejournal.com Phil Goetz

      I am fairly confident that the average policy maker has little to no background in economics and finance. I am sure of this because I have seen the debates on the floor of both house and senate and all but one or two members have a significant grasp on monetary policy – let alone macroeconomics or price theory.

      Agreed. For example, the concept of “opportunity cost” is unknown in American political debate.

      Why should they? Their constituents don’t know enough about how economies and policy to realize that they should look for these things in a representative.

      I wrote a post about this on Less Wrong called Mechanics without wrenches.

  • http://elder-gods.org/~larry Larry D’Anna

    > The basic Keynesian analysis of this question is simply wrong. Professional economists abandoned it 30 years ago.

    I’m pretty sure Paul Krugman qualifies as a professional economist.

    • Dan

      Krugman’s academic work was in international economics, not macro.

    • david

      Also, Krugman’s actual position seems to be more subtle; as Sumner and others have pointed out, Krugman only switched to Keynesian fiscal expansion after asserting that nontraditional monetary policy would fail for political reasons.

      I think it’s quite true that nobody does hold the naive Keynesian model as true today.

  • Paul

    Larry, as an undergraduate at a prestigious US university I studied the model for which Krugman won his nobel prize. It has NOTHING to do with almost everything he opines on. People think because he has a nobel prize his opinion on everything is correct. Not so. Just about every empirical macroeconomist at any university is more of a specialist on these issues than he.

  • Floccina

    Because of his passed I would assume no matter how honest a man he is that Paulson would naturally be biased as to the importance of the Wal l investment banks.

  • Unnamed

    Cochrane’s claim that modern economics doesn’t support a stimulus is disputed, for instance, by DeLong and Krugman.

  • TGGP

    Influence flows from policy to academic macro theory, not the other way around.

  • Dan

    “Modern economics gives very little reason to believe that fiscal stimulus will do much to raise output or lower unemployment. … The basic Keynesian analysis of this question is simply wrong.”

    WRONG. Purple sky anyone? Empirical data is a b*tch sadly to say, just look at China’s massive stimulus spending, any explanations?? Why is stimulus policy tried again and again and succeeding,when it is oh so yesterday?

  • michael vassar

    Hopefully: I think that Robin is implying precisely what you say he isn’t implying, and moreover, based on my experience with both academic economists and financial elites, I think he is right.

    People in almost all sets of nested concentric affiliations naively, sincerely and self-interestedly assume that what’s best for their most narrow affiliation is also what’s best for their broadest affiliation. They also punish those who don’t appear to assume this story, but have the most frequent opportunity to identify and punish defectors from the story within their narrow affiliation

    • http://hanson.gmu.edu Robin Hanson

      Michael is right.

      • http://www.hopeanon.typepad.com Hopefully Anonymous

        I wrote part of that poorly. I meant that Prof. Hanson wrote it in such a way that the two seem inseparable in outcomes (regulatory capture vs. naive belief that what’s good for GS is good for America). I think it’s reasonable to reserve regulatory capture as an alternative theory.

  • Michael Bishop

    As Bill said, “You (through Cochrane) use a bit of sleight of hand.”

    There is a case to be made against the stimulus, but some economists argue that policy makers would be wise to ignore a lot of recent macro. I would expect Prof. Hanson to be more sympathetic of the criticisms of macro. http://delong.typepad.com/sdj/2009/01/in-which-we-love-some-but-not-all-stimulus-spending-skeptics.html http://krugman.blogs.nytimes.com/2009/01/27/a-dark-age-of-macroeconomics-wonkish/

    How about this Arnold Kling quote:

    “I have always thought that the issue of the relationship between financial markets and the “real economy” was really deep. I thought that it was a critical part of macroeconomic theory that was poorly developed. But the economics profession for the past thirty years instead focused on producing stochastic calculus porn to satisfy young men’s urge for mathematical masturbation.”

  • Mike

    What do modern macroeconomic models say should have been done (and if you have the time, why)?

  • DBT

    I don’t doubt your general ideas here and definitely think they are mostly correct. I, as I see many of the other poster here, don’t necessarily believe that Keynsian economics is dead–as there are a lot of “professional” economists who buy into it, whether or not you or I do.

    Another quibble is with the story of Bill learning to fly from a distraught ex-CEO of a tech company. I doubt if you or Bill truly understand how venture capital works, because if you did your story would sound much less plausible. A venture capitalist invests in early stage companies and gets equity, these investors expect to invest in a firm that will either a) go public, in which they will monetize their equity (they don’t keep public companies on their portfolio) or b) get acquired by another company, in which again the VC montizes the equity. A VC will have no control of a public company and cannot oust a CEO. Also, VCs are almost always ex-CEOs of successful tech companies that have cashed out, they nearly all have experience starting and running tech companies–they empathize much more with the CEO of a portfolio company than with the Wall Street elite. The likely story here is that this ex-CEO had a very big, great idea and was a reasonable manager of a start-up company but was not ready to be a corporate apple-polisher and run a business with more competition, smaller margins, etc, as it is a very common story that founders get ousted as CEOs.

