Theory and practice
By Scott Sumner
Before getting to today’s post, I’d like to correct my previous post on Brexit. When discussing the impact of Brexit on British growth, I forgot the evidence from asset prices. The British pound falls on news that Brexit is more likely, and falls even more on “no deal Brexit” becoming more likely. It’s hard to quantify that evidence, but it certainly counts for something.
Alex Tabarrok discusses research by the recent winners of the Nobel Prize in Economics. This comment is worth thinking about:
Michael Kremer wrote two of my favorite papers ever. The first is Patent Buyouts which you can find in my book Entrepreneurial Economics: Bright Ideas from the Dismal Science. The idea of a patent buyout is for the government to buy a patent and rip it up, opening the idea to the public domain. How much should the government pay? To decide this they can hold an auction. Anyone can bid in the auction but the winner receives the patent only say 10% of the time–the other 90% of the time the patent is bought by the government at the market price. The value of this procedure is that 90% of the time we get all the incentive properties of the patent without any of the monopoly costs. Thus, we eliminate the innovation tradeoff. Indeed, the government can even top the market price up by say 15% in order to increase the incentive to innovate. You might think the patent buyout idea is unrealistic. But in fact, Kremer went on to pioneer an important version of the idea, the Advance Market Commitment for Vaccines which was used to guarantee a market for the pneumococcal vaccine which has now been given to some 143 million children. Bill Gates was involved with governments in supporting the project.
Economists like to dream up optimal policy regimes. For instance, I’ve discussed how monetary policy could be guided by the forecasts embedded in asset market prices. One option is to peg the price of NGDP futures contracts at a level consistent with 4%/growth in NGDP.
One counterargument is that this policy is not currently politically feasible, which is true. But these thought experiments can have value even if the hypothetical policy is not actually adopted, as we can see in the case of patent auctions. There are many similar examples. Thus, if carbon taxes are not politically feasible, then tradable pollution permits might be a close substitute.
In my view, monetary policy is already paying increasing attention to forecasts embedded in asset prices, and the role of market forecasts will continue to increase over time. I doubt that central banks will ever adopt the precise policy that I’ve been advocating, but I also believe that by 2035 the Fed will be implementing policies that the market expects will result in roughly on target outcomes. Exactly how they do that remains to be seen.
PS. People often argue that economics is not a real science, unlike physics. That debate is silly, as it’s not an argument about the nature of economics; it’s an argument about how we should define “science”. But if I wanted to make that argument (and I don’t) here’s what I would point to:
In 1978, Arno Penzias and Robert Wilson were awarded Nobel Prizes in Physics for noticing that there is background radiation throughout the sky. AFAIK, no one has ever won a Nobel Prize in Economics for this sort of random discovery. Instead, Nobel Prizes are awarded to very distinguished economists for major theoretical breakthroughs, or else a long history of important empirical work. If there are exceptions, then please let me know.
Why can’t a single lucky discovery be worthy of a Nobel Prize in Economics?
PPS. Please don’t tell me that the economics prize is “not a real Nobel Prize”. That’s even more tedious than the claim that economics is not a science.