Tuesday, December 30, 2008

Innate Gender Differences

One of the best way to get yourself shunned in Academia is to speculate about gender difference in intelligence. That's why this guy--rumor has it, it's Robert Gordon--writes anonymously.

He (she?) discusses work put out by an Italian professor I once worked with, which shows that the gender gap in mathematical achievement disappears in more gender equal countries, and even reverses itself for sufficiently progressive societies. The unnamed genderist finds that such a gap exists and is durable. The Italians find otherwise because gaps close at high levels of ability--which are also countries where feminism is in vogue. Some statistics shows that this gap is largely explained through genetics. If you get tired of genetics-intelligence hand-waving, just check out Gladwell.

Cue the just-so evolutionary stories. I imagine telling these must be a high point of parenting.

Monday, December 29, 2008

Farewell To Alms (II)

Gregory Clark has a reply to his critics up.  I wrote about him before here.  His big idea is that the traits required for success in a modern economy, like performing repetitive tasks after basic needs are met, are not 'natural' but rather diffuse across populations which are in a Malthusian stress environment.

Apart from some nasty academic bickering, there's a lot of interesting stuff in his reply.   Agriculturalists in New Guinea seem to fight as often as hunter-gatherers, while other settled people tend to be relatively peaceful.  The big change here is probably political, as villages take on tribal and clan identities and go to war as parts of larger agglomerations.  There's probably enough variation along this degree to see if that relation holds in general.  So rather than just Hunter Gatherer--building Pyramids, there are a few steps in between.  

There are other interesting simulations testing the degree in which genes/culture can diffuse, and some calculations suggesting that hereditary plays a big role.  Ultimately, this is never going to be entirely convincing until people actually find the genes in question, and nail down which characteristics are best at predicting economic success.  If IQ by itself can do so well, then more disaggregated measures--verbal, mathematics, however Howard Gardner you want to get--should be able to do even better.

Clark also takes up a bit what I see as the biggest hurdle to all distance-from-agriculture-based explanations: The income variance across Asia.  Agriculture has been dominant in East and South Asia for some time now, so you need to bring in political explanations to explain why Japan is so rich and North Korea so poor, and why relative income has changed over time.  Peasants from these populations sent overseas as indentured servants tend to do well--after Britain abolished slavery, populations largely from Tamil Nadu and North India were sent all over the Carribean, Indian Ocean, Africa, and Southeast Asia and are orders of magnitude better off than populations in India.  This would imply substantial "slack" available in long-standing agrarian economies for capitalist buildup.  Also see Yasheng Huang and the entrepreneurship of rural China.  

Clark addresses this issue in his book by recourse to low labor productivity across Asia suggesting that supply is slow to respond to economic incentives.  But as Deepak Lal shows, indigenous Indian responses during British occupation was fairly quick quick.  Cotton mills went up about a century before the Tigers, taking advantage of free market, free trade competition spread by the Raj.  Sure, you can say that only the banias, Marwaris, Gujarati entrepreneurs, Jains, Parsis, etc. took over as entrepreneurs, but by the Smart Fraction theory that should be enough.  

The proximate cause of lower labor productivity with respect to early Japanese competition is that the Japanese mills domiciled female laborers and made them work all day.  In India, a coalition of English philanthropists and mill owners pushed very labor-friendly regulations limiting hiring and firing, encouraging strikes, and so forth.  The English mill owners of course wanted to kill the competition, but political economic considerations kept and built up these laws after Independence.  The core of Arvind Panagariaya's great new book is that these regulations raise the cost of labor--India's greatest endowment and source of comparative advantage--pushing the manufacturing sector into skill and capital intensive production.  With the end of industrial licensing and ability to trade on the world market, these new industries are soaring, while the bulk of the garments industry--in contrast to places like Bangladesh, old Taiwan--remains small scale.  Foreign trade looks very important here, as central as it was to just about every growth explosion except America.  

So the story goes that you need enough heterogeneity in the population to allow for natural capitalists and entrepreneurs, who finance and start industries in an agrarian society.  If local farmers are their only customers, they go bust.  But if they start producing for the world, they take advantage of economies of scale and ramp up productivity.  Everyone gets richer, the Flynn effect kicks in, and more people are drawn in.  Not so great at explaining places with significant resource endowments, or places where agriculture growth has been dominant (Denmark, South Germany...), but for those places interaction and trade with the industrializing segments was crucial.  

Indian Foreign Policy

Some great stuff from my favorite South Asian diplomat about India's America delusion:

The past four-week period has also shaken up Indian illusions regarding Washington's regional policies. It is plain to see that the US never really abandoned its "hyphenated" policy towards India and Pakistan as South Asia's two important rival powers, both of which are useful in their own ways for the pursuit of the US's geostrategies

That's about right.  The pro-US bias in the Indian strategic community is driven by America-envy and regional disgust much more than it is by realpolitik.  Bush has done an expert job at playing on this Rodney Dangerfield ethos by convincing people that superpower status is possible if you sign on a sufficiently pro-US agenda.  This is really the status and respect Nehru cultivated people to expect, but India really doesn't offer enough to America to justify a broad licence.  Even the British are kept on a short leash, and their interests mesh pretty well.  

India's regional objectives--contain Pakistan, limit terror, hegemony over neighboring states, deter China, while getting guns and oil in exchange for tech support--overlap only partially with America's.  The decades old partnership with Russia is lapsing, while Iran is given the cold shoulder over a necessary pipeline deal, and other Middle Eastern states spurned, for what end?  So an English-speaking elite can feel good about being a star player on the Asian League of Democracies?  The American treatment of Pakistan shows that they value combating terror as a national priority, and India's treatment will be judged as a part of a regional settlement taking into account Pakistan's feelings.  In the 1960s, Johnson restricted food aid out of spite for India's non-cooperation with Vietnam.  

It's unreasonable to expect any more, and also bad to pass a nuclear deal which will solidify relations with the Americans at the cost of near-collapse of the government while bringing meager energy returns.  Just build some roads, privatize everything, and get the Russians on the phone.  Their Shanghai alliance has the same facade of autocratic unity that the Communists put up in the '50s, and beneath that you can see the tensions between a state which is rich in energy and land but short on people and one with the reverse endowments.  I'm sure the Russians could make better use of a South Asian ally (the Chinese already have theirs) with substantial technological expertise, the better to weigh against the Chinese, Americans, and whomever else they feel like annoying.

Wednesday, December 24, 2008

Some Internet Criticism

The great part about the Internet are the cascading torrents of links which turn the whole thing into an integrated network.  Of course, a small number of important sites do a great deal of the shifting through and highlighting, but it's not entirely a top-down system as the original sources are often spotted by topic specialists.  The entire enterprise remains hugely dependent on the big newspapers to generate things to complain about.  

The process is hugely addictive, certainly for consumers and likely for the intermediaries as well.  Pick up the Outrage of the Day, add a political spin, and send on down the line for supporters to fawn and denigrators to be outraged at your having brought up the subject up, having your view, etc.  It's like a jolt of crack to see the day's information, get pulled into the argument, weight sides, and scribble nonsense at the other side.  Most things people do offer delayed rewards, so it's no surprise to see millions flock somewhere which offers the constant allure of More Stuff To See, more information, more discussion.  That incessant flow disguises the fact that people rarely talk about the thing in itself, almost never have the background or understanding of the topic, and so most things are thinly covered politics.  But behind all the shallowness that comes with discussing even the most serious of topics you can see even broader dynamics of push-and-pull between broader personalities and outlooks, which do change even if no one ever changes their mind.   

