Spreadsheeting r>g

01/05/2014 § 3 Comments

Thomas Piketty’s book, Capital in the 21st Century, has been getting press, some favourable, some lukewarm, some critical. There’s even a bluffer’s guide (bonjour paresse!).

I haven’t read it, but that won’t stop me commenting. Specifically, the little shorthand ‘r>g’ making the rounds had me thinking. Unfortunately, my thought is also the first entry in the bluffer’s guide: the thesis isn’t new. This is the tendency for the rate of profit to fall, by some 19th century economist, dressed up a different way. It’s also something my actuary/economist dad pointed out to me years ago — that stock market returns couldn’t keep outpacing economic growth forever. And something that can’t go on forever, won’t.

But it isn’t real until you can put it in a spreadsheet. So, I tried. My first attempt failed because ‘r>g’ isn’t enough by itself.

So, I tried again, this time including a marginal propensity to save, which you need in order to determine how much income gets converted into wealth. It turns out to make for interesting calculations.

Here’s one example. Start with GDP = 100, divided 60/40 into wages and rents. Assume g = 0.02 and r = 0.08. With the amount and rate of rent, you can calculate initial capital (K), which is here 40/0.08 = 500.

GDP Wealth
g= r= MPS_L= MPS_K=
0.02 0.08 0.1 0.8
Year total wages rent savings, L savings, K Final K
1 100 60 40 6 32 532
2 102 59 43 6 34 566
3 104 59 45 6 36 602
4 106 58 48 6 39 641
5 108 57 51 6 41 682

What happens in the second period depends on what happens to rents. If they are entirely consumed by dissolute third-generation scions, then they don’t add to the stock of capital. So period 2 depends on the marginal propensity to save, which here I’ve assumed is 0.8 (80%). Final K is higher than the initial K, and the amount of rents increases. The result over many periods is the following:

wagerent1

The picture, though, is sensitive to the assumptions. Assume g = 0.03, r = 0.08, and MPS_K = 0.4, and here is the 100-year picture:

wagerent2

It turns out that the results depend on initial allocations, relative rates of returns, and savings rates. Crucially, too, I haven’t actually created a stock of K wealth that is owned by the initial L. I created the category in the spreadsheet, but then didn’t use it. If labour starts owning bits of capital, well, either that’s employee-owned companies or control of the means of production by the proletariat — I’ll let you make the call.

It seems that the problem is prying rents out of the hands of capital-owners, rather than the rate of rent itself. One way, of course, is taxes. A 50% estate tax looks like a useful way to get MPS_K from 0.8 to 0.4, for example. And dissolute grandchildren should also be encouraged.

Happy May Day!

Minister makes sense on alcohol minimum pricing

27/04/2014 § 4 Comments

Note: Eric Crampton at Offsettingbehaviour is an expert on the economics of alcohol consumption in New Zealand, and has posted on this. I purposely wrote this post first (because I have looked at modelling of minimum pricing), then checked out his comments. This post is especially long — sorry.

The Ministry of Justice released a report calculating the impacts of a mandated minimum price for alcohol. The reporting (in both the Christchurch Press and the Dominion Post) was that the report said minimum pricing would be good, lots of people were in favour of the policy, and the Minister blocked it anyway.

Minister Collins was absolutely correct to stop the policy, but not for the reason stated. The reporting was that

The ministry recommended that a minimum pricing regime should not be considered for five years. It said this would give time for Government to assess the impact of alcohol reforms which passed in late 2012.

And you think, fair enough, let’s see what happens with existing measures before we go adding new ones.

Back up a moment — who were these ‘people’ who favoured the policy? Well, all the same people who have been trying to reduce alcohol consumption for years. Specifically, SHORE can’t just let people drink in peace. They feature prominently in the article. It turns out that they supplied a lot of the data and analysis for the MoJ report, too.

SHORE got wound up a while back because alcohol has become ‘more affordable’. What does this really mean? It means (a) people have become richer, and (b) they have decided to spend some of their new riches on drink. This is clear evidence that people like alcohol. Given their druthers, they would like more of it rather than less. Alcohol is a ‘normal good’. Affordability is generally a good thing — think housing.

Back to the MoJ report — what did the report say, anyway? I’ll give you the high points.

