Summers’s incentives

By Felix Salmon
November 2, 2010
David Segal to Stephen Gandel to Barbara to Justin to Brad DeLong and back to Barbara again.

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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.

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