One of my personal pet peeves is the autistic understanding of language which happens all around.  When people talk in the real world they bring all sorts of implicit meanings behind gestures, phrases, etc.  The anonymous and toneless nature of the internet grounds everyone in the literal meaning of words, which greatly impoverishes thought.  Take analogies for instance.  People make analogies all the time to compare certain aspects of A to certain aspects of B.  Any random A, B are likely to have something in common, but when people make this connection they generally mean that something in particular is going on.  This is after all how we learn; we link new things to things which we already know.  On the Internet, people will generally take the connection out of context, and mock it on face value.  People care less about how a statement is interesting than about it's truth value, but people also don't care enough to look up the thing's truth value and instead rely on heuristics.  

Broader psychological misunderstandings abound.  The urge for firebrands and activists to hear themselves results in a massive overpopulation of fundamentalists of every stripe.  Nearly everything on the Internet is reductive.  People everywhere search for validation and online they get it through low blows, petty remarks, and swift thrusts.  It's as if the place is run by the Oxford Debate Society.  The particular psychological rut of conspiracy theories, shallow thought, and general angst make the Interet a very motly but, well, a very "male" place.  Despite all the links, it's very antisocial, with very little in the way of relationships or empathy.  These aren't gone, however, but come up in the strangest of places.  

It's very much like a city in that way, with a blizzard of activity covering up a lack of introspection, memory, and history.  What has happened before, what is really going on now, and where things are headed are abandoned as people race to meet the demands of the current cycle.  It's like travelling the world with some smart, but not too smart, argumentative friends who have amnesia.  I don't know what this is doing to our intelligence, but someday the internet will drop the vicious circles and parlor tricks and become the thing it was meant to be.  The problem is not that it's escapist, but that it's not escapist enough and is still bound by the conventions other people set in other media.  I want to stumble upon Dutch's blog, see more passive-agressiveness, maybe some irony and parody.  Things that don't make sense, complex psychological issues, some other prose than dry and without adjectives.  A Russian novel in parts; something jointly written by people across the world.  

Wow, it's tough to talk about things in the abstract.  

Tuesday, December 23, 2008

The Death of Newspapers

Along the general vein of fretting over newly lost industries from cars to investment banking (Seriously, housing's gone, no one cares about 'renewable' garbage anymore, retail is gone, what exactly is the economy running on?), there has been a lot of talk about the decline of newspapers.  Generally, people tend to blame the Internet for everything and diss management for failing to take advantage of counterfactuals like starting their own Craigslist.  

Yes, the Internet is a really big deal, a fact which Google trends makes very clear to me.  But big brands, as Yglesias notes, are doing really well.  Magazines have done alright too.  It's the combination of the Internet plus all sorts of other stuff that are putting journalists out of business.  After all, virtually every newspaper now puts their content on the web.  They've realized that they're not in the business of selling paper, but rather of selling media content, which can happen in any medium.  

Online media distribution has very different economics though.  For one, you don't have the crazy diseconomies of scale which have supported cozy regional oligopolies.  If I'm on the web and searching for news, I might as well go to the best source of news, while in my hometown I might be limited to a few local papers (no, you don't want that mail subscription to the NYT).  The best online sources of content have generally done pretty well with respect to page views.  The strategy of many news teams, however, has been to respond to budget crises by cutting back writers, which pushes more people to other online sources, which hurts the budget more, which causes another death spiral of cuts... the WSJ and NYT, however, have kept up pretty good news teams and seen plenty of visits their way.  

But newspapers would still be fine if they were able to just move their customers online and still make similar ad revenue per customer.  They'd perhaps be better off since the cost of a newspaper is pretty close to the production cost.  The big problem is that Internet advertising is nowhere near as profitable as print advertising.  You behave very differently on the Internet than other media places, and advertisers don't really know how to deal with that.  They might fix this one day; the first TV ads were rip-offs of radio ads and no one paid them any attention.  Perhaps the defining characteristic of the Internet is the network structure of links and the quick diffusion between sites; it's not crazy to think that someday we'll want to click on those links, since we click on everything else we see without thinking about it too much.  Probably the best way to get there is to data-mine personal information to deliver links that look like things I click on all the time.  I click on the news stories at the top of my Gmail account, for instance.  People are going to lose a lot of privacy, hands will be wrung and the occasional sob story will hit Newsweek and people will be better off.  But right now Internet advertising is less profitable for newspapers by a substantial margin; it's not that they've lost customers so much as they've lost the profit/customer. 

The Internet also takes away a lot of the reason for their being a newspaper, which is after all a bundled product of various smorgasbord news items.  This used to be the most efficient way to deliver a mass of information to a person.  These days, people tend to use specialized sources--ESPN (or, even better, deadspin) for sports, gawker for entertainment, Slate for contrariness, blogs for opinion, and so on.  There are a handful of aggregators, and of course the best media brands with international coverage draw attention, but there's much less reason to use a mid-size town newspaper for this purpose.  There's maybe less serendipity of coming into wayward news events online, but really people use the internet for a lot of random stuff.  If historical evolution went from the internet to the newspaper, old hands would complain that young folk no longer get the educative experience of browsing Wikipedia.   

Some newspapers have responded by increasing specialized coverage to appeal to wider audiences, and letting reporters write blogs to create some personal information channels.  In the long-run, the Internet is a very un-democratic institution which makes everything follow a power law.  So a few blogs dominate, and many of these tend to be run out of big media institutions (and staffed by Ivy Leage grads...); the remaining big blogs are mostly legacies.  Again, the problem lies in monetizing all of these people.  It tends to be only possible with extremely rich people, which is probably why Murdoch decided to keep the WSJ behind a wall (while silently redesigning the site).  Yeah, that leaves you without ammo in the daily link barrage, but your proprietary blogs can still participate in that while you focus on profits.  

This has all been great for consumers.  Following the general trend of globalization--kill local options while increasing choices for everybody through trade--it's easier to get quality everything than every before.  Probably investigative reporting will take a big hit, since bloggers are better at shifting through things in the public domain rather than adding original reporting, but who really cares.  The top-quality newspapers will do very well, as will niche publications and anything that caters to rich people.  

The big unresolved problem in my mind is coming up with decent personalized aggregators.  Sites which take a person's given preferences to deliver things that 1) All their friends are reading 2) Appeal on the basis of 'you really should know this' 3) Provide some random flavor 4) Are similar to things you have read 5) Go beyond fetching stories to summarize ongoing debates 6) Provide "Internet criticism;" broad, meta-criticism of overarching trends and themes.  Of course, you'll be able to make this as personalized as desired, vote up/down on stories, send to friends, etc.   Google News doesn't really cut it--humans might need to get involved at some point.  Naked Capitalism is nice for some finance/economics stuff.  Newser is pretty interesting too, but there's a lot of room to get better.  Slate does some of this, and a service similar to Slate, but for everyone and user generated, recently went bankrupt. 

Basically I'm waiting for the point where I berate people for not reading/creating blogs like normal people and instead twittering or some nonsense.  

Sunday, December 14, 2008

Population Heterogeneity and Income Inequality

Economic explanations for income inequality across nations have changed a lot. Easterly does a good summary, but basically people used to look at things like capital (ie, Rostow big-push) but then figured out that sometimes countries don't attract capital because they're poor, rather then being poor only because of a lack of capital. The search moved on to deeper causes of poverty, such as quality of institutions and policies, development of human capital and productivity, and political issues like violence.

