First as tragedy, then as depressingly avoidable tragedy

31/01/2012 Comments Off on First as tragedy, then as depressingly avoidable tragedy

This piece by Stephen Castle (NY Times), via Brad DeLong, seemed somehow familiar:

Bowing to mounting evidence that austerity alone cannot solve the debt crisis, European leaders are expected to conclude this week that what the debt-laden, sclerotic countries of the Continent need is a dose of economic growth.

A draft of the European Union summit meeting communiqué calls for ‘‘growth-friendly consolidation and job-friendly growth,’’ an indication that European leaders have come to realize that austerity measures, like those being put in countries like Greece and Italy, risk stoking a recession and plunging fragile economies into a downward spiral.

So, imposing austerity on fragile economies in the hopes of extracting onerous debt payments might be a bad idea? It doesn’t just risk pushing the economies into downward spirals, of course. There are the potential impacts on the political choices of the people, too (assuming the EU still allows democratic elections rather than technocratic country managers imposed by Brussels).

Where have we heard this before? Oh, yes, Keynes described what could happen when debt repayment arrangements are onerous, in The Economic Consequences of the Peace. But then, his ideas ‘are fairy tales that have been proved false’, no?

Book report: The Death of Economics

30/01/2012 Comments Off on Book report: The Death of Economics

Used book stores are odd. It is hard to get really good books, because people hold onto them. So, you get middling books, textbooks, and very common books. The economics section is usually quite grim: a volume of Galbraith, a 4th edition of Samuelson, and Atlas Shrugged.

It was in such a shop that I found The Death of Economics by Paul Ormerod. I’d heard his name in relation to Butterfly Economics, so I gave it a shot.

Here’s the quick summary: Ormerod overstates his case. A lot. The book is internally inconsistent, because he uses economic research to show that economic research is mistaken about economics. It is also inconsistent with the external world. My exhibit: yesterday’s FT blog by Martin Wolf. He describes a panel discussion on ‘The Future of Economics’, in which four very senior economists had criticisms and suggestions that were nearly identical to Ormerod’s. Maybe economics has an amazing capacity for renewal and reinvention, so that Ormerod’s criticisms of 20 years ago are now the received wisdom. Or, possibly, the situation was not so dire as he suggested in 1994. Neither explanation suggests a dying discipline.

On to the details. The first half of the book criticises mainstream economics, following a well-worn path. Classical economists were better because they were philosophers and political economists. The marginalists took a wrong turn by adopting a physics model for economics. In the 20th century, the focus on mathematical prowess turned economics inward and away from real life. In particular, the fiction of the rational individual has led us astray.

This is a selective reading of economics. As Ormerod himself explains, there have been many disagreements throughout these different eras. He counters the dangerous mainstream of economics by citing…other economists! For example, while discussing the problems with general equilibrium theory, he relies on work by von Neumann, Arrow, Lipsey, and Lancaster. Economic research doesn’t appear as blinkered as he would have us believe.

The second half of the book proposes new ideas, focusing on determinants of unemployment. There is some interesting stuff here. For example, he has graphs that suggest the rates of unemployment and inflation have a more consistent relationship than the levels. He also runs through some work on attractor points and the Lotka-Volterra system. His point is that an economy cycles around an equilibrium relationship between unemployment and inflation, but the specific equilibrium point can be shifted by external forces or social preferences.

In effect, Ormerod is saying that he has a better model. He favours a different set of variables (rates rather than levels) and a different mathematical expression (attractor points rather than linear regressions). Structurally, though, his argument is basic economics. A mathematical equation, properly specified, can describe human behaviour.

The last chapter reveals Ormerod’s real confusion. He forgets that economics comes in two flavours, micro and macro. Macro examines economy-wide indicators; its behavioural foundation can be rather thin. Micro is about rationality and its limits and what they imply. There have been attempts to bring them together, but the Grand Theory still escapes us. And this is, perhaps, his real criticism of economics:

Over the course of time, the system possesses many potential solution paths. Any actual path which is observed, from the myriad potential paths which could have been followed, will not correspond, except by the purest of coincidences, to the one which would have been chosen by the globally optimal maximising behaviour of ‘rational’ individuals. (p. 209)

Perhaps this is just a book of its time, 1994. Rational expectations theory hadn’t lived up to its promise in the 1980s. Unemployment was rising in Europe, Japan was in trouble, the US growth was low. Economists had new things to explain.

Perhaps, too, the biggest issue with the book is its title. Economics, even the mainstream general equilibrium theory Ormerod so heavily criticises, has not died. But then, Some Suggestions for Improving Economic Theory probably wouldn’t have sold as many copies.

Who is Merkel’s audience?

