Monday, September 29, 2008

Things I Was Wrong About

To be honest, I never really expected a financial meltdown of this scale.  Sure, the housing meltdown was inevitable and subprime losses were particularly bad.  But I never envisioned that amplification effects could magnify asset losses through catastrophic deleveraging.  At this point, there have been problems in virtually every sector in finance--from real estate based paper to derivatives, brokerage firms, insurance, interbank lending, corporate lending, money markets.  The next wave will presumably come from hedge fund and private equity withdrawals.  These problems have spread far beyond Wall Street.  Decoupling is dead, as every major economic zone is facing worse conditions.  The Baltic Exchange Dry Index, a measure of shipping, is considerably down.  

The legacy of letting Lehman die is pretty mixed.  As the WSJ reports, Lehman's demise really kicked off the cash crunch.  (By the way, has anyone else noticed that they redesigned the site and are ungating more of their content?  If this is Murdoch's doing, I'm all for him.)  The fact that money market funds owned Lehman bonds contributed to their drop in Net Asset Value below par--kicking in redemptions and a Federal bailout.  Still, while it doesn't look like people took events that seriously after Bear Sterns--including Lehman, which was tardy in finding a buyer--Lehman's fall was enough to ensure a round of bank consolidations and recapitalization.  

And, of course, we are not at a bottom, though I did pick up quite a bit of stuff right around the short-term bottom that we saw.  It'd like to imagine that absent Congress not approving the bailout, we would have seen the worst, but I'm no counterfactual historian.  In any case, trying to time or predict macro events in the economy is as hard as predicting the weather.  No one worries about selling at the exact highest price, so why worry about that when buying?

All that said, I remain optimistic--cautiously exuberant, if you will--about the future.  The "fundamentals" of economic strength are doing well; growth in BRIC and frontier markets is going on a breakneck pace, developed countries remain filled with capital and educated workers, and global flows in capital and ideas remain fluid.  Meanwhile, equities have seen something like an eight year price slump combined with a third-off haircut.  It's always the end of the world when you're facing the full brunt of the crisis, and it's those people who are able to stomach buying into panic that make out like bandits.  


I really hate House Republicans. I had the WSJ page open, where it had the headline "Dow Crashes 600 as Bailout fails." A few minutes later I click refresh. Everything is the same, except it now says "700."

Sunday, September 28, 2008


It's sad to hear things like this; that the financial crisis is cutting jobs and educated foreign people are finding it hard to stay in America due to work requirements. It should be obvious that a skill-based system like the ones Britain and Canada have, rather than a work and family run system, makes the most sense. I'm surprised you don't see more liberals argue for such a policy, as it reduces inequality (having more elites drives down the fees they charge) while improving efficiency and equity.

I'm for all sorts of immigration, but you do have to wonder about the long-run impact of tacitly allowing large-scale immigration of relatively poorly educated Hispanics. It's in their best economic interest and helps many people here as well. But you also have the Heckman result that family environments matter for educational attainment, and then the Godin-Katz result that education is driving trends in the distribution of income. I once asked Heckman about the implications of his research on immigration policy, but he was a bit evasive. Well, America will be home to a large number of people with sub-optimal education and income levels persisting across generations. Again, this is probably an optimal welfare transfer, but it's out of synch with the policy for foreign professionals and calls for some public policy (like early childhood intervention).

Capital Gains Tax

The CBO has a bit up on the changes in revenues from individual taxes over time. They find that the revenue from taxes went way up in the Clinton years due to events unconnected with Clinton, rather than changes in the tax code, while tax revenues did change in the Bush years due to new laws. Of the non-legislative gain in tax revenue during the Clinton years, capital gains taxes on the sale of investments constitute about half. Clinton also drastically cut capital gains on housing, so the housing bubble resulted in relatively little in the way of capital gains revenue. This change may be responsible for the rise in house prices; more on this later, data willing.

There's some debate over the ideal capital gains tax rate is. Charles Gibson and a WSJ editorial I once read make the supply-side argument that lowering this rate increases revenue. I'm skeptical, but in any case the variation in taxes gives Clinton an undervedly good reputation for managing the economy and Bush a worse reputation than he deserves. In reality, the rate of economic growth and the pace of tax revenues vary more or less randomly and place huge constraints on what Presidents can do. This fact tends to be ignored by people who expect elected officials to both not overstep their Constitutional boundaries and wield absolutist power to revive the economy.