Now, some people are looking at the underlying dynamics of why those things happen. Galor has an interesting scheme in which populations under Malthusian pressure gradually change their value structure to become more market-biased, and Gregory Clark claims that genetic and cultural changes lie behind Europe's economic dominance. Other folks at Brown have come up with some research which traces the population heritage of different groups, finding strong historical presistance for generating income.

This intersects nicely with other population genetic research. Heckman has done a lot of work on the technology of skill formation, finding that the amount of skills you can build up when early determines a lot about your future. So while everyone faces similar incentives to pursue education, people have differing abilities to do so, so you get income inequality. A major cause of population differences is time distance from agriculture. Groups that have been settled for a long-time look very different from groups that just picked up agriculture, the the latter groups have a very very difficult time adjusting--in terms of building up a tolerance to alcohol, for one.

There are a few issues with this picture:

1) How do the underlying cultural/genetic population parameters intersect with broader political themes? Presumably South Chinese populations across Hong Kong, Macao, Taiwan, Guandong are similar, but different largely exogenous political changes had very, very different results. But often, political institutions are built from other grassroots pressures, and interactions are complicated.

2) Why is this historically a bad predictor? If you go back thirty or fourty years, you see African countries living in a Malthusian environment where a high disease burden keept income relatively high above subsistence level. Post-colonial growth wasn't bad, while poverty was really concentrated in East and South Asia. Latin American countries weren't doing bad either (Argentina was one of the world's richest countries at one point) despite having a large population with minimal state history. Then things changed and historical stereotypes started to look like they have some relevance.

3) Among populations with similar experience in State-building, why is there so much variance? Mesopotamia/Egypt have a very long history of urbanization, while in England Romanization was very weak and the real state-building happened much later. But England made the transition into a Neoclassical economy first, and presumably carried the spillovers to other nearby northern European states with similarly short development history. The Mediterranean region, which is where you have the long state histories, still remained a backwater. So even within Europe, there are a lot of political/technological confounds. You can start to explain some of this by soil degration and salinity; early Mesopotamians destroyed the land so Persia and Greece became more important; and so forth until gradually the seat of power moves further north and west away from the site of initial agriculture, but this really adds to the complexity. This is also specific to irrigation-based technology for certain cereals.

Once you expand outside Europe, things get even trickier. China of course has a great long history of technological innovation and highly capable state formation, and rice cultivation with effective fertilizers kept soil productivity high. Income, however, lagged up till a few decades ago even the poorest of African nations. Catch-up growth has been significant, but that was not the only way it could have gone. India also has a very long state record, but the parts of the country with the biggest heritage in that direction are also some of the poorest right now. The point of much of this research (also Jared Diamond) is that you can kind of predict the important countries from 1500 and also some relative rankings since history matters, but this alone doesn't tell you why Europe and Japan have done well, and not Persia or Turkey. Explanations that try to do this (ie, Diamond's argument that Europe is near a lot of water) look pretty ad hoc.

4) Non-linear post agriculture histories play some part in this. For instance, many tribal people in India have known about agriculture for a long time, many are agriculturists, and all are in symbiosis with other settled groups. But they're not the same as either other agricultural groups or the more isolated groups such as the Senitalese. In India, long periods of political violence and a general lack of centralized authority (as well as whatever the effects of caste may be) probably kept the population in less of a "settled" mentality than other parts of the world. But it was still more prosperous in aggregate historically than places which only recently have seen wealth, say Eastern Europe.

5) Supply-side responses dominate how much money you have only recently (and maybe not even now). Brute force has generally been much more important.

6) Most likely, population parameters established through cultural and genetic selection determine cognitive and non-cognitive skills (The non-cognitive skills--persistence, motivation, learning to follow orders, etc. are pretty underappreciated and possibly more important). In a country like America, which is a pretty meritocratic place, you can look at the population's wealth share for a rough guide of the "potential" income (selection effects on immigrants and other historical legacies are important here too). You can look at Mauritius and Singapore similarly. Relative ordering may be fixed within a country, but explaining difference in average levels of income, even holding population composition constant, is a good deal about various geographical and political factors. In the long-run, a country's politics should respond to keep income at potential, especially in a competitive international environment, but this can take a while.

The slow rate of response of human labor to the demands of a commercial economy generates rents for the people who catch up. Capital is pretty elastically provided, so interest rates are pretty similar across time, but it's much slower to get a skilled human supply-side response, so some people collect substantial rents and you see a lot of inequality.

One-Party Democratic Rule

Bryan Caplan wants to know why certain places, like Singapore develop as single-party Democracies.

The traditional two-party result in Game Theory makes the assumption that voter preferences lie on a linear continuum. So given any two people, one will be more "left-wing" than the other, and you can find some moderate in between. Parties then jostle for the median voter, and political dominance is unstable.

In reality, the political landscape tends to be more broken up. You have issues like abortion which cleave the electorate. With large population areas, such large Democracies, there tend to be sufficiently many issues that the two parties take on many differing positions and you can effectively think about a "marginal voter" who is torn about which policy preferences should receive greater weight. So any political dominance is always unstable, as the other party can create enough wedge issues to come back.

The problem in smaller political units is that voters are split on fewer issues. Voters tend to be much lower information on local races and go with identity more often. In Chicago for instance, the Daley machine can get at least 60% of the vote in primaries from their vote bank of Irish, immigrants, and other whites. It's hard to compete as another Democrat (let alone a Republican) since Daley serves his base very well (plenty of union and city jobs), and his base is over half the Democrat primary pool. Add to that the fact that city dwellers tend to have relatively uniform social preferences on issues such as abortion, gay marriage, teaching evolution in school, etc.

Similar ethnic divisions are at play in Singapore (Malaysia too). With a large Chinese supermajority, the Lee family makes sure to reward their supporters well. South Africa displays this pattern too, with the ANC commanding the undivided support of a large black base (though high-profile splits in that party might be important).

Explaining this paradox is all about showing why a competing party can't arise in small places while they can in large ones. If you can get >50% of the population to care about a simple set of issues, and then become the best person at providing them with their needs, you have a stable dominant equilibrium even in a democracy.

More interesting perhaps is explaining the long legacy of one-party rule in large and pluralistic democracies like India, Mexico, Taiwan. There the answer also has to do with the costs of building a political machine, and the use of state coercion to tackle political opposition, as well as reputation buildup in the freedom struggle (in India). Information costs in large democracies mean that the scions of politically powerful families start with a heavy stock of reputation capital, explaining the prominence of political dynasties in South Asian Democracies (Gandhi, Bhutto, Zia), and also American and Japanese Democracies.

This is also why you see a greater share of female political leadership in some foreign democracies than in America. In the US, political leaders tend to be drawn from the stock of well-connected lawyers (which is largely male), while in other countries leaders are often drawn from certain families (which are, presumably, half female). Hillary Clinton's rise was only possible from her position in the Clinton family, and Pelosi too is politically well-connected. Just like female rule in those countries, the rise of female politicians here is more a dynastic victory than a feminist one (just like how Queens Elizabeth and Hatshepsut didn't really advance women causes either). People like Merkel, Thatcher, and Mayawati seem like better signs of social progress. But it's also seems easier for women to run in Parliamentary systems rather than in a more direct democracy system. With a Parliament system, you can become a great advocate for your party's views, making you as valuable as any other person, with the added benefits of tokenism. When you're running for election among real people, you also have to deal with certain stereotypes. Successful female candidates always seem to behave hyper-masculinely (Clinton, Thatcher, M from Bond) or very nurturing and non-threatening (Palin, Sheila Dixit), but they have the advantage that it's harder to attack them without looking bad. Widespread acceptance of female leaders is going to take a bit.