27/01/2012 § 2 Comments

Chancellor Merkel suggested yesterday that Greece might not survive in the euro. Have her staff been reading the blogosphere? Have they seen what many have seen, that negotiations seem to be on the road to nowhere? Perhaps, perhaps.

But I wondered, to whom is she speaking? In one sense, the substance of her comments contained nothing new. The news is that she said it. Why, and why now?

Here are some possible audiences:

  • Investors: Merkel is saying, don’t judge the euro by Greece. Yes, we have this gangrenous lower limb, but we will amputate if necessary, and it isn’t very big, anyway.
  • Greece: Merkel is the resolute cop, who arrives at the scene where Greece is holding the euro hostage. The cop says, ‘I’m not afraid to shoot the hostage.’ Greece drops the hostage and capitulates.
  • Institute of International Finance: Maybe Merkel is a poker player? Is she calling the bluff of Greek bond holders? ‘You’ve been talking a pretty big game there. Now it’s time to show yer cards.’

I’m not sure her comments change anything on the ground, but it is interesting to hear her make them.

The ‘right’ level of mobility

26/01/2012 § 10 Comments

Oh dear. Tyler Cowen has suggested that class mobility might not be that bad, and John Quiggin has taken him to task. The underlying question is, what level of mobility would indicate a meritocracy? Or at least the level of meritocratic reward we prefer? Does low mobility in itself indicate lack of meritocracy?

In the last year or two, I have joined both Mensa and the Triple Nine Society. It turns out that high IQ societies are obsessed with IQ measurements and what they mean. For example, the last TNS newsletter had a great article on the Flynn effect (named for NZ’s own Prof Flynn, University of Otago). I have therefore been reading and thinking lately about what IQ is and what it profits a person.

This debate about mobility and meritocracy touches on three issues:

  • selection of breeding partner
  • heritability of intelligence/IQ
  • correlation of earnings and IQ.

Conceptually, if people select breeding partners with similar IQs, IQ is totally inherited, and earnings correlate perfectly with IQ, then society will be both rigid and meritocratic. Relax any of the conditions, and you introduce mobility into a meritocratic society. If we then take as given:

  • individuals are allowed to select their preferred partners
  • individuals will prefer partners similar to themselves
  • heritability is biologically determined, rather than decided by social policy,

we are left with asking, what should be the reward for a given level of IQ?

I built a small spreadsheet model to try to understand this. I generated 100 people with random IQs (mean=100, SD=15) and gave them incomes equal to exp(IQ/10). I paired them so as to minimise the sum of the squares of the differences in IQ across all breeding pairs (1000 random draws). Then, each pair had two children. Their IQs were 50% random and 50% inherited. Their incomes were also equal to exp(IQ/10).

I put both the parents and children into quintiles and calculated the class mobility of the children. Here is the result:

In this meritocratic society, 73% of children are within 1 quintile of their parents. There isn’t much mobility. Only 6% of children have the really big moves, |3| or |4| quintiles.

All the inputs to the model are subject to debate. How inheritable is IQ? How do we select mates? How much should or does income depend on IQ? What are social preferences for equality of outcomes?

The key point is that, given the right parameters, you can have both class rigidity and meritocracy.

Technology in the service sector

26/01/2012 Comments Off on Technology in the service sector

Over the last few decades, the service sector hasn’t extracted large productivity gains from new technology. Manufacturing and the primary sector have done better. Services are becoming larger parts of advanced economies, so the lower productivity is a worry for total economic growth. Baumol (1967) provided the basic model. Although the Brookings Institution along with others proclaimed the disease cured in the 2000s, other research suggests this isn’t true.

I’ve eaten in many, many restaurants, bistros, and cafes over the last few weeks. The wide range of technology has been fascinating.

In midtown New York, we had breakfast in a diner. From our booth, we ordered pancakes, eggs, bacon, and toast. The waiter wrote our order in an order pad, the same kind I used 20-odd years ago in my restaurant jobs. Then, he gave the order slip to the cook who made our food. When we asked for the bill, he wrote the prices from memory and added it up.

In Aix-en-Provence, we went to a steak house that was part of a national chain (I had a salad — *sigh*). The waitress had a handheld electronic device for taking our order. The device sent the order to the kitchen. When it came time to pay, the order was in the electronic till, which added up the prices. The waitress also brought a wireless device to the table for EFTPOS payment.

The food and beverage sector has had very low productivity growth. Looking around, though, you see lots of different technologies being used. This is a heterogeneous sector, so there’s no surprise that you see heterogeneous technology.

At a guess, the most efficient technology depends on several aspects of these businesses. If the staff and the menu don’t change much, then paper tickets are probably more efficient. Staff know the details of the dishes, they know the prices, and inventory management is fairly routine. Higher staff turnover or more frequent menu changes mean that new information has to be provided to staff more often. Those restaurants can use IT to do that efficiently.