First, a minimum price produces nearly the same reduction in moderate drinking as harmful drinking. The report acknowledges that harmful drinking is less price sensitive, but says that the fact that harmful drinkers consume cheaper alcohol means that the minimum policy has more bite with harmful drinkers. Figure 27 makes the link, showing that those who drink more frequently are more likely to be buying cheaper alcohol. The link is there but fairly weak. For those who drink daily, 25% are buying alcohol in the cheapest 20% of products (with no link, it would be 20% of them). So, 75% of daily drinkers are buying more expensive products.

My main issue with this is the blatant classism: if you work drunk on Bombay gin martinis or ruin your liver with Dom Perignon, that’s all good. The report wants to sort those icky people drinking Chateau Cardboard and growlers. While trying to target the fraction of the fraction of the population who BOTH buy cheap booze AND drink harmfully (roughly, 25% of 11% (Figure 1), or 3% of consumers), they are penalising people who want a moderate drink on a budget.

My second issue is the elasticities that drive the whole analysis. Just to be clear, there are two main elements to the modelling. The elasticities (how price affects consumption) are one main element. One set of elasticities, from SHORE and AC Nielsen, are in table 7 (p. 24). They are, shall we say, inconsistent with the literature. The report even points this out:

It was decided that the significant reductions in consumption estimated using NZ elasticity estimates are not a realistic representation of what is likely to happen in reality and are contrary to all international evidence of the responsiveness of alcohol consumers to changes in price.

And yet, the analysis still uses these elasticities. The report also uses the Sheffield elasticities, provided in Appendix 3, which have harmful drinkers as more price elastic than moderate drinkers (own price elasticity). So, a key element of the modelling is suspect.

Thirdly, the other main element of the modelling is how drinking links to harm. I spent a little time trying to dig up reliable data, and it isn’t available. The report tells us that it’s a problem:

For all the harm models there is the possibility that the functional form and slope of the relative risk functions are mis-specified (for example, most functions are assumed to be linear). The savings in alcohol-related harm generated are highly sensitive to the form and specification of the relative risk function. (p. 8)

Translation: we don’t really know, and it makes a big difference, but we’re gonna just go with what we’ve assumed.

Finally, the report finds:

A minimum price or excise increase would have some impact on low risk drinkers, but the savings to society significantly outweigh the lost benefits to consumers. (p. 7)

I’m not sure how they’ve made the calculation, but I’ll explain what I’ve seen. Chapter 9 has a big graphic in which the net social effect is the benefits in reduced harm less the ‘Costs of the pricing policy (deadweight loss + lost value of industry assets)’. This figure is after Chapter 8 runs through impacts on consumer surplus, industry revenue and Government revenue. The figures in Chapter 8 are pretty standard, but figure 13, the long-run impact of a price increase, splits the lost consumer surplus into ‘Lost consumer surplus after pricing policy’, which is a deadweight loss triangle, and ‘Transfer of consumer surplus to government or industry’, which is a rectangle showing the rent from the increased price.

The problem arises because it isn’t immediately clear how that rent rectangle is being treated. According to the Chapter 9 definition, it isn’t a social cost, because it isn’t a deadweight loss and therefore isn’t a cost. Now, this is technically true. If the rent can be captured by government or industry, then it is not a loss to society; it is a transfer from consumers (who may then gain by, for example, more government spending).

However, it is still a loss to consumers. They still, as consumers, have to pay more, and are losing that consumer surplus. Therefore, if you want to draw a conclusion like ‘the savings to society significantly outweigh the lost benefits to consumers’, you need to include that transfer in the ‘lost benefits to consumers’. It is not clear that the analysis does this.

So, a summary. This report is suspect. I haven’t read the whole thing and investigated every calculation, but what I’ve seen suggests that all the assumptions are spelled out and all the details are included, so that if you work at it you can begin to understand how parameters and assumptions were transformed into a crusading conclusion that alcohol must cost more! But it should not be the reader’s job to sort through those details. It is incumbent on the Ministry to provide accurate and impartial analysis. I do not believe, in this case, that they have done so.

Perversity of preferences

10/04/2014 § 2 Comments

I’ve been watching the roll-out of the Affordable Care Act (ACA) in the US. I understand why the Rube Goldberg apparatus was set up the way it was. Doesn’t make me happy about it, but it does mean that more people are better insured.