Basically, I want to stop reading pointless articles on how some things are correlated to other things, because the world is basically random and few people have any influence on or understanding of the events that go on. Okay, that's a little extreme, but at least come up with a defense that (though it may raise an interesting point connecting inequality and women's relative wages) justifies blatant political pandering.

Friday, September 26, 2008

Mad Max

The aftermath of Katrina left much of the southeast United States short on gas as refineries and pipelines shut down. A few weeks ago, I was in Asheville, NC seeing something familiar in the aftermath of Ike. Asheville is at a high altitude and it's hard for gas shipments to reach there after a crisis. It was pretty exciting, really, to see the entire region practically shut down. Many gas stations ran out of gas, others--mostly independent retailers--had prices going up to about $5 a gallon. Some stations tied to the oil majors had lower prices, but had large lines. Traffic plummeted and at the clinic I was working at, many people cancelled appointments.

Well, this is still ongoing. From what I hear, gas is still in short supply, and stations either have no gas or long lines for expensive gas. Police are stationed at pumps, and all sorts of events have been shut down or curtailed. It's a great glimpse at our dependence on fossil fuels, and the chaos and anarchy underling the well-greased market system of tradable goods and services. It's tough to imagine Appalachia with excessive gas prices. Without roads to connect far-flung valley communities and mountain outposts, you either have self-contained hamlets or a handful of denser areas. And without the tourism or expansive mountain cabins, there are few remaining attractions. It's going to be a lot easier to replace this addiction with biofuels or compressed natural gas rather than move to a Japanese or European style of living.

Thursday, September 25, 2008

About Those Alphas

The basic premise of hedge funds is that smart people amply compensated can make lots of money. The empirical evidence for this is mixed. On average, including failed firms and management fees, it's doubtful that hedge funds beat a diversified market average (this is the basis for Buffett's bet). But a substantial number of firms have piled up impressive records over the years with high "alphas," or above market performance.

I just came from a talk by Markus Brunnermeier, who circulated the ideas I've discussed before. Much of the talk was focused on the amplification methods that turn a drop in asset prices into a financial meltdown, with some commentary on potential regulatory solutions. The idea is that the old agent-based macroeconomic models really fail to get at the connectedness of modern finance; but he suggested some tools for understanding those links. One was a measure of spillover risk across institutions, measuring by looking at past performance during crises. These turns out to be significant, and there were all sorts of interesting comments.

But Brunnermeier also examined the impact of taking these "tail risks" into account on manager alphas. It makes them disappear. That is, paper gains achieved by hedge funds--which have presumably hedged against shifts in the overall market--come through neglecting the counterparty risk associated with the occasional collapse of financial institutions. That's not to say hedge funds are useless--you would like to have the wealthiest people bear crisis risk, and it might be profitable for them--but it implies that hedge funds as a class rely on undisclosed crisis arbitrage for their profits.

Of course, hedge funds have not peformed as badly as markets in general this crisis, so perhaps this is a phenomenon particularly concentrated among certain strategies (or an artifact of old data, or not yet apparent). But it's more support of the claim that modern profit machines rely more on frauding investors than ouwitting markets.

Wednesday, September 24, 2008

Financial Magic

A lot of people are very skeptical of the merits of modern finance. After all, financiers pay themselves obscene amounts of money, devise complex schemes to fraud people, and periodically self-destruct while calling for public bailouts. On top of that, they don't made anything you can touch or drop.

It's easy to question whether the best marginal talents headed to Wall Street are really worth their paycheck. Not too long ago, about 40% of corporate profits among companies in the S&P 500 went to the financial setor--a figure which surely represents the extraordinary level of leverage going on, combined with various asset bubbles. This share will certainly go down. But it's also true that finance is an important and value-adding portion of the economy.

Consider an economy without a robust capital market. One of Indira Gandhi's more disastrous policies was nationalizing India's banks. Lending was no longer conducted on the basis of profit, and was rather directed at unprofitable but politically sensitive areas of the economy. India also maintained very high interest rates for a long time. From one perspective, economic development is all about expanding the productive part of the economy, and an efficient financial system is necessary to funnel capital towards the productive sectors and firms. McKinsey estimates that there is a massive gap between India's most and last productive firms, and that closing the gap would yield enormous results. They also find large gains in financial sector reforms. See the Rajan proposal for what that might look like.