Also, more impersonal workplaces — ones with lower levels of trust — need more monitoring. If ordering, preparing, and billing are all tied together, it is harder for an employee to pocket the money from a bill paid in cash.

There is a story here of a sector trying to figure out what works and what doesn’t. It would be great to have enterprise-level data to analyse the productivity impacts of different technology choices.

Slavery and old time religion

25/01/2012 § 2 Comments

There have been good discussions on ethics and vegetarianism on TVHE and Offsetting Behaviour recently. I don’t have anything to add to the central topic, but this footnote from Offsetting caught my eye. Eric is trying to work out why eating animals is okay but enslaving humans is not:

You can maybe square this by saying people get massive disutility from being slaves while animals don’t know that they’re slaves. But humanity has a long history of slavery, and most slaves, as best I’m aware, didn’t commit suicide. So by revealed preference, lifetime utility was likely still positive. And then we’re stuck again.

I think I can explain the lack of suicide in a way that doesn’t require a positive lifetime utility: old time religion.

Let’s focus specifically on Christianity. It gives you something to hope for after this life. This life may be full of pain and woe, but you will be rewarded in the next life. In fact, the Beatitudes (Blessed are the X, for they shall f(X)) promise that the worse things are now, the better they are going to be. And, following Pascal’s logic, the afterlife is infinite while this life is finite. Therefore, possible reward outweighs any cost you must pay now.

To lock things down in this life, however, early exit is not allowed. Catholicism, for example, holds that suicide is a mortal sin. Sin separates you from God and ruins your afterlife. Therefore, you must live out your years if you want your eternal reward. Utility over the span of a natural lifetime might be negative, but the slave doesn’t suicide because of the promise of future reward.

I’m not sure how to incorporate this into an economic framework. We could say that we don’t have enough information to value the lifetime disutility of slavery — it is potentially nearly infinite. We could also say that religion is providing comfort in the present, so that the sum of disutility from slavery and utility from religion is positive. That is, you shouldn’t have baby farms unless they are religious baby farms.

Just moving away from flippant theorising for a moment, let me refer the reader to Ta-Nehisi Coates. We are in the sesquicentennial of the US Civil War (1861-1865). Slavery is thus being discussed in the States, and Coates is a thoughtful writer on the topic. Today, for example, he wrote about the capital value of slaves and its influence on rhetoric. I was raised in Virginia, and our history classes took a rather Southern view on slavery. Coates provides a different perspective.

Internet works: story at eleven

24/01/2012 Comments Off on Internet works: story at eleven

I’m back at work after a great holiday. I decided to unplug myself from internet for a few weeks, which was just lovely. I get rather wrapped up in news and commentary so a clean break was the way to go.

My travels took me to New York, Paris, and London. I did pay attention to newspapers and television in those cities, particularly to the economic and financial news. Despite coming from the other side of the world, I felt pretty well informed about the major stories. For example, there were no big revelations in the news coverage of the euro stories.  Of course, it was interesting to hear the tone of coverage and see which aspects were emphasised.

It is fascinating and empowering that we can sit in New Zealand, plug into the internet, and be as well informed as most people in the world financial centres. The internet is an amazing tool for spreading and finding information.

And of course, that’s the problem for old communication technologies. Hence the push-back from Hollywood and others against the internet. The SOPA and PIPA bills in the US Congress have been stopped for the moment, but the larger issue isn’t going away. Movie, television, music, even book companies are trying to figure out how to make money in the new technological environment. One way is to adapt to the technology; another is to have the government restrict the technology to protect their businesses.

When the Web was first commercialised, I used to think about McLuhan’s dictum, ‘the medium is the message’. What was the new medium, and what message did it carry? It seemed to revolve around three things: content tailored for the individual, the active role of the individual in sourcing material, and the individual’s ability to reflect on old material and produce new stuff. If you want it, you can probably find it on the internet, and then you can tell the world what you think of it. If you can’t find it, you can make it.

However, this active individualism is based on high-tech tools whose control is contested. People and companies are fighting over control of the infrastructure that allows me to type my thoughts into a text box and quickly produce a webpage. That’s the other part of the medium-message: the individualism is contingent. It isn’t a veneer, but it also isn’t self-sufficient. This was the AOL business model, and it is still being attempted in various forms.

The old communications technologies – the broadcast technologies – are more appropriate for mass production and passive consumers. Internet technology is more individual and fluid, but large-scale providers are still important (Facebook, Apple, Cisco). The two realms also interact with each other. Movies use the internet as a plot premise; TV shows let viewers comment on-line; the value of Megaupload is partly derived from the products of the old media firms.

So, yep, the internet works. But its success will be televised.

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