Knowledge that Transforms

our earlier article, we developed model which supported the hypothesis that the proportion of the staff budget which each senator from 48 states returned unspent 1978 was significantly influenced by their political philosophy: conservatives, on average, returned higher proportion than liberals. their comment, Steven Cobb and Robert Hagemann emphasize that some state may have been omitted and, as result, the coefficients estimated from our model may be biased. They develop an approach intended to correct this, that is, a regression estimated on differences between state senators will automatically purge the regression of all state effects (p. 524), and find that the relationship between the proportion returned and political philosophy is statistically significant. Although concern about omitted is justified, there are two shortcomings with the approach that Cobb and Hagemann employ that deserve mention. First, differencing is an appropriate technique to use with cross-section data, as Carl Christ observed, because the cross-section has no analogy to the value the time series case (1966, p. 210).1 time-series, the data are uniquely ordered, but this is true cross section. The data which Cobb and Hagemann difference are cross section of two on senators within each of 48 states. The crux of the issue is which senator is subtracted from which within each state, because in economics there is usually no meaningful way to order ... cross-section observations (p. 209).2 As an illustration, consider three states (A, B, C), each with two senators (denoted by subscripts). Several differencing schemes can be proposed which generate for each state: (A,-A2),(Bj-B2), (Cl-C2); (A1-A2), (B1-B2), (C2-C1); and, (A1-A2), (B2-BB), (C2-C1), among others. Each scheme generates different set of values for the dependent variable and for the independent variable measuring political philosophy. The different data sets will produce confficting estimates of the coefficients their model and choosing among them is necessarily arbitrary. When all permutations and combinations among 48 states are considered, Cobb and Hagemann's approach produces hundreds of different data sets that yield hundreds of conflicting estimates for the same parameters. Of course, the within states can be ordered by some rule (political philosophy, proportion returned unspent, tenure office, age, etc.),3 but the choice of rule is itself arbitrary. Second, for purposes of exposition, consider the where senators are either extreme liberals or conservatives; liberals spend all of their staff budgets, whereas conservatives spend none of their funds; also, every state has two senators with the same political philosophy. this ideal case, our model will verify that political philosophy determines spending behavior, but the model presented by Cobb and Hagemann will not, for when differences are taken, the value of the dependent variable (and the independent variable for political philosophy) for every observation is identically zero and no empirical estimates can be obtained whatsoever. One *George Mason University, Fairfax, VA 22030. Research support provided by the Sarah Scaife Foundation and the Earhart Foundation is gratefully acknowledged. 'In strict sense, Cobb and Hagemann are differencing, employing lagged values. However, Christ explicitly points out that ...using first differences as is equivalent to using variables (p. 177). 2Christ adds that In pure cross-section modelthe typically have no natural order, though certain cases we can imagine putting them the order of size, social status, or distance from some focal point, or what not (p. 209, emphasis added). 3If political philosophy is used, the question then becomes which measure of political philosophy. We used three: the American Conservative Union, the AFLCIO, and the Americans for Democratic Action rankings of senators.

To understand the significance of the and wealth elasticities estimated in my 1975 article and reestimated for a variety of samples by George Perkins, it is useful to recall the legal controversy that surrounded education finance in the early 1970's. In the historic and much publicized case of Serrano vs. Priest (1971), the California Supreme Court held that California's system of educational finance violated California's state constitution because local educational outlays were related to local property values. Similar cases were being introduced in the courts of other states and in the U.S. Supreme Court. Perhaps the most commonly discussed legal remedy in cases like Serrano was a plan referred to as power (DPE) by its original advocates, J. E. Coons, W. H. Clune, and S. D. Sugarman in their very influential book (1970). District power equalization is a matching grant formula that makes each percentage point of tax rate levied on the market value of local property produce the same revenue, independent of the actual local tax base. To be more precise, let W, be the tax base (wealth) per pupil in school district i and 6i be the tax rate chosen by school district i. The per pupil tax raised locally would therefore be Ti =61iWi. District power equalization would make the total per pupil revenue of district i proportional to 6i but independent of W, or Ri = 6iW*, where W* is the equivalent tax base implicitly assigned to all school districts by the DPE matching rate formula. The matching rate for district i (min) is the number of state level dollars given to district i for every dollar of revenue that they raise locally; therefore 1 + mi = R/Ti = W*/Wi. The DPE formula is important because it implies that the local price of educational outlays is proportional to wealth. If district i's of buying educational outlays is defined as the amount that the district must produce in local tax revenue per dollar of total spending, the DPE formula implies pi = TIRi = WJ/W*. In terms of the pricewealth elasticity of my earlier paper and Perkins' comment, district power equalization implies v =-1. My reason for estimating and wealth elasticities of demand for local school districts was to answer the following two questions. First, if the courts required the state governments to finance education in a way that eliminated the currently observed association between local wealth and educational outlays, what would be the appropriate matching formula? Second, if the courts mandated the district power equalizing rule, what would be the resulting association between wealth and educational outlays? To make these ideas more precise, I decided to measure the association by the elasticity of per pupil education outlays with respect to per pupil wealth and called this elasticity the degree of wealth neutrality. By applying Theil's famous formula for specification bias, I showed that the wealth neutrality (a) can be written

The turmoil that has characterized macroeconomics for at least a decade originated with the inflation that emerged in the late 1960's and persisted stubbornly throughout the 1970's. The inability of the neoclassical synthesis to model inflation convincingly spawned the new classical models. Because they infer macroeconomic results more directly from principles of maximizing behavior, they appeal to some as more rigorous. Many others reject them as irrelevant because neither the microeconomic behavior that these models postulate nor their macroeconomic implications are realistic. The central postulates are that all agents are price takers and that all markets clear in the sense of Walrasian auction markets. In a dynamic, or multiperiod, context this means markets clear in rationally expected future prices. The most controversial implications are policy ineffectiveness and, in some versions, the proposition that inflation could be eliminated with little cost in real output. As one of those who was unimpressed with these more provocative postulates and implications, I was distressed that anyone took them seriously, and that the profession became so divided over important policy issues. But it is also true that some more interesting ideas, that were originally linked with the auction-market model by Robert Lucas and other authors, might not have been developed without the controversy. One is that the rational expectations methodology should be applied in a thorough way to macroeconomic relations. Another is that private agents' behavior will depend on the rules governing the conduct of policy, or the policy regime. I am optimistic that we are on the verge of generating more light and less heat than we have been recently. The interesting new ideas and methodology that have developed in the course of the past decade's debates will continue to be explored. But inevitably, I believe, these and other ideas will be examined within the framework of an economy that in crucial ways does not operate with auctionlike markets. Both the lack of empirical success with the classical postulates and the intellectual challenge of developing a more general micro foundation to supplant the auction model are pushing in this direction. With this development, the gap between rigor and reality should narrow as researchers differ less about the basic postulates underlying macro models.