I suspect that as China goes democratic, it will also follow a one-party democracy. Running political operations in all Chinese states is very expensive, so a single party can take advantage of economies of scale. Meanwhile, there is a relative population homogeneity and relative policy consensus. Most political disagreements center on personality differences between rival power cliques, which currently takes place behind closed doors but could easily be democratically decided. The government is very popular and would easily win elections; popular pressures already determine much of state policy. The big difference might be on foreign policy, in which a democratically elected government would be constrained into acting more hawkish on a world stage to save face domestically. Economic policy would also probably become more distorted through the influence of rent-seeking interest groups. On the plus side, voting out incumbents is a great way to let of political steam. Right now this is taken care of by the occasional execution or firing of the designated fall-guys, but if conditions are bad enough you want the guy at the top to change too.

Wednesday, December 10, 2008

South Asian International Relations

Two thoughts:

1.  There are not nearly enough Indian realists.  V.S. Naipaul's biographer and the National Interest are two good examples, but generally people respond with either a "invade Pakistan" or "as always, Hindu nationalists are to blame" perspective, neither of which are entirely valid.  Is it too much to ask for a government which can coherently formulate national goals, and execute them with a minimum of fuss?  Apparently it is, so you have a government which is both incapable of fixing national security or intelligence, and also lashes out at Pakistan in unproductive ways.  

2.  Am I the only one disappointed at Obama's foreign policy policies on South Asia so far?  He talked about publicly declaring strikes against Pakistan, which John McCain rightly criticized as leaving Pakistan no option but confronting you.  Obama had to establish enough of a warlike posture at the time (given his policy on negotiating with Iran) so I can overlook that.  But now there are all these thoughts coming out about how Obama wants to appoint an envoy to "fix" the Kashmir problem.  Daniel Larson and Reihan both point out how this isn't a terribly feasible option, and can be pretty counterproductive.  We'll see how this fusion of realism/liberal interventionism philosophy goes, but my suspicion is that it breaks down in the next crisis.

Monday, December 1, 2008

Mumbai Terror

Kristol points at this piece by Martha Nussbaum, which discusses all sorts of acts of terrorism except the one that prompted the piece.  It's almost as if the academics are not disinterested scholars, but ideologues with big axes to grind.  I really lose more and more respect for these sorts of academics the more I read the things they write.  This Slate piece is also fairly inane.  

In contrast, the Indian media has pretty good reporting (especially of government failures, which were many), while the Economist has been excellent.  The always valuable Asia Times Online has a great article on the attacks.  Read the whole thing, as they say, which shows (if true) how the attacks were planned out of Pakistan, aided by rogue ISI officials, and executed by the LeT, with Al-Qaeda involvement.  Of course the Indian Embassy in Afghanistan was also attacked with Pakistani assistance.  The civilian government appears to have little control over the actions of their intelligence agencies.  

One of the reasons this makes a lot of strategic sense for Pakistan's military is that cross-border tensions will expand the need for their traditional mission--mass troops against the border with India--and reduce the urge to attack terrorism near Afghanistan.  A really interesting response--not that it's going to happen--would be for India to deploy troops to Afghanistan where NATO won't go and continue to implicitly support separatist movements in Pakistan.  Pakistan has plenty to fear from asymmetrical warfare too.  This bears costs of its own, but India has a pretty solid track record in post-conflict stablization (and has the troops to do it with).  That would squeeze Pakistan pretty badly, and that's exactly why it makes for a great barganing chip in any Kashmir discussion.  

Thursday, November 27, 2008

We're All Keynesians Again

The whole point of Friedman and Schwarts' book was to blame the Great Depression on poor monetary management by the Federal Reserve.  Free markets work, without crisis, if only the government can not ruin everything.

Well, it looks like the pair provided necessary, rather than sufficient, conditions for avoiding the chaos resulting from massive deleveraging.  Substantial losses in asset values destroyed bank balances leading to a crisis in solvency, and a consequent loss in financial sector trust.  We don't have the liquidity problems that were present in the Depression--the Fed got that right this time--but it looks like the problems in both time periods are related to all sorts of other stuff.  As consumers get out of debt, they decide they want to retire with something, and stop spending, and then the economy crashes.  

This is a straightforward Keynesian stimulus that shouldn't be necessary anymore.  Cowen makes the argument that a fiscal expansion didn't help in the last Depression, but that's because FDR hampered his own stimulus with higher taxes.  I think it's hard to get away from the stimulus plans of Krugman and Larry "never saw a stimulas plan he didn't like" Summers.  

Wednesday, November 26, 2008

Send in Rainbow Six

Looks like my grandfather could be right in predicting that the Mumbai terrorists came from Pakistan via boats.  This was a pretty sophisticated attack, in line with LeT's growing reach.  The stated goal was to scuttle peace talks, but there's another pretty clear goal in terms of the coming elections in six states, most of which are a close BJP-Congress lineup.  The worst impact could be in Delhi, where, despite the fact that Sheila Dixit is surprisingly popular and competent, the UPA government has managed to both suffer a string of attacks and damage their Muslim base through suspicious police shootouts.  I think it's tough to imagine this going any other way than seeing the BJP back in office, with Advani as PM and Modi on his heels with a vision of a much more muscular Hindutva agenda.  Hopefully as they stay in power, they become captured by national interests and moderate a bit away from the Sangh Parivar in favor of a broader, conservative agenda that can actually capture half the national vote on a regular basis.  They dropped swadeshi easily enough; hopefully they can go from anti-Muslim to anti-Pakistan or anti-terrorism.  Otherwise there will be more terrorist attacks to come, and not all of them from abroad.  

India will survive.  Meanwhile, the idea of Pakistan is making less and less sense.  There is essentially a Punjabi core and a series of lawless, politically mobilized frontier areas.  Shaukat Aziz, a former Citi executive, did a great job at Finance Minister, but Pakistan has seen growth surges before, and this one looks to be ending the same as the previous ones with institutional collapse (though the lawyers' revolt was surprising and a testament to growing bourgeois sentiment).  They look to be in a serious financial crisis too (who isn't?) while the military state is keeping much of the mess together, and will probably intervene again sooner or later.  As Kaplan points out, Afghanistan and Pakistan are increasingly linked, and Obama has decided to double down in this part of the world.  

Tuesday, November 25, 2008

The State of Value Investing

I've written some stuff on why value investing isn't maybe the best thing in the world, and how Berkshire's S&P 500 equity puts are threatening the company. Felix Salmon makes a really obvious point I wish I thought up about these contracts. The idea is that money is worth different amounts in different periods of time, so by taking the tail risk that things go really bad, Berkshire faces an extraordinary loss: Things go really bad, and Berkshire has to pay out on the contract. And the probability of things going really bad is tough to tell from past data.

This is indicative of a broader issue with Berkshire and value investing. Berkshire the business specializes in taking exactly these sorts of extreme catastrophic risks. Value investing in general specializes in exactly those companies which go under in times of extreme stress. Value stocks do bad in a crisis, and this fact pushes up the premium for these stocks in good times (who wants to own something that is worth so much less exactly when you need money?). Only when there's a crisis do you see--as you do now with United Health, the rail companies, GE, American Express--how bad things can get.

