Phishing for phools

I've been trying to read this. Not a huge fan of the field of behavioral economics (or here; subscription required). Don't get me wrong, yes, it provides some critiques of elements of the mainstream (marginalist) approach, regarding essentially the notion of individual rationality, as did the work of, say, Herbert Simon, in the past. People don't tend to act in a rational way, at least not in the substantive way that is prescribed by the mainstream.

Evidence on the notion of universal selfishness is weak. Experiments have undermined the notion that the primary motivation of human action is self-regard. The ultimatum game, which has been played in many different countries and cultures, suggests that humans have a strong preference for fairness. Sam Bowles, who provides a short blurb for the book's back-cover, is one of the several progressive economists that thinks that the critique of rationality developed by behavioral economics is revolutionary, and that it is the source of an alternative to the mainstream (or probably more in line with his views of an evolution of the mainstream; he once said in a lecture at the University of Utah that Marx and Arrow said essentially the same things).

My view, and I promised a more detailed discussion when I'm done with the book, is that this is just one more iteration of the marginalist analysis trying to be relevant by introducing imperfections, the previous one being the idea of information economics, often associated with Joseph Stiglitz and George Akerlof, who is the co-author of the book with Robert Shiller. Stiglitz referred to his information economics as "Post Walrasian and Post Marxian Economics." It was very much in the Walrasian tradition, however.

In the case of behavioral economics, the notion that individual behavior is what matters continues to be central, even though the assumptions on how agents behave differ. The methodological individualist notion that all explanations must start from the microeconomic unit of analysis, and that microfoundations are central, prevails. The predominance of the individual over the whole. That is substantially different from what I would see as the main methodological stance of heterodox economics. Behavior is often discussed as being underpinned by social classes, as in the surplus approach tradition, and history and institutions are the basis for behavior. Markets often get stuck in sub-optimal positions, not so much because agents behave irrationally (even though they do, and behavioral insights might be incorporated in heterodox models), but because they work in different ways than assumed in marginalist analysis.

Issues of causality are considerably more important than behavioral issues. It is the structure of causality between variables that implies that effective demand (rather than Say's Law) holds, meaning that investment determines savings, for example. The same can be said about the determination of prices, where subjective elements are considered as given (and discussed at a lower level of abstraction, in historical and institutional fashion), and analysis proceeds from the objective elements associated to the technical conditions of production and a given distributive variable (again distribution being discussed at a lower level of abstraction, where the historical and institutional factors that affect labor legislation, the strength of unions, etc. play an important role).

PS: Besides these problems the book by Akerlof and Shiller starts by quoting Adam Smith invisible hand out of context, which is really problematic, and shows that the profession should go back and learn the history of its own discipline.

Total Factor Productivity does NOT measure what you think it does

The conventional discussion of Total Factor Productivity (TFP) starts from a production function. For that reason most people when they hear about the problems with TFP, think that it refers to aggregation problems (which on top many confuse with the capital debates, which did involve a critique of the production function, but was about more than that). 

The problem is that TFP is NOT productivity at all. So start from a Cobb-Douglas production function (it doesn’t really matter what production function for our argument):

Log-linearizing and deriving with respect to time you obtain:

Where alpha is the share of wages in national income. Solow suggested that the residual (dA/A) must be the combined effect of the increase in productivity of all factors of production (TFP).

Now consider the income identity that by definition tells us that net income (net of taxes) is composed by the remuneration of capital and labor. We have:

There is no need here to be concerned with aggregation questions. This is an identity and the data reflects NOT a theoretical construct, like the production function, but a national accounting identity. 

The total derivative of the identity would be:

Diving by Y, and with some manipulation, knowing that r=R/K, we get:

Note that the first two terms can be re-written using the above notation for the shares of profits (R) and wages (wN) in total income. We have:

Note any similarity with the growth accounting equation? The Solow residual is basically a weighted average of the rate of growth of profits and wages. This is what is being measured, since the data actually comes from the identity, not an imaginary production function. Even if you had a production function, you still would be measuring the identity.

Jesus Felipe and John McCombie have done extensive work, building on the work of Franklin Fisher, Herbert Simon, Anwar Shaikh and others. The use of TFP, when the evident measure of productivity should be labor productivity, only leads to additional confusion in mainstream analysis of economic growth (the other big problem being the supply constraint and the notion of a natural rate).

PS: There are several papers that one should read on (subscrirequired), but I suggest the following one (subscription required) by Felipe and McCombie that shows the kind of confusion that using TFP leads to when applied to the interpretation of the East Asian growth experience.