Making financial markets ever more efficient brings diminishing returns, but even some of the newer complex products are useful. In general, derivatives allow people to manage the uncertainty and risk inherent in dealing with goods traded on a macro level. The markets for currency, interest rates, equities, and commodities are highly volatile, yet firms and individuals are able to use derivatives to limit potential losses, amplify gains, hedge risks, or guarantee a solid stream of income. Airlines rely on fuel derivatives to control costs, while extraction companies ensure consistent profits amid large shifts in the prices of commodities. Credit default swaps enable people to make investments in corporate and government bonds--giving funding to risky companies and governments that would never otherwise raise capital. Argentina is getting funding exactly because complex finance exists--no one would fund them without protection in the case of default. Even Shiller envisions more complex mortgages--ones that would automatically forgive payments in bad times--as a way to prevent future mortgage crises. Sulpur trading schemes dramatically reduced their emissions in America, and a financial marketplace for carbon is one of the few feasible ways to deal with global warming.

But Warren Buffett calls them weapons of destruction. Well, he also holds long-term equity puts, some credit default swaps, as well as currency positions on his books. Their collapse in market value destroyed his recent profits, but he is likely to profit significantly from them in the long-term. It's long been more profitable to do as Buffett says rather than follow his statements.

Tuesday, September 23, 2008

The Milton Friedman Institute

Let's just go ahead and get this out of the way. The University of Chicago plans on forming a new research institute on economics with Milton Friedman's name, and many faculty are opposed.

I was excited to see this idea, because Universities are generally such poor stewards of their endowments and intellectual capital. Compare, as Brad DeLong once did, the decisions made by the heads of the University of California system and Harvard during the 1960s. Harvard increased in size, but not by much, becoming essentially a highly profitable hedge fund with some land in Cambridge for tax purposes. The Cal system drastically expanded to cover over a hundred thousand people with high-quality college education. It's hard to imagine that Harvard made the better choice from the point of view of the public, but it's their viewpoint which is universal. If you believe that higher education is worthwhile, then it's bad that top institutions are doing so little to spread knowledge, improve teaching, or jump-start massive research projects (MIT's OCW aside). Are the liberals who run these places so elitist that they believe that knowledge should be restricted? Or are they unable to seriously consider educating more than a few thousand souls a year?

In any case, the MFI was a great way to capitalize on one of the University's core strength's--economics--and dramatically advance the cause of outreach and research (and at low cost to the University, too). You can disagree with the choice of naming it after Friedman, but it was a natural fit given his stature and connection with the University.

This move caused a wave of ill-will and poorly reasoned diatribes. Supposedly the plan would "reinforce among the public a perception that the university’s faculty lacks intellectual and ideological diversity." So the University should not develop one of the few right-of-center departments in economics, let alone academia, out of concerns for perceived intellectual diversity? Set aside for the moment issues of the quality of output (if work is done by University faculty and the charter written by prominent economists--unlike Hoover--then I personally have few concerns). What entitles academics the right to silence the research of others? Have any of the points the critics made justify that?

I don't want to be a scold on this issue. Others do that better than me anyway. I just want to point out the ways in which this employer-run institution fails students, teachers, and the public. Administration is hampered in promoting their key function--research and teaching--by faculty for whom the allocation of power and money between disciplines is more important than agumenting and disseminating knowledge. Expanding college education is essential to reducing inequality, and research is also useful. Unfortunately, we can expect no large initiatives on these goals as long as Administrators cater to the needs of entrenched academic interests. What about Chicago campuses overseas to spread a distinctive form of thinking? The focus could even be on Humanities subjects that are often overlooked elsewhere, or on contructing "Cores" for cultures other than the Western European. Why should it be that expansion and innovation are not even an option for a Chicago-based University, but basically required for a Chicago-based firm? Maybe the people over at the MFI could figure this out.