The Supreme Court ruling that cleared the final roadblock was exactly the sort of split-the-baby decision we should have expected. As sometimes happens with rulings, the implications weren’t immediately clear. In particular, the provision that states could opt out of the Medicare expansion turned out to be more important than was first thought. The implications were recently discussed in an interview with Prof Jonathan Gruber, MIT, Director of the health care program at NBER:

[T]he single thing we probably need to keep the most focus on is the tragedy of the lack of Medicaid expansions. I know you’ve written about this. … I think we cannot talk enough about the absolute tragedy that’s taken place. Really, a life-costing tragedy has taken place in America as a result of that Supreme Court decision. You know, half the states in America are denying their poorest citizens health insurance paid for by the federal government.

(N.B.: ‘half the states’ does not mean half the people — the states in question are less populous than the ones that expanded Medicare.)

Why do I point this out? Because the economist Gruber was surprised by the politics:

if you’d told me, when the Supreme Court decision came down, I said, “It’s not a big deal. What state would turn down free money from the federal government to cover their poorest citizens?” The fact that half the states are is such a massive rejection of any sensible model of political economy, it’s sort of offensive to me as an academic. And I think it’s nothing short of political malpractice that we are seeing in these states and we’ve got to emphasize that.

‘What state’ is an incorrect way to think about the issue. It wasn’t ‘states’ that decided. It was people, specifically politicians and the voters who support them. What politicians-and-the-voters-who-support-them would turn down free money? People who believe — who prefer, let us say — that poor people should not be helped. That poverty is just desserts. That poverty is just the flip side of positive incentives for hard work and sober decisions. These people prefer a certain set of incentives aligned with a specific view of how the world works (Weltanschauung, if you don’t mind me saying).

This ACA situation is the Ultimatum Game writ large. We just played the game in class. When the offer was 50:50 or 60:40, it was accepted. When it was 90:10, it was rejected. Person A turned down free money because Person B else wasn’t ‘playing fair’, wasn’t acting according to Person A’s preferences.

Politics is a way for people to express their preferences and try to foist them on other people. It is also a bloodsport, as Dr Thompson would remind his readers. That’s my way of saying, of course these people rejected Medicare for the poor, even at a cost to themselves. They are using the issue to Make A Statement about how the world should be, and if people get hurt, well, omelettes and eggs.

It’s an important lesson for economists working in policy. People’s preferences are wild and woolly, and when expressed through political process can lead to seemingly perverse results.

Magic asterisks

27/03/2014 § 3 Comments

I’ve been fighting magic asterisks lately.

Unfortunately, I’ve been doing it secretly — anonymous reviewer, confidential client work — so I can’t share the details. I can’t even show you the costume. But I can rant a bit.

The original Magic Asterisk (TM) was a Reagan-era budget device from David Stockman. To make the net budget come out right, he resorted to adding asterisks that indicated unspecified spending cuts. The cuts didn’t happen, of course, but the budgets balanced. The books might not have, but the budgets did.

I am starting a collection of terms that people use in economics as magic asterisks. These are devices — rhetorical, mainly — to get them from what they can prove to what they wish to be true. They are little bridges from reality to ideology.

Here is the start of my collection, and why [note heavy use of sarcasm]:

  • Lock-in, path dependence — sure, the decision you face looks straightforward, but the unspecified opportunities that you are destroying in the fractal future are amazingly valuable! If you make the wrong choice, you will be forever condemned to a life of regret and penury.
  • Non-linear — oh, man, it’s gonna go boom! Don’t you see, it’s non-linear. Just a little push, and you’ll be smiling it’s all over! Like, y’know, compounding interest and discount rates and the parabolic effect of gravity on a tossed ball.
  • Uncertainty — you don’t really know, do you? The future is uncertain. Anything could happen. Oh, and maybe some evil demon is just dreaming all this.
  • Chaos theory — classical mechanics doesn’t really understand cause and effect. Butterfly wings and hurricanes, that’s all I’m saying. It may look unimportant, but it could have really big consequences.
  • Bounded rationality — you can’t know everything! and people make mistakes! That means you don’t really know anything and you’re probably even wrong about that.

Don’t misunderstand me. All these terms have meanings. Actual, y’know, defined meanings that can help us understand economics better. Take bounded rationality. As Simon developed the idea, it focused on using rules of thumb in structured environments to achieve a ‘good enough’ outcome without optimising. Some people think it just means not optimising. Some people think it means optimising subject to cognitive constraints. It was something different — it was about the method that people used. Powerfully, it shows how using rules of thumb is useful in predictable circumstances but possibly catastrophic in others.

Feel free to add your own.

Millennials’ problems so much more problematic

25/03/2014 § 7 Comments

You wanna set me off? I’ll tell you how. Bring up the problems of the Baby Boomers/Millennials.