This can still be a smart bet to make. Thomas Sargent has some interesting Bayesian calculations in which different actors share risk. Normal people trade away risk, while other agents take these risks and make out like bandits in good states. But it's a bet that makes use of a broader story: Stock markets are as close to information-efficient as you like, and the whole story of day-to-day fluctuations is driven by differing risk premia. It's very very difficult to make money picking and choosing stocks (More on this later...), but there is a role for smart managers to pick up different sets of risk exposure. In some extreme sense, there is no other way to make sense of investing.

Monday, November 24, 2008

The Coming Credit Failure of the US Government

The big news today is the plan to bail out Citigroup by the FDIC and Treasury. You can read all about this elsewhere. There are some broader points, though, which I haven't seen too much discussion.

There's a big question in my mind why the Citiempire went down to begin with. It's pretty easy to see why Bear Sterns and Lehman fell. Both were borrowing short to lend long with a great deal of leverage, so their entire business model depends on trust. With the stock market as a barometer of that, their tangible value starts being a function of the stock value, and when the stock goes down, people have less trust, so the stock is worth less, and so on. Morgan Stanley and Goldman Sachs avoided these problems by becoming associated with bank deposits which lowered the counterparty risk of dealing with these companies.

AIG's bust is pretty straightforward as well--bad risk managment related to CDOs and credit default swaps caused counterparties to demand huge payments as collateral, which AIG could not provide. Buffett's Berkshire is currently going through similar problems related to their investments in long-long term S&P index puts (who are the buyers?), for which Goldman apparently wants some collateral, and also concerns of losing investment-grade ratings for debt.

Citigroup is a tougher case. On the face of it, they have healthy free cash flows (not as nice as say Banco Santander's, but better than WaMu). Sure, many of their assets are toxic, and it's tough to figure out which ones are, but they certainly have the cash to handle day-to-day transactions in ways the Investment Banks could not. Insured deposits and lines of credit with the Fed give it a much stronger lifeline. Somehow, the crisis in confidence was enough to sink the company.

Brad DeLong's explanation is the best I've heard. Bad distributions on risk models, exploding risk premiums, and general bank concerns sank the company.

(One thing to keep in mind about bad risk modeling is state dependency. That is, money isn't worth as much in different states of the world (which is why no one will buy insurance against nuclear winter). Ideally, this would be a reason for banks to make sure they have enough to survive in times of crisis--as with Rajan's proposal of financial crisis insurance. That proposal is a pretty clever way of making sure banks have capital in times of need, without needing to tie up cash in boom times when agency problems (ie, Chuck Prince) are pushing to make quick cash with that money. Plenty of people call for more regulation in financial markets, seeing it as the same sort of quantity-based good as infrastructure or oil. Banks are very, very good at regulatory arbitrage and regulatory capture, so short of China or India style regulation, there will still be bank crises, and the more interesting stuff is how to design institutions which are incentive-compatible between regulators and banks.)

So it's tough to detail exactly what's wrong with Citibank. The general problem common to all the minor problems, however, relates to the basic structure of the company. Citi was conceived as a "global universal bank" where you go for all banking needs. The critics said that this would lead to all sorts of sprawl and size issues, and they were right. Citi was incapable of judging or handling risks, insulated by the notion that it was a "safe, big" bank. Pandit has tried to keep the broader model alive, but the collapse of his old Hedge Fund under Citi's care shows that it's difficult to integrate many business segments with different risk appetites under one roof. There's a lot of pressure now to sell off Citi into manageable pieces. This is a problem for Citi and also those "Citi-clones"--UBS maybe, perhaps even JPMorgan. Internationally, you have banks like ICICI. Some of these are really too big to fail, and are maybe even solvent. But they face severe management problems.

But whatever the problems with any of the too big to fail banks, the Treasury can print out enough money to keep them afloat longer. How much longer can they keep doing that? With long-term entitlements and debt spending up to tens of trillions, huge deficits and stimulus plans pushing those further, more and more bank guarantees and bailouts, how much longer can the government keep up their credit rating? Right now, they benefit from the flight to safety. Eventually, this will stop, as will continued purchases of Treasuries by foreign governments. Facing higher costs of capital would destroy the financing capacity of the Federal Government to be the ultimate IMF for the American economy, bail out firms, and would crimp monetary and fiscal tools to combat recessions. On top of all the other problems in ensuring normal governance with expensive rather than cheap debt.

Wednesday, November 19, 2008


For what it's worth, I tried one of those websites that gives a psychological profile from your blog, which coincides with my type from elsewhere.  Normally I would say this sort of thing is worthless, but if it returns the same score from different methods at least it's consistent.

Monday, November 17, 2008

The Death of Value Investing and Buy-And-Hold

Two strategies for dealing with investing that have held up over time are value investing and buying and holding.  Value Investors--exemplified by Buffett--buy things that are cheap and high quality (what is everyone else doing?), while the buy-and-hold people say it's useless to time the market or pick winners, and just buy some of everything whenever they can.  

Value Investing has a decent historical track record.  Cheap companies (many ways to measure this, just say their profits are large compared to the market valuation) do tend to perform well over time relative to the universe of picks.  The value mavens, and the field is growing, chalk this up to impatient markets.  

But the world of cheap stocks is cheap for a reason.  These companies are characterized by high leverage, are often cyclical, and have a high probability of going bankrupt.  Buying these companies is equivalent to taking on the risk that the entire economy won't crash, things will get better, and liquidity will flow again.  Which is completely fine; it's just that this risk premia delivers results exactly because of the low probability--perhaps even a probability so low you can't find it in historical data--that things may get really, really bad.  

I think we just saw one of those events.  If you look back at the track record of the value guys, they bought up cheap stuff earlier this decade and wound up doing pretty well.  That makes sense; the economy was in trouble some time ago, but liquidity, rising asset prices, and continued consumer spending propped up the levered, discretionary (cheap) portions of the market.  Then things crashed.  And then the value guys, if anything, were burned worse than most.  They mostly never saw how bad things could get--when your mindset is shaped by the Great Moderation and you think long-term, it's hard to--and so were pitching finance stocks, real estate, construction, even airlines, the whole way down.  It seems likely to me that, rather than being compensated for picking companies that were "psychologically" out of favor, value investors were instead compensated for bearing a "value" risk that paid off during the liquidity boom and hit a "black swan" as that funding died off and the risk embedded in low prices became evident.  

This is a very broad picture and doesn't capture everyone.  If Buffett read financial papers, he would no doubt refer to Piotroski's great paper, which shows that it's possible to discriminate between cheap stocks to find the ones with high quality.  He'd then argue that this the quality comonent matters as much as the cheap part.  I don't have much to say against that; the part of the paper I found most interesting was that within the class of poorly covered companies there are a few gems.  Still, with Buffett down as much as he is (and coming back through deals only he could get) the presence of accounting "quality" seems to cut out exactly when you need it.  

So maybe on a risk-adjusted basis, you can still find some good bargains.  Suppose that you can't.  What's the optimal strategy?  Many people resort to some sort of "buy and hold" idea, based on the historical trend that stocks go up about 10% a year.  Again, as with value investing, you have the problem that though there's a wealth of historical data, your true sample size is something much smaller because shifts in a few macroeconomic variables explain a lot of the changes in overall stock performance (and those variables are very historically contingent on all sorts of things).  Do we expect stocks to grow to infinity?  If the true risk-adjusted interest rate was really large, then a family could simply keep putting money away and grow arbitrarily rich.  Maybe this works for a few people but definitely not everybody.  Presumably embedded global political and economic risks crash wealth to zero every now and then.  Russian, Chinese, and German bonds were very popular about a century ago.  This is another way of saying that the equity premium, measuring the overperfomance of stocks relative to other investments, reflects actual risk which comes out at inopportune times.  