I am more hopeful for Colleges in the developing world, where hope is more audacious and the do-nothing dons fewer. The Gulf has many proposed institutions and is attracting a lot of interest, there are some interesting Indian proposals, and many Chinese Universities lack the tenure model. And that's not even getting to practices inside the classroom. As Matt Yglesias points out, either lectures are effective at imparting knowledge--in which case we should find the best professors and have them reach the most people --or they're not, in which case we should find a better way.

Regional Disparities

It's a myth that countries grow and that unequal growth is somehow pathalogical. Generally, a few people in a small area start growth, which then feeds into the economy as a whole. Trickle-down does in fact work, which is why the poorest decile of a rich country is much better off than the richest decile in a poor country. When the relevant area to figures out growth coincides with the political grouping--say in Botswana or Hong Kong or Mauritania--we say that the country is getting richer. When that area is inside of a larger political unit, we say that there are regional disparities.

And so you have the well-chronicled fact that India's growth is regionally unbalanced. This is often sold as the claim "western and southern states do well" but there's a bit more to it. This map (blue and red are good, brown and yellow bad) is a little dated--from the 1991 census--and so does not capture recent unequal growth, but does look at some measure of development at a district level.

One thing to note is that the landlocked northern "bimaru" states in the Hindi belt--Bihar, Madhya Pradesh, Rajasthan, Uttar Pradesh are not doing so great. Most inland areas in general are doing fairly poorly as well. Development is largely clustered into two sets of districts: Those near the coast and those along the far northern Delhi-Punjab corridor. Of course, there are some cities here and there that do well, and the whole of Maharashtra appears well-run. Coastal Andhra and Orissa are not uniformly great, but those two states have made a lot of progress in the last fifteen years not seen on the map.
This disparity is a little striking as northern India was for a long time the richest portion of India. It was the seat of the Mauryan, Gupta, and Mughal Empires and home to the British Raj. This wealth persisted even after independence.

Political mismanagment goes a long way towards explaining this gap: National Congress rule tried to eliminate regional imbalances, which involved neglecting the richer states. On the state level, coastal and far Northern states are simply run better than those in the center. Geographical size seems to matter, as smaller states tend to be better run, while the bimaru states are all massive (Though Maharashtra is rather large as well). This was the rationale for breaking off some states from the larger ones, a policy that seems to have worked rather well.

You also have to wonder if being landlocked is a curse, as per Sachs and Collier. State-level variation in GDP in America does not seem to be especially correlated to distance from the coast, but that also reflects massive investments in infrastructure that reduce transportation costs. Those inland states in India that got rich did so by exporting crop surpluses on highways and railways.

Increasing the ties betwen inland India--which includes the bimaru states as well as rural portions of coastal states--into the part of India which is growing rapidly is obviously important. It's also essential to tapping into India's "demographic divididend"--India's relatively youthful workforce. It turns out that this bonanza is largely expected in the high-fertility bimaru states--which already contain about 40% of India's population between them. For labor-intensive industry to take advantage of these workers, inland states will need to be as investment-ready as coastal states. Otherwise, the rich parts of India will see large wage inflation and the poorer parts significant unemployment.

Massive investments in human capital and infrastructure are necessary to close this gap, and accountable governance in smaller states is the way there. Plans for a freight corridor between Delhi and Mumbai along Tokyo-Osaka lines are promising, and the Golden Quadrangle linking major Indian metros is working well. Another corridor from Delhi to Calcutta along the Grand Trunk Road could hit another quarter of the population.

Monday, September 22, 2008

Why Is There A Financial Crisis?

The losses incurred by holders of real estate-backed loans are real. These loans were handed out at the peak of the bubble to people who could not afford them at unsustainable rates. When low downpayments met a collapse in housing prices, many borrowers faced loan values greater than their home values and walked away. This effectively made billions of dollars invested in the commercial paper that was a key workhorse in international finance worthless.

Before the crisis, this fact was evident to many people. Several hedge funds attempted to short the market for such loans, and were destroyed. I know of at least one person, however, who managed to time his trades right and made quite a few billion dollars. However, most people did not face the responsibility that those traders did and continued to buy and sell worthless paper. It's not the "models" that are at fault; other models that actually corrected for the unique credit qualities of recent borrowers would give you higher predicted defaults. Rather, the originate and distribute model reduced the incentives to model correctly and allowed mortgage originators to hand out loans to poor borrowers and resell them into a global savings glut.

