Felix Salmon

Summers’s incentives

By Felix Salmon
November 2, 2010

This blog became a locus, in my absence, for a fascinating debate about economics and economists, which wended its way from David Segal to Stephen Gandel to Barbara to Justin to Brad DeLong and back to Barbara again.

My favorite part of the discussion was Brad’s response to Justin. Justin made a simple point: the central tenet of economics is that incentives matter, and financial incentives in particular; economists get paid lots of money by financial institutions; and yet they get strangely touchy when anybody links these two facts.

Justin had John Cochrane in mind as the strangely touchy economist, as following his link would have shown, but Brad thought he was the person being referred to, and launched into a defense of Larry Summers and his response to Raghu Rajan at the 2005 Fed meetings in Jackson Hole.

Here’s Paul Krugman on the debate in question:

The 2005 Jackson Hole event was a sort of Greenspan celebration; still, it does come across as excessive — dangerously close to saying that if the Great Greenspan says something, it must be so. Second is the extreme condescension toward Rajan — a pretty serious guy — for having the temerity to suggest that maybe markets don’t always work to our advantage. Larry Summers, I’m sorry to say, comes off particularly badly.

Brad sees it differently; he says that Summers “did not ‘dismiss’ Raghu’s concerns”. But Summers did start off with this:

I speak as a repentant, brief Tobin tax advocate, and someone who has learned a great deal about the subject, like Don Kohn, from Alan Greenspan, and someone who finds the basic, slightly Luddite premise of this paper to be largely misguided.

Summers fits three things into this opening sentence. First, he renounces his previous dalliance with a Tobin tax — a tax based on the idea that a tiny amount of fettering of unlimited and virtually cost-free financial transactions might be a good thing. Second, he pays obligatory obeisance to Alan Greenspan. And third, he says that Rajan’s entire paper is based on a “slightly Luddite premise”.

All of these are things that Summers would do if he had been captured by the financial services industry: they’re entirely consistent with such capture. As were all of Summers’s deregulatory impulses when he was at Treasury, including overseeing the Commodity Futures Modernization Act.

Brad stands up for Summers’s intellectual honesty:

If you think that Larry pulled his punches in August 2005 on the importance of reforming compensation schemes because fourteen months later he was going to take a job at the hedge fund of D.E. Shaw, you attribute an extraordinarily degree of precognition–back in August 2005 I thought Larry had weathered the storms at Harvard and would be president until 2010 or so.

But this misses the point: Summers had already been captured when he was Treasury secretary, and he was hired by DE Shaw partly because he was captured.

Being captured is not some kind of intellectually dishonest overt bribe, where you truly believe A but profess to believe B because doing so makes you rich. It’s much more subtle than that, based partly in the wealth and success and sterling reputations of those (like your mentor Bob Rubin, perhaps) who believe B. And it’s a survivorship-bias thing, too: if you don’t believe B, you’ll never rise to the kind of position where your opinions matter as much as Larry’s do and did.

And as Barbara says, there’s a lot of framing going on too:

We have all, to a large extent, adopted this world view as our own—and that has altered both the way we perceive problems, as well as the way we analyze and try to solve them. But this way of understanding the world is, ultimately, only one of many. In certain circumstances it will fail.

Summers has a pretty unique way of perceiving, analyzing, and solving problems. Many policymakers, including Barack Obama, value his particular insights. But the fact is that most of the time Summers seems to end up doing and proposing exactly what Wall Street would most want him to do. Pace Brad, he might well be fully aware of the problems with Wall Street. But yes, by using words like “Luddite”, he does dismiss those concerns, or persuade himself that the costs of acting on them are greater than the benefits. And given that incentives matter, it’s silly to believe that his conclusions are wholly unrelated to his status as an extremely powerful multi-millionaire.

14 comments so far | RSS Comments RSS

This has gone way beyond “capture.” The establishment economic academia-DC-Wall Street nexus has effectively destroyed alternate epistemologies. We create true believers, nurture them in one arena and interchange them as easily as lego figures. How on earth could we expect any of them to “police” any of the others?

Posted by LadyGodiva | Report as abusive

please quote what brad says that larry summers said.

“He said that in a modern economy with sophisticated financial markets we were likely to have more and bigger financial crises than we had before, just as the worst modern transportation accidents are worse than the worst transportation accidents back in horse-and-buggy days. He said that Raghu’s “paper is right to warn us of the possibility of positive feedback and the dangers that it can bring about in financial markets.” Indeed, for twenty years one of Larry’s conversation openers has been: “You really should write something else good on positive-feedback trading and its dangers for financial markets.”

undermines your premise, no?