Another approach--interestingly, lining up with what Buffett has long said--is that stocks are like bonds.  That is, their returns are not distributed randomly, but can instead be reasonably predicted considering something like their dividends and price, much like how bonds are priced given their yield.  This makes sense from both a fundamental view--stocks are claims on the profits of a company--and an asset pricing view--the premium that investors are willing to pay for risk depends on broader circumstances.  Cochrane uses this to make the point that price volatility is not that big of a deal.  Another point is that--just as you don't go out and buy "bonds" regardless of the interest rate--you would do better to buy or sell in varying amounts depending on how cheap markets are overall.  Yeah, this is a lot similar to the value investing world.  But there are a few differences--one, you pick entire industries (or the market as a whole), not individual stocks.  Also, you don't depend on psychology for your returns, but rather on understanding risk premia at different times, for different asset classes.  You don't buy and hold "forever," but look at implied yield rates.

Here's what that would look like.  You take some stock of capital and divide it up into different asset types ("things"--real estate, commodities, materials, bonds--international equities by market cap, etc.) and you cycle money in and out of these asset types by judging aggregate valuation levels.  So you would have bought all sorts of equities (many emerging and small) several years ago, then commodities sometime in the last few years, then you would have shorted real estate, then equities (especially foreign), then commodites.  Any analysis you can do helps you make decisions.  Within asset types, you move out of expensive into cheap.  For all asset types, you buy quality.  Risk management is important; you hedge risks, including risks that assets start to move together, and volatility risk (out of the money puts).  

I realize I've just replicated a "hedge fund" but hopefully not all of them behave this way.  For one, a disturbingly large number of them turn out to be not that much into shorts.  The broader idea is that you don't claim any ability to "pick stocks," but rather you exploit different risk premia across different asset classes in a consistent manner.  As far as the individual asset components go, we may be in a world where the prices of many assets starts to link.  But even if you're playing only with one asset, timing long-short opportunities and remaining in quality should help you out.  

I'd have to backtest this with a more systematic approach.  May or may not "beat the market" but should get some returns while being explicit about the risk.  

I don't know why I'm so stupid as to write up every potentially profitable idea I have.  Hopefully no one reads this.  

Sunday, November 16, 2008

Teaching English

High Schools need to teach people few skills.  Give them some degree of numeracy, and teach people how to write.  Math is handled through subfields--Geometry, Algebra, Trigometry--which are fairly well divorced from the quantitative demands of a modern workplace.  Simple estimation, problem solving, data analysis, and computer skills (programming, modeling) seem much more important today, but are generally not taught.  

Writing is handled pretty poorly too.  Many people are very bad at this, even after spending as much as an eight of their total school career in English classes.  How does that happen?

Obviously it's going to be hard to teach people no matter what--especially as they get older, and given the poor quality of American teachers and the state of our knowledge of how people learn.  One thing that doesn't help is conflating "teach people how to write" with "teach people how to analyze literature." 

I've been trying to figure out why we spend thousands of hours on getting kids to understand Shakespeare, when teaching them to write and edit simple prose is so much more useful and also highly underprovided.  As far as I can figure out, this started on the University level in the late 19th century, as the German research model took over.  The justification for keeping disciplines became entirely dependent on research output, so English became a "science" just like any other, focused on textual analysis.  High Schools looked to Colleges for inspiration, and parents figured that as long as kids were reading and writing, they were doing well.  Plus you to satisfy that vague feeling that kids should read some English literature at some point for culture's sake.  

But this English racket doesn't make any sense.  Teaching writing primarily through the lens of literary criticism encourages a particular obscurantic style of writing and focuses on questionable methods of literary analysis at the expense of building basic skills.  If you go around online, you'll find many English teachers frustrated that they can't convey their love of literature to kids.  Tough.  None of them seem to question the whole notion of reading centuries old English literature to teach writing.  Fire the whole lot of them, kill the union, and hire the direct instruction people to improve the writing quality of high schoolers by a few standard deviations.  

Lies my Teacher Told Me

I was always told that getting a liberal arts degree would pay off in the long run in both psychic and monetary rewards.  Who knows about the psychic/intellectual rewards.  But I've always been skeptical about the monetary rewards.  Most data that's available shows that the quant fields--math, finance, econ--do much better than the soft disciplines for the first job (some of the skills premium for postgraduates was probably mispriced because of asset bubbles, excessive leverage, and poor risk models on the finance side--more on this later).  Again, the liberal arts partisans claim that this is unique to your first job, and that the liberal arts majors dominate over time.  This would actually be somewhat odd to see, as most people receive a similar, small annual increase every year regardless of major.  

Well, this is easy enough to check.  The government collects stats on the profile of around 8k graduates 10 years out of graduation.  As the chart shows, the math/quant/sciences dominate the liberal arts guys income-wise.   

Some weird stuff does happen in the distribution of income separated by major, shown left.  Engineers aren't as well represented as you might think at the top bracket given their high mean.  But the social and biological scientists dominate the humanities.  Psychology does abysmally, trailing even Education with .31% claiming an income in excess of $150,000 (2003 Dollars).  At the very least, this is good evidence that the liberal arts are not a great path to riches.  

The better question is whether this reflects knowledge learned in school, or whether majors serve to filter students along measures of intelligence and career preference.  Unfortunately, I can't correct for all potential problems as they don't release the full data, but I can look at some things anyway.  

First-I checked SAT/ACT grade variation by gender.  There's not too much resolution--I only have scored by quartiles, and many are missing---but this data would suggest a higher mean score for males as well as lower variance.  However, this group has already been preselected, so data at the bottom tail is unlikely to be perfectly representative.  Interestingly, this pattern is reversed for GPA: Females dominate the top end of GPA.  However, GPA is not as directly comparable between people, especially given the stark differnences in major choices by gender, and the differences in average GPA by major. Interestingly, given this difference, undergraduate GPA and test scores correlate.  The top quartile on the SAT/ACT had a 3.45 while the bottom received a 3.13. 

I also have SAT/ACT quartile by College Major.  Business majors don't do so great on standardized tests, but obviously make plenty of money.  The quant majors disproportionately pull in the top scorers.  But the Humanities, History, and Psychology do well enough test-wise.  But given another result from this data--that SAT/ACT predicts future income--it's clear that the liberal arts are underperformers in future earnings, taking intellectual ability before College into account.  

This isn't entirely definitive, and I'd like to run some real regressions here.  A big issue is personal preference for career--how much you make is a function of how much you want to work, and what you want to do as much as raw ability before or after College.  And obviously, there's more to college than becoming employable.  I really don't even know how much I could say from this data.  It's not clear what is contribution of a major to earnings outside of personal initiative and intellgience, or even to what degree College gives people skills or labels people as belong to various levels of quality.

Thursday, November 6, 2008

Real America

Here's a county level map of presidential voting in 2004:

Here's a similar map for this election:

Not that much changed, though Obama made incremental progress in many places. Here, however, is where McCain did better than Republicans in 2004. Arizona and Alaska make sense, and of course southern Lousiana lost a lot of black Democrats. But McCain made his pickups almost exclusively in a particular geography--the upland south.