So again, the losses from handing out such loans is high. But it's perhaps on the order of $500 billion--severe, but similar to the asset collapse from any bubble. The problems from this crisis, however, have spread into many parts of the finance industry and into the real economy as well. It's a big question how a relatively manageable loss nearly broke down the entire financial system.

One explanation I gave earlier is that marking assets to market overstated the problems for certain firms and caused a crisis in confidence. That's a part of the answer to why there was a spiral, though such transparency is good in general. Here at my day job, many people are interested in this question and I came across other ways to get from "manageable loss" to "end of the world".

A key factor is the extraordinary extent to which modern finance relies on debt. Many people imagine that you can show up on Wall Street and easily make money if you have flexible ethics. Generally though, most people face very efficient markets and thus need to ramp up on leverage to amplify any small inefficiency they find. Investment Banks were among the worst offenders, and their debt was very short-term to boot. As banks faced continual deterioration in their balance sheets, financial requirements forced them to raise more capital. An interesting solution to this problem is Rajan's proposal to replace required capital deposits with catastrophe insurance for banks. The idea is that forcing banks to keep a certain amount of liquidity on the books prevents that capital from being used precisely at the hour of need, so instead banks could contract out for funding conditional on facing a crisis.

There are other liquidity spirals that amplify original shocks. The complexity of the financial toxins spread around induced significant asymmetric information and constraints on knowledge. People don't know what's going on and can't find out, so they reject entire asset classes as worthless in bad times. Finally you end up with classic bank runs when people lose faith in financial institutions altogether. This happened not just in the case of Northern Rock and IndyMac, but was a factor in Bear Sterns, Lehman Brothers, and the rest of the Investment Banks. Tightly linked financial markets run on trust between counterparties, so you have giant network effects that blow up any perceived risk. See James Surowiecki on this point.

The financial system was so highly leveraged and tied together that blaming subprime mortgages is a little besides the point. The entire financial system was in something of a bubble, and was one asset collapse away from destruction. Much smarter regulation will be required to fix and prevent future crises, and that's unlikely to materialize.

Sunday, September 21, 2008

Market Theories

I'm not a big critic of the Efficient Markets Theory.  Most of the time, for most equities, the market price provides a reasonable valuation based on aggregating probabilities of the paths of future earnings.  The overwhelming mass of investors fail to beat market averages--including Jim Cramer.  But there are of course a few superb investors whose performance cannot be attributed to chance--the superinvestors of Graham and Doddsville to name a few.  

But it's interesting that decades after the original value investing texts were first published, only a handful of investors have managed to successfully beat the markets--and those who do often employ similar strategies that implicitly weed out the majority of stocks as decently priced.  To me, that implies that just a few people are endowed with the capacity to do something different (They have a different emotional mindset?) while others can't copy.  This is akin to having private information.  Their presence will make the markets more efficient, but it can take some time and they'll make a good deal of money as they do so.  

Portfolio Theory, however, has never made much sense to me.  There is of course a resemblance to Efficient Markets, but the assumptions are crazy.  For one, you have no accounting for Talebian Black Swan risk, which has taken out many people including LTCM.  There's no economic reason that past performance predicts future extreme risk--an event which is by definition low probability.  So-called post-modern Portfolio Theory is a little nicer as it correctly terms risk as the downward portion of volatility, not uncertainty itself.  But another approach is to throw out normalities altogether and focus on fractals, as Mandelbrot does.  I've often thought stock charts appear self-similar at different time scales, and Mandelbrot takes this approach to produce a pattern which echoes Portfolio Theory's randomness for much of the time but with a healthy appreciation for crazy events.  It's promising stuff, and not only because it involves fractals.

Saturday, September 20, 2008

Mark to Market Accounting

One of the puzzles of this financial crisis is the rapid spread of problems from subprime mortgages to prime mortgages to commercial mortgages to credit markets to investment banks to insurance companies.  The underlying fundamentals were rather bad, but do they really justify a wholescale collapse of the entire financial sector?