    • Douglas Knight

      There is some symmetry. Is the CEO telling a self-serving story? or did the I-bankers tell him a self-serving story? The story would be most credible if the cynical explanation came from the VC. If the VC has sympathy with the similar tech CEO, but knows that he has to appease the I-bankers, it may be a self-serving story for the VC to see himself as wise and cynical, but at least he’s not painting his actions as the best possible world. (and, yes, I do know how an IPO works.)

      The part that seems least plausible to me is “forced out.” That makes it sound like he couldn’t cut a cynical deal to install a figure-head rain-maker.

  • Michael

    TGGP is historically correct that influence flows from policy to academic theory and not the other way. By the time Keynes published his “General Theory” in 1936, the New Deal had already been under way in the US for three years, and comparable policies were being pursued in other countries. Academic theory has mostly been a post-facto justification of what policymakers did or wanted to do well before it was formulated.

    • Douglas Knight

      The timing is deceptive. He wasn’t an isolated academic. He was advocating his policies to politicians long before they saw print. And some of them saw print in the “Treatise on Money” in 1930 and “The Means to Prosperity” in 1933. That might not contradict the other claims, depending on their meaning, but it might.

  • andrew s.

    And this is why futarchy will never gain any ground.

  • http://blog.jim.com James A. Donald

    Macro economics is in practice, merely sound of courtiers flattering the powerful

    Macro economics is in large about ill defined quantities such as aggregate demand. If one constructs a theory of ill defined quantities, it is easy to get the results that politicians and bureaucrats like to hear.

  • http://entitledtoanopinion.wordpress.com TGGP

    “As We Go Marching” discusses how policies associated with Keynesianism (deficit spending to revive an economy) had been popular among politicians for years before Keynes came up with a justification. Rawls similarly came up with a Theory of Justice to prove how reasonably people must assent to the Great Society, and in a personal letter logically proved that baseball (which was then much more popular) is the greatest sport.

    Keynes should not be so associated with the New Deal either. He wrote to FDR advising against some destructive policies that lowered output.

    sincerely and self-interestedly assume that what’s best for their most narrow affiliation is also what’s best for their broadest affiliation
    Sounds about right, and I think also applies to the neoconservatives. They don’t just echo the Israeli government, and in the case of policy toward Serbia they thought they knew better. They’ve got a vision which they think must be in the best interests of the U.S, Israel, and most of the world and would rather not even consider that there could be tension among those different interests. It’s the halo-effect where the things you like are just plain good by nature without drawbacks.

    • http://www.hopeanon.typepad.com Hopefully Anonymous

      sounds incorrect or at least significantly incomplete to me.
      Should look at how various differentiating beliefs for an organization make them more competitive.

      Some narrow affiliation beliefs may be arbitrarily bad for broader affiliations. Some may be bad for broader affiliations but may help the narror in competition with other narrows.

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  • chesh

    In a fairly obvious display of the powers of signalling, while I’ve always respected you for your keen insights, finding out you went to GENCON has made me feel genuine affection towards you, as the in-group implied by that affects me much more on a conscious daily level than most any other group we might share membership in.

  • http://shagbark.livejournal.com Phil Goetz

    It’s odd that the comments have focused on the mention of Keynsian economics. (I can’t resist commenting myself – it was frustrating earlier this year to hear the New Deal invoked almost daily on the radio as proof that a stimulus was needed, when my excursions using Google indicated that this was controversial at best. It looks to me like what pulled us out of the depression was selling war supplies to the British; but I know little about it.)

    But, I thought this was the more important part of the post:

    The US has a finance and policy elite defined by college ties and related social connections, an elite with a strong sense that only people in their circle can really be trusted, and that their institutions must be saved at all cost at taxpayer expense if necessary.

  • Matt

    Since they’re moderated, I’d ask that this version, w/o typos and with a few additional sentences be used instead. I apologize for the sloppiness.

    This description of the academic macroeconomic consensus is wildly off the mark. It’s just a description of the “freshwater” rational expectations (or real business cycle) school associated with the University of Chicago, and completely ignores the “saltwater” school prevalent at Harvard or MIT. Freshwater views are stil, I’d guess, narrowly the minority among academic economists, and have essentially no adherants in the policy world (e.g., the Fed, ECB, IMF, World Bank, BIS, etc.) or among Wall Street economists. Brad DeLong, Paul Krugman, Simon Johnson and a variety others have been arguing in a various fora that the RE school has proved its uselessness in the current crisis. (Larry Summer’s takedown of real business cycle theory in the Minneapolis Fed Quarterly Review still says most of what needs to be said.) The school’s preeminence in academic macroeconomics probably peaked a few years ago. Alex Tabarok and Alex Cochrane are showing their intellectual insularity, not accurately summarizing the academic consensus. It’s ironic that the freshwater view would receive such strong expression on this website, where biases and heuristics in decion-making are key themes. The now abundant literature on behavorial economics and finance has taught us that people simply don’t make decisions as idealized rational agents optimizing an intertemporal objective function. (Even if individuals did, additional strong assumptions are needed to move to statements about the behavior of the macroeconomy.)

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