Posted by q_is_too_short | Report as abusive

another rinstance of economists getting themsevles in a snit when asked about conflicts of interest [where they sit on boards of directors – e.g., glenn hubbsard – or write reports without indicating that they were paid to write them by a particular group – e.g., fredrick mishkin – is to be seen in charles ferguson’s “inside job” where, interestingly, john campbell, chair of the harvard econ department, seems to beleive that there is nothing wrong with harvard not having a disclosure policy or any conflict of interest guidelines

Posted by dlah | Report as abusive

Who cares if he was mean to Rajan or not?! Summers’s bad policy kneecapped the Obama presidency and every progressive cause with it.

Posted by chrismealy | Report as abusive

How many times have I said this:
Academics construct models of social and economic self-interest. But for those who call themselves “liberal” these models go side by side calls for “objective” “responsible” and “serious” journalism and the defense of “reason” by which I can only assume they mean “disinterested” reason. The cognitive dissonance gets to be annoying.

Is reason the acceptance of simple self-interest or the promulgation of an academic ideal of collaborative sociability? Idealism or realism, and the rigors of competition? I prefer reason, but reason says greed is inevitable but stupid: useful only in its side effects. And anyway the useful thing isn’t greed but simple fear. it keeps you on your toes.

I’m a socialist and a pessimist so there’s no contradiction. But DeLong imagines himself an idealist even as he defends the glories of cardboard tomatoes for the masses. Hypocrisy is more corrupt than honest indifference.
Q: How can a liberal idealist be a realist?
A: If it’s only others who can’t be trusted.

To the pure all things are pure. Technocracy is not democracy. But geeks like technocracy. Shiny happy monads. My kingdom for an adult conversation.

Posted by Juan1 | Report as abusive

there is nothing unique about economists. everyone wants to kiss the ass of the people above them hierarchically. it results in the following: a higher salary, a better job, a nicer house, kids at a better private school (or moving to a neighborhood for a better public school).

this is why people sell out (or, quote a movie i worked on, “i didn’t sell out son, i bought in. i bought in.”). our society has been poisoned by this set of facts. the worst have risen to the top of most of our key sectors in our plutocracy, we have moved quickly from the plutocracy to the inevitable kleptocracy, and the rest of us now have to kiss the ass or suck the dick (never confuse the two, as roseanne once sagely observed!) of thieves and scumbags. and yes, larry summers is both. he’s a terrible person. it may be hard from brad’s cocoon of like-minded liberalism in berkeley and in academia (NB: i’m from a liberal college town and am politically very left–i know whereof i speak) to understand, but questioning the motives of our alleged betters is not necessary–they are all venal and base. period.

anyway, i do hope that whatever it is that that people like brad and other a-list economists want is what they get for being useful idiots.

Posted by robertogreen | Report as abusive

Whenever I see Larry’s rather ample frame on TV talking about joblessness, I’m always reminded of these lines from WH Auden:

“When he ordered a jacket, the New England mills.
For months had no more unemployment ills.”

Posted by maynardGkeynes | Report as abusive

It is not necessary to assume that economists such as Summers do not sincerely believe in the same things as the commercial interests their policies favor. The economists who do not believe in those things will simply not be supported for office or given money for themselves. This sort of preference is often invisible to those who receive it. On the other hand there is no reason why self-interested individuals would not deliberately slant their “academic” views even without prepayment, in the expectation of rewards later.

Anyway, to a physical scientist – or anyone who observes the absurd and contradictory things spouted in the name of economics – the idea that there is no self-interest or other outside influences in the “science” of economics is laughable.

Posted by dowty | Report as abusive

I think you need to read Summers comments. He did not say Luddite. He said “lead-eyed premise.” Not the same thing. Why not read something before pronouncing.

Posted by bwickes | Report as abusive

“there is nothing unique about economists. everyone wants to kiss the ass of the people above them hierarchically.”

That’s the point isn’t it. If you call yourself a serious intellectual you don’t kiss anybody’s ass, ever. And now intellectuals supply the idealist’s quantified Platonist theory of other people’s ass-kissing. Who needs history (even your own[!!]) when you have reason?

When my mother’s first husband went to work in the White House his friends called him a sell-out: he’d abandoned the life of the mind, thrown disinterested reason out the window. His response as far as I can tell was that hacks were necessary in this world. And they are. But he ended up pitching the Great Society and the Vietnam war. Call it a mixed bag.

Now technocratic banality is the ideal. This blog is part and parcel technocratic culture. Anyone who doesn’t give a rats ass about the market one way or the other would call this post rediscovering the given. Everybody fantasizes their own stable foundations. You don’t have to call it religion, just call it faith. DeLong and Summers are liars who believe their own lies. And this is shocking?
What’s the meaning of life Brad? Felix? Progress? Faster? Towards what?