Here is a dissenting opinion from the WSJ opinion pages citing the research of a Yale professor on marking assets to market.  The idea is that while gaining accurate market information on the value of assets is worthwhile, there are certain cases (such as when firms intend to carry securities to maturation) where it's not a helpful calculation, and can in fact increase speculative downward pressure.  I'm not too sure what to think of this idea, but it's interesting.  Certainly I'm taking a close look at financial companies which have been beaten up due to holding assets that the market does not value, but do not have any short term liquidity constraints.  

Blood in the Streets

The big news is that the Treasury is rolling out $700 billion to buy troubled assets of financial institutions to clean the pipes, if you will, of credit markets.  This number is apparently large enough that the financial consuls Bernanke and Paulson feel the need to consult Congress on the issue.  

This measure is troubling in a few ways.  One, it threatens to prolong the crisis by hiding mortgage problems in the government's books.  As I've mentioned before, the danger is the potential for a Japan-style prolonged recession.  This plan saves the worst offenders, while doing little to force banks to deal with their losses and move on.  Moral hazard remains a big issue. 

Two, it's not the best use of taxpayer money.  Yes, this deal could pay for itself over time, but there are better ways to command the government's influence properly.  Zingales and Krugman are both against the deal and have some interesting alternatives.  Krugman would rather the government act as Sweden and nationalize firms to float them at a later date--treating the government as sort of a private equity buyout firm of last resort.  Zingales would use the government to coordinate moves such as eliminating dividends, raising equity, and debt restructuring.

The nice aspect of these deals is that they leverage some of the strongest capacities of government: Coordination, transparency, and liquidity.  Friedman and company tend to categorically despise all government action (except of course on financial intervention), but there are clearly many different sorts of intervention.  Personally, I don't care as much about the raw amount of government spending as the form that government regulation assumes.  Paulson's plan calls for a massive government bailout without holding firms accountable.  Other plans envision a light government footprint paired with reasonable interventions playing on government's strengths to force firms to solve their problems themselves. 

Friday, September 19, 2008

Inequality, Part II

I went to an interesting talk today on risk pricing. The equity premium puzzle is an issue that no one has really resolved yet. The idea is that the long-run return to holding "risky" equities remains excessive to the present day. One answer that the behavioralists give is that humans are simply risk averse, but many people find the degree of risk aversion necessary to explain the phenomenon inplausible.

The speaker's idea was to combine rational agents (with potential differing apetites for risk) with Bayesian agents who lean about the economy. The Bayesians are stupid, but through their learning converge the economy over time to the rational model. There are a few rational agents in this economy--the Warren Buffets--who know what's going on. Over time, these guys get richer and richer. The main conclusion of the paper is that the market can put a high price on risk, one that converges over time to a reasonable price, in an economy populated by smart people and stupid people who are quick learners.

There is a distributional aspect to this model as well, however. The smart people raise their share of income over time, due to their superior knowledge. Of course, in economic shock periods, as now, they do not do so well, but in the long run, under normal economic conditions they make out like bandits. I've discussed before the education model of inequality, which explains how the educated do better than the non-educated. This model, in which there are super-educated people, plausibly explains the movement at the very top of the distribution. This is happening in an institutional setting where it's harder and harder to deny the smartest and most productive people the proper value of their labor. You can wonder what is the optimal tax to apply to this group, but you should also wonder how to join it.

Ancient Americans

One of the myths that's floating around is the romanticized image of hunter-gatherers. Back to at least Rousseau, people have imagined that contemporary society is horrible, but that ancient humans were somehow more in tune with nature.

As with all idealized images, this is not quite true. Ancient societies were considerably more violent, both to each other and neighboring tribes, and were probably responsible for many mega-fauna extinctions. They were probably more prosperous than following agricultural societies, and possibly many contemporary societies.

This idealization extends to ancient Americans, who were thought either savages unfit to manage land or else the best people who ever lived--a standard to which we can compare and degrade our own unsustainable follies. As it turns out, civilization in pre-contact America was extensive, long-lasting, highly urban, highly dependent on agriculture, and had a dramatic impact on the landscape from the Amazonian jungle to the North American plains. The vast herds of buffalo and birds encountered in the 19th century are not a legacy of a pristine past, but a direct result of the deaths of countless residents due to Old World diseases. Ancient societies managed the landscape at will, with many destructive consequences and other good ones. Contemporary societies are doing the same.