Ted Rall is right on this. He’s brought it up before, and he’s nailed it again. We Gen Xers don’t matter:

I’ve been disappeared.

Erased from history.

Dropped down the memory hole.

(bye)

If you were born between 1961 and 1976, you no longer exist.

Is it just me, or is this a spoken word piece?

I’m hearing how hard-done-by these poor Millennials are. And y’know, I have some sympathy. Except that nobody cared when I had tens of thousands of dollars of college debt and home ownership seemed like a pipe dream and full-time work was scarce and we were all doing jobs that didn’t require a college degree. Now I’m supposed to care about the Millennials?

Oh that’s right, there are more of them.

And so, when they can’t afford cars, it’s a movement (or not). Not like when Xers were in their mid-20s and couldn’t afford cars — we were just slackers.

When their Boomer parents try to sell their houses and can’t cash out, it’ll become a public crisis to be solved with public money. When those same Boomers can’t sell their accounting practices and plumbing businesses because they didn’t train their successors and didn’t share the wealth, it’ll be another crisis to be solved with tax breaks and succession subsidies.

But sorry, Ted, there is nothing we can do about it. Remember that the US presidency skipped a generation, going from a WWII veteran (Bush I) to a Baby Boomer (Clinton) and skipping the generation in between. It’ll happen to us, too.

We’ve already been disappeared.

Details of economic perceptions in US

24/03/2014 § Leave a comment

The Pew Research Centre reviewed some interesting results. They start off saying that there’s a puzzle:

One of the biggest political puzzles of 2014 is why the public remains so bearish about the economy, and in turn critical of Barack Obama’s stewardship of it, given clear signs that economic indicators are improving.

First, they have been finding for the last few presidential administrations that perceptions of the economy are linked to party affiliation. That trend still holds. What is curious is that Pew thinks it is curious. It makes perfect sense, really. If your guy is in power, you are probably going to be pleased with how he’s running the place. If the economy is strong, it’s because of him. If it’s weak, he’s doing the right thing to make it better. So, the partisan gap isn’t surprising.

Secondly, they report a gap in perceptions of personal finances that correlates with education:

For example, college grads now size up their finances roughly as well as they did before the Great Recession took a toll on their outlook. In contrast, personal financial assessments of the less well-educated Americans have not improved as the economy has recovered after the Great Recession.

But again, this roughly reflects what’s happened. People with college degrees have tended to do better, both before the recession and after. The assessment of the non-college graduates is probably realistic: more unemployment, longer unemployment, lower wages, etc.

I’d be really interested in similar surveying for New Zealand and Australia. UMR Research, for example, has the Mood of the Nation survey. The reports on their site don’t break down results by demographics, though.

Consultant as analyst

20/03/2014 § 1 Comment

I attended a talk on economic modelling today. It was a straightforward presentation of a certain technique, explaining how it works and providing some examples.

There was some close questioning of the presenter. The questions weren’t always, um, helpful. They weren’t in the spirit of the presentation and raised questions with no real answers.

As I was listening, I suddenly heard Lacan’s discourse of the hysteric. And then I thought about the whole structure of the talk.

The presenter was trying to say something like this: economics has some theories –> we can turn those theories into a model –> we can solve the model –> we can then model things that didn’t happen or haven’t happen.

It was all presented in the discourse of the university: knowledge (S2) trying to reduce the excess (a), bounding the uncertainties and keep them from spilling over the edges of the research. The group contained many who were aspiring to know ($) more about the technique: holding the workshop produced a group of people who wanted to know.

The questions did not stick to the discourse. They did not, for example, ask what the equation structure was or where the elasticities were sourced. Such questions would validate the modelling. They would confirm that having an elasticity is important, and having a model in which to put it is important.

These questions were:

  • why do you believe your theory? I have another one
  • have you included my special knowledge of the subject?
  • your method is incomplete, isn’t it?

These are questions  that come from the perspective of the hysteric. The perspective was: I have lived, I am specific ($) — what does your unifying model (S1) have to say about my own experience?

Then, a consultant in the room answered from the analyst’s discourse. The comment was, we would like to talk to you more about it. It would be good to discuss your specific knowledge and incorporate it into our analysis. The idea of the un-modelled excess (a) would make the specific subject ($) speak, in order to re-produce signification (S1).

Odd to think of consulting as analysis, but I think it might work.

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