Macroeconomic models suffering from pretense of knowledge syndrome
The global economic crisis has led many economists to ponder and rethink over their economics tools and models. In particular, macroeconomic modeling has come under severe criticism for being based on unrealistic assumptions which gave policymakers and economists false beliefs over the state of economy.
RICARDI CABALLERO in a paper titled “Macroeconomics after the Crisis: Time to Deal with the Pretense-of-Knowledge Syndrome” says that the core economic model has become so ingrained in economists that changes are difficult. These models are very attractive and sophisticated but fail to capture reality. The other models that matter and have variables like leverage, financial cycles, credit and so on are part of the periphery and are not admired. He argues that we should not pretend that the core models are solving any real problems. In other words, we are living in pretense of knowledge.
The focus in these models has been to aspire for micro-theory-like precision. He notes that there has been a pendulum shift in macroeconomics over the years as earlier there was not so much focus on maths and models. Both are extremes and a middle way needs to be worked out. It is a big challenge but macroeconomists can no longer continue playing internal games. The alternative of leaving all the important stuff to the “policy”-types and informal commentators cannot be the right approach.
LAURENCE MEYER, a former Fed board member, recently criticised the current models in an interview with Cleveland Fed. He points out that there are two kinds of models—one the old model which was quite good. And now we have these modern macro-models which are used only to get published in journals.
The crisis has led economists to think deeper about macro tools and their limitations. More is likely to follow in days to come.
Economics of foodgrain management in India
KAUSHIK BASU, chief economic adviser at India’s finance ministry has a very timely paper on a very complex and least understood issue—foodgrain management in India (“Economics of foodgrain management in India”).
Mr Basu suggests that foodgrain management involves three functions—production, procurement and distribution. Most of the time we either criticise production (low yields, lack of productivity) or distribution (food stocks rotting but people dying of hunger, for instance). However, the policies of government procurement also need to be looked at. Trying to correct one segment of this complicated system is likely to end up in failure or, at best, have limited success.
Mr Basu notes two different motives for foodgrain procurement by the state—to provide food security to the vulnerable population and to even out foodgrain price fluctuation from one year to another. Further, how we procure the food has an impact on how the government releases the food, and vice versa. There is a paradox in government food policies. First, it keeps the Minimum Support Price (MSP) higher than the market prices to help the farmer. Second, if it sells the foodgrains above the MSP it is costly for the public. If it sells at a lower price it leads to fiscal deficit. So, what should it do? Mr Basu explains that procurement cost is a sunk cost and not selling it will add to fiscal deficit anyway.
The paper argues that the government should not waste too much energy thinking that large percent of grains will be bought by traders who will hoard it and sell it at profit. In order to prevent people from making profits, government ends up hoarding a large part of grains which does not help anyone. Instead, the idea should be to let people make profits and get the overall government objective right.
Importance of program design in education programs
RAJASHRI CHAKRABARTI has an insightful paper on the importance of programme design and incentives (“Design of Voucher Programs Is Critical to Achieving Education Policymakers’ Intended Outcome”). It deals with the education voucher programme in US which allows students to shift from public schools to private schools. It gives scholarship to students for the switch. He studies two such programs in Milwaukee and Florida.
Under the Milwaukee programme, vouchers were imposed from the outset so that all low-income public school students became eligible for vouchers to transfer to private schools. In contrast, schools in the Florida programme were first threatened with vouchers, with students of a particular school becoming eligible for vouchers only if the school received two “F” grades in a period of four years. Unlike the Milwaukee schools, threatened Florida schools had an opportunity to avoid vouchers. The study shows that the performance effects of the threatened public schools under the Florida program exceeded those of corresponding schools in Milwaukee.
This is an important finding as it shows how careful design can help increase the success rate of public policy programmes. It also helps lower expenditure on such programmes as in the case of Florida. By merely threatening schools, better performance was achieved and there was no expenditure on vouchers as well.
Amol Agrawal is an economist with STCI Primary Dealer Ltd and blogs at Mostly Economics