The firsts rules for any technocrat are or should be should in the twin facts that life is pointless and the people are stupid; and the first principle is of limiting harm. Beginning with these you begin to construct the parameters of a system of flexible authority. But expertise is no replacement for maturity. Mathematics is useless if you don’t have a Shakespearean understanding of life and people. The greatest technocrats would rather be doing other things. Are there any adults in the room?

God save us all from businessmen who call themselves moral. No wonder I spend all my time with drug dealers and arms merchants. “Morality is for other people, I have a job to do”

Their clarity of purpose is strangely calming.

Posted by Juan1 | Report as abusive

This post is very strange indeed. The word “incentives” and the names of economists appear in the title, but the post does not seem to involve any consideration as to what economists might mean by incentives. We do not refer to anything which might influence action. We refer to the effect of the future consequences different actions on a choice.

Regulatory capture as described here would *not* be called an incentive. Importantly, behavioral economists argue, among other things, that incentives are not the only explanation of action. Note this is a new appraoch and, while no longer widely rejected as heterodox, most economists generally consider it irrelevant to their work.

Do I mean to say that most economists think that actions are a function of their consequences and nothing else (including the difference between perceived and actual consequences). Of course not. But most economists assume that is a good first approximation and then go on as if they did believe that crazy extreme view.

Tendencies to pick up the opinions of people around you and to follow the thought of eminent leaders are not responses to incentives as the concept is used in economics. I think that the only way to reconcile this post with its title is to argue that all action must by definition be the effect of incentives. That makes the claim tautological and robs the word “incentive” of all useful meaning.

Also have you ever met Larry Summers ? He is not a go with the flow kind of guy. He tends to debate everything so when among economists he can say that basically all of economic theory is a big mistake. I quote him “I think the day in which they came up with the idea of the utility function was not an especially good day in the history of economic theory.*” Then at the World Bank he signs memos about how there isn’t enough pollution in developing countries, because the lives of people in developing countries are worth less than the lives of people in developed countries (his instructions to the memo writer were to write as an economist haters parody of an economist).

Rubin wasn’t his first mentor you know. Before that it was Martin Feldstein. Some of Summers very good very early work was proof that Feldstein was full of it.

I have no idea how Summers got so confused about finance and incentive contracts. When I knew him, he was advocating a Tobin tax. But I don’t think it had to do with incentives in any meaningful way and I sure don’t think it had to do with group think, going with the flow or anything like that.

*This quote is from memory and I was one of two people there. I can’t provide any independent evidence that Summers said that. I am quite confident that I am the only person who remembers the event and I definitely mean that I’m sure Summers has long since forgotten saying that.

Posted by robertwaldmann | Report as abusive

Oh and how exactly does one get from being mentored by Rubin to opposing a Tobin tax ? My anonymous source says that Rubin expressed interest in how to make a Tobin tax work when he was chairman of the NEC.

Also speaking of Summers dismissing warnings about new financial products you do know that he said Rubin’s views on new financial instruments were like telling people they had to play tennis with wooden rackets. Not as rude as the word “Luddite” but hardly polite.

Posted by robertwaldmann | Report as abusive

I offer two contributions: one is to note that Felix truly should be proud of this thread – the comments are extraordinary and I would be proud to meet any person on this thread and continue this conversation.

The second is that this is truly a complex problem, as RobertWaldman points out. There is an element of pure, pleasant social compliance. There is an element of natural selection, as it is natural to select people who think the same way as you for advancement and rewards, and that is not about “incentives,” and at the same time it concentrates the rewards in the hands of people like Greg Mankiw and Larry Summers. I also think that there can also be an element of conscious self-manipulation, to find it more likely to get invited/published/quoted to agree, and that is an “incentive.”

But I also think there is a change in culture, one that I have certainly seen since the 1980s. And that is that independence of thought and reputation for honesty is truly less valued. I would argue that there is a subtle, uh, Malthusian effect – there are plenty of people to replace me if I cause a ruckus at work, and there are fewer tenured positions at Universities, etc, and finally, there are loan officers who will outearn me if they don’t care about processing liar loans, and investment bankers who will outearn me – and replace me – if they bundle up bad mortgages and put lipstick on them when I won’t. And of course, there are reporters who will replace me if I can’t find Sarah Palin as endlessly fascinating as some of my readers do.

The values of integrity and trust, and independent judgment, are simply valued less today. I would argue that this, too, is another miracle of our greatly expanded market economy.

Posted by Dollared | Report as abusive

“Tendencies to pick up the opinions of people around you and to follow the thought of eminent leaders are not responses to incentives as the concept is used in economics.”

Then maybe you have to redesign the “science” of economics to include more Shakespeare.

“But my friends said 1+1=3!!”

Posted by Juan1 | Report as abusive

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