This is a rough breakdown of that region. It's a pretty distinctive part of the South. Slavery was never big here; there is virtually a total complement between this and the following graph.

The share of African-Americans.

Similarly, this is also where Bill Clinton won his votes in the Democrat primary (purple is where he won > 65% of the vote). Hillary Clinton did very well here in those areas as well.

This gets at ethnic breakdown in this area. This is be a bit hard to read, but basically the plurality ethnic group reported to the census here is "American"--these people are Scotch-Irish who predominately identify by nationality. The regions where such groups are numerous map very strongly to those places where McCain/Palin grew the Republican vote share. Household incomes tend to be fairly low, with some of the biggest pockets of isolated poverty anywhere in the country.

Presumably this reflects the impact of adding Palin to the ticket. You have cultural identification by "real Americans," a strong evangelical turnout, and racism, though I suspect Condoleezza Rice or Colin Powell would do well here. Further South, record turnout of black voters pushed Obama's share upwards, while further North, social conservatism, broadly, is a smaller force.

This illustrates the point that the South is both "larger" and "smaller" than people think. The Deep South plantation economy was restricted to the far southern geographies where that was economically viable, while broader southern culture is shared by a larger community of Scotch-Irish that stretches into Ohio and Pennsylvania.

Politically, it doesn't seem to make a lot of sense in retrospect for Republicans to double down on this demographic. One of the post-election quotes from MN governor Pawlenty caught my attention. The original Sam's Club Republican was caught saying that his party needs to focus on attracting women, Hispanics, blacks, and young people. Well. What demographics was your party targeting to begin with?

The young vote doesn't bode well for them, as young people these days are fairly liberal on a range of economic and social issues. Some of this will obviously fade away over time, but the social liberal bit will probably stay; roughly, every generation moves out a step more liberal than the previous one and stays there. The cost of catering to the real Americans is felt in the plummeting support Republicans see among young voters, minority voters, and the educated. Obviously, these groups are pretty large and growing, while whole communities of Rockefeller Republicans are going extinct. The electoral benefits are pretty slim, as the bordering states were Republican anyway. The Republicans faced a very bad fundamental position and were probably going to lose barring some crisis. But McCain's decision to head even further right after winning the Republican nomination, target this crowd through a VP pick, and then run a campaign centered on inconsequential right-wing dogma points and attack ads did little to endear him to the broad swaths of American independents who swing randomly from party to party, and for whom McCain is actually fairly popular. It's enough to make you nostalgic for some Rovian tactics. At least he realized that you need more than half of the population to win, even if hubris over statistically dubious "political realignments" did them in.

Wednesday, November 5, 2008

Why Would You Want This Job?

Those of you who pall around universities are no doubt aware of the insanities of getting a job. Few people really know what they want to do, and so end up following whatever career bubble is big at the moment. Of course, the econ majors look at all sorts of highly unpleasant jobs with mediocre hourly wage. Private Equity is a big job opportunity here, and I think the following quote is priceless:

First Year #1: "Did you hear about the [big foreign bank] presentation yesterday?"
First Year #2: "No."
First Year #1: "This managing director is up in front of the podium answering a question about work-life b
alance someone asked, the junior guys are sitting in chairs on the stage behind him. Fifteen, maybe twenty seconds after the question one of the junior guys literally passes out and falls out of his chair onto the stage. They called the paramedics and everything. It was crazy."
First Year #2: "Is h
e ok?"
First Year #1: "Fine, apparently. Exhaustion. Just got off the plane from London, no sleep for a week because of a deal he was working. Right after the man
aging director just talked about how great the work-life balance is."
First Year #2: "They have a London office? Are they hiring for the Londo
n office?"

I wonder about this in the context of politics sometimes. The benefits of entering politics are obvious; Brooks has some good pieces on the massive ego involved. But, especially today, the costs are also apparent and sometimes you have to wonder why anyone would ever want to deal with certain problems.

Consider the problems facing the US Government. For one, the public debt has topped $10 trillion with no end in sight. This is not quite so horrible compared to other countries, but pretty bad nonetheless. This will be an enormous problem looking forward, as expenditures are headed steady upwards and revenues are so-so.
A huge problem that's going to hit the Obama Administration is something I've worked on a bit in my day job--the upcoming failure of Option ARM loans. These were really some of the worst structured products developed lately; the premise being that you can pay less than a normal loan balance because house prices only go up. Seriously. These people are going to wake up in 2010-2011 with loans resetting, balances well in excess of housing prices at the absolute bottom, and they're going to walk away from their homes in droves.

Below is a picture of the federal budget, and you can really see the impact of GWOT and the sprawling DHS on government spending on the defense side. Obama will most probably find it difficult to meaningfully cut this issue. He's stated that he'd like to add more soldiers, and the Democrat measure of doubling down in Afghanistan will probably be expensive as well, as that country is dying. Some sort of political compromise with the Taliban would probably be cheapest, but would also be hard to sell. It's almost certain that another crisis will emerge in the next four years;
Iran failing, further problems in Iraq (which, really, the US can't reasonably abandon responsibility for), Afghanistan, or ongoing problems in tribal Pakistan. One of the biggest issues with military spending is the unofficial agreement of military branches to split spending in equal ratios among the Air Force, Army, and Navy. This is horrible for all sorts of reasons, as the demands on the Army have never been higher, while there are really no peer competitors against the US Navy or Air Force. It's unlikely that we're going to see another Bill Clinton-style peace dividend.

The cost of health care is also expanding at insane rates. Of course, there are all sorts of great consequences of better health care. But the marginal dollar spent on health care has very little value added. Spending on healthcare varies dramatically around the country, and it's not clear that these variations explain different health outcomes. And, of course, health and lifestyle issues are more important to health than medicine. Doctors are essentially handing out different treatments for the same conditions with little concern for cost or efficiency. The evidence-based medicine movement sounds great, but will probably have little actual impact on lowering costs.

The rising cost of healthcare is leading to one of America's two entitlement problems; the exploding cost of Medicare/Medicaid. Obviously projecting straight-line out might not be the most reasonable estimate, but the government will have to take up more and more of the slack as private and employer insurance markets unravel. These programs alone are tens of trillions in unfunded liabilities; add to that several tens of trillions more for Social Security.

There are really two big ways of restraining health costs--consumer choice (as in Singapore) or government rationing, and Obama has really failed to endorse either. You can read this endorsal of Obama's health care plan, which does have some things going for it. But to imagine that a "technological revolution," or paying for results (which they do in Britain, if I'm not wrong, with the result that doctors game the system) will do anything about the trajectory of health care costs is silly. All sorts of health care systems work in other countries, but the likely path of American health care will likely follow Massachussets--a greater role for the state, more penalties on employers for not providing coverage, and higher costs. Maybe this is about what we should be doing; I just don't want to be the one to figure out how to pay for it. Payroll taxes to pay for social security and health spending is probably the worst way I could imagine to do so.

It's also shaping up how that fleecing the rich bit isn't a great response. It's unlikely to happen soon anyway, the country being in recession and all. But as the Federal Government depends largely on rich people for funding (and especially, post-2003 or so, on capital gains taxes), you have much less revenue when the ranks of the richest are decimated.

So there are long-term and short-term problems. The long-term ones are more severe, but America is perhaps better placed to deal with them than other countries. A culture of entrepreneurship, relatively free markets, etc etc all boost America's productivity with respect to zombie countries like Japan or Italy, which are looking at large swaths of industry which are globally uncompetitive, massive debts, large government involvement in the economy, and of course that looming demographic death spiral combined with xenophobia towards the immigrants that could otherwise save their economy.

The short-term really depends on events in the next four years. In one scenario, the economy dips, but recovers in time for Obama to be hailed as a Democratic tonic to the failed Bush-Kirk policies. In the other, things continue to get worse globally, finance takes its time coming back, and the recovery in the rest of the economy becomes jobless. The cost of foreign crises and domestic bailouts both wrecks the economy while derailing Obama's broader domestic agenda, which was basically premised on the notion that the big thing wrong with the economy was the excessive share of income going to the rich. Another energy crisis is also possible; is there really that much more oil production now than six months ago? Housing remains shot while the option ARM folks default as well.

What can the Federal Reserve possibly do? Interest rates are going to remain low for some time. Boosting the money supply--at a time when there is plenty of money waiting on the sidelines--will encourage further speculative bubbles and lead to an eventual crisis in inflation that can really only be solved by Vockler-style massive rate increases. The impact of interest rates in the upper teens will be not be good on a highly indebted consumer base suffering a bad recessing following a so-so decade, and even if this happens on more of the "upswing" portion of the recession. The European consumer base was never that strong, and at some point American consumers are going to have to start saving if they want to enjoy their (longer and longer) retirements. Where will the recovery come from? Of course, Chinese consumers appear to be using some of that cash they've been saving, and the government there also has plenty of cash, though there's plenty of pessimism in that part of the world too. But much of any sort of surplus sales there generate will presumably flow to corporate profits. After all, the factories are all there; excess rents will just be repatriated as manager compensation. Other emerging markets are facing all sorts of currency and sovereign debt crises, while the commodity producers aren't doing too great.

And once we purge the bubbles out of our system, what sort of "real" substantive employment is going to take place? Who could possibly be hiring in three to four years? Much of the job growth in the last eight years--such as it was--was driven by construction (real estate bubble) or finance (real estate and stock bubble). Of course, infrastructure and alternative energy are always mentioned. I suspect they will turn out to be new government boondoggles that further destroy the budget. William Bernstein makes the point that there's no real economic law that says that technology needs to improve jobs. After cars made horses obsolete, they died off by the millions. It's hard to guagethe demand for American unskilled labor the future, but it's hard to imagine a scenario in which it goes up that much; so presumably that whole sector of the country will kind of stagnate, clinging to their guns and so forth.

Again, a lot of this depends on timing. Best case scenario for Obama: Things start improving by the time 2012 rolls around. That really is a long time; it was hard in the 2002 recession or 1992 bust to think of things improving, but of course they did, because the fundamentals of the American economy were, and are, strong. Of course, neither of those times during a period of global problems and credit issues. But if things don't start to get better, I expect to see ads about the Obama-Kirk economy pull in a wave of populist, social conservatives into office.

Tuesday, November 4, 2008

The Great Depression and Now

There's an interesting pair of articles out there looking at the source of the Great Depression.  The usual Friedman story is that the Federal Reserve cut liquidity at a time when they should have raised the money supply, leading to a wave of bank crashes and other effects.  This interpretation is central to Bernanke's current handling of the crisis. (even though Anna Schwartz, Friedman's collaborator, sees the current crisis as coming from solvency problems, rather than liquidity.  John Cochrane, as well as the rest of the Chicago GSB, would probably agree with that assessment, and have been against the Treasury bailout plan for that reason.)  

The argument goes that long-term trends that improved corporate profits at the expense of consumption led to a structural crisis devastating the economy.  Corporate profits, in the face of weak consumer demand, was then fueled into speculative activities such as the stock market.  The stock collapse was made worse by these firms pulling out their investments, and long-term recovery was fueled by the gradual expansion of consumer demand through government supported efforts.  

The recourse to "shares" of income doesn't appear very causally important, as it ought to be the levels of consumption and corporate profits that matter, rather than their relative ratio--though it may be useful as a marker for those constituent changes.  But leaving aside the explanatory power of the consumption and corporate profit story with respect to the Great Depression, it doesn't seem like a great way to explain today's problems.  

One reason is that it misses consumer holdings of assets.  Many people before the Depression of course held stocks, and the collapse in asset value spurred additional saving.  Similar things are happening now, as consumers smoothed their consumption by relying on the increase in their home value (and stocks, to a lesser extent) to finance additional spending.  The drop in home and stock values are going to reverse the massive indebtedness of the average American household, and the resulting drop in spending will make it much harder to come out of the recession.   Certainly the share of corporate profits (in retrospect, inflated due to asset bubbles and leverage) to consumption has been rising.  But household consumption has also done well lately--the problem in fact being that consumption was too high, fueled by debt collateralized over overpriced assets.  

It's not clear either that stocks were overpriced because corporations faced weak consumer demand and instead blew profits on speculative investments.  Some may have, but by and large it appears that thrifty corporations saved cash, while consumers splurged.  

The broader picture, however, of weak consumer demand, and corporate profits chasing speculative investments with low rates of return do seem to be present in various Asian countries.  As James Surowiecki notes, the enduring cheapness of Japanese stocks is fueled by the depth of the fall from overpriced asset values in the 1980s, thrifty Japanese consumers, and bad corporations.  Return on equity is notoriously low in Japan, as companies rely on cheap debt funneled from sister companies to make value-destructive investment decisions.  It's really becoming apparent that Japanese corporate structure is not really capitalist (as someone pointed out, it's the only Communist country that has worked) but rather works to maximize the interests of corporate insiders.  

Another place where you are seeing something of this pattern play out is China.  Krugman some time ago was skeptical of the productivity of the Chinese economy, claiming that it was instead fueled through expanding inputs.  Since then, it's clear that labor productivity has played at least some role, but recently the picture is more mixed.  Consumption remains low as a portion of GDP; the bulk instead goes towards investment or (much smaller) exports.  A powerful case has been made that the Chinese economy is becoming less capitalist, rather than more.  

The argument goes that Chinese growth in the last few decades was dominated by small-medium enterprises, many of them local.  Growth recently has been capital intensive, and dominated by state-owned enterprises.  The banking system is filled by bad loans and provides easy credit to flailing politically-connected firms.  The most salient consequence is the wholescale devastation of the landscape from Beijing to Shanghai--commissar command of the economy results in undervaluing natural resources, which are cheaply converted as inputs.  Energy and water efficiency are horribly low, even comparative lto other countries.  

Speculative investments have also dominated the landscape.  Real estate was valued highly, as was the stock market.  Company investment in equities resulted in vicious circles (my company's value depends on the earnings of other companies, who are also invested in my company's stock...).  So large part of the recent boom is probably fictional, a relic of the hunger of state-owned-enterprise for overinvestment and speculation.  The image of capital investment--skyscrapers, factories--is impressive, but really not as relevant from a capitalist point of view as the return on investment.  Now, it turns out that a lot of this investment is worth less, while of course much of the export-oriented facilities is endangered.  Shifting to more domestic consumption is the obvious next step, and that's presumably the way things are going to head.  

It's hard to imagine the political consequences of necessary adjustments.  Everyone says "growth down into the single digits," but one hedge fund guy I've talked to expects a falling economy.  The long-term growth potential is clear, but recent and future growth is looking much more tenuous.  This is obviously a problem, given the lack of ways of political expression.  The Tibet riots came out of nowhere; doubtless others are mad about the falling stock market, health safety failures, a collapsing housing market, and looming economic issues.