It's also interesting that new discoveries are pushing back the dates of the earliest American finds to be contemporary with the earliest Asian river-based civilizations. Somehow, human societies independently discovered parallel technologies and social organizations at around the same time. I guess there is some rate of mental evolution necessary to make these advances which hit a threshold worldwide around that time, aided by global climate trends.


Some countries are rich, some are poor, and nobody really knows why. A popular explanation is institutional quality; some countries correctly structure law system/bureaucracy/regulations to ensure properly functioning economies. I think there's something to this, since clearly poor governments have poorly functioning economies while good governments tend to have awesome economies.

However, the basic idea has been taken too far, perhaps most extremely in the Washinton Consensus. As this Economist article shows, poorer countries tend to have a higher cost of firing workers, but differences in position don't seem to be great in explaining per capita growth or income. The BRICs have relatively poor governance, as does Germany. Yet the BRICs also have great growth, even relative to other poor countries. In Rodik terms, large income differences between countries imply high expected growth rates through convergence, which are occasionally realized when countries remove binding constraints. That is, poor countries have a lot of potential, which can be tapped not through a wholescale upgrading institutions on social democratic lines (though that is good), but through eliminating context-specific roadblocks.

Thursday, September 18, 2008

Cultural and Intellectual Consequences of Financial Collapse

I'm no Naomi Klein, but many crises have been followed by large shifts in opinion. One, I think there will be significant backlash overseas. The European bankers, Chinese state-run investment firms, and Sovereign Wealth Funds all bought worthless US paper all the way down and were rarely transparent about it to their investors. I imagine we'll see angry conspiracy theories thrown out about malevolent American coercion forcing these trades, some of this directed at the funds too. This will curb global capital flows and trust; both foreign money coming in and the willingness of people to accept American money flowing out.

Obviously, the crisis will be blamed on poor "regulation" and free market practices. For why that's not the best way of looking at it, see Cowen. But the outrage against corporate overlords will be strong, and there will be a strong push towards greater federal oversight. My guess is that retroactive analysis will emphasize the powerful and beneficial role of the Federal Reserve and Treasury in stopping the crisis, and people will demand similar action elsewhere. After all, we bailed out Bear Sterns, so why not bail out the little guy as well? It's easy to look at the situation and see failing markets and effective federal regulators.

Government manipulations of the housing market--tax credits for capital gains and mortgage payments--are likely to continue.

So I guess this is just saying that the country will shift left, which is what many people expected anyway. It's not the worst thing in the world. As Lawrence Summers said recently, markets have worked well in delivering people tradable goods and services, while problems lie in the delivery of social services such as healthcare, education, and poverty assistance.

Intellectually I have to imagine that there will be a, well, malaise. It's been close to a decade now of stagnant growth in GDP and equity prices; combine that with a global crisis, a housing collapse, one war that's seen as failed (Iraq) and another that's seen as misguided (terror), higher commodity prices, and failures in leadership from politics and economics. Everyone talks about the iconic status of Jon Stewart in this generation, but maybe we'll see the more disaffected and hopeless side of that. Timewise, I'm thinking late '80s-early '90s, or mid to late '70s as a model. I suspect a new narcotic will become popular. If nothing else, people will start to spend all of their time on the internet. People will associate with others on finer and finer gradiations; trust and community will collapse as xenophobia rises. Materially, it will be the best time ever in human history.

Looking back, this doesn't make a lot of sense, but predicting things is hard.

McCain's Healthcare Plan

I've mentioned before that though McCain's domestic policy is notable for its absence, his notion of ending the exclusive tax benefits of employer-provided healthcare and instead providing tax credits for people to buy their own policies is actually reasonable. But it's received a lot of criticism from various people, with the concern being that people will see their employer insurance cut.

But here's Obama economist Furman on the impact of ending the tax exclusion:

Virtually any way of replacing the health exclusion with tax credits or tax deductions is likely to increase coverage. The current exclusion provides an incentive to go from no insurance to some insurance and from some insurance to more insurance. A reformed system would eliminate the incentive to go from some insurance to more insurance, and put much or all of those dollars into increasing the incentive to go from no insurance to some insurance. The direct effects of the tax incentive would be reinforced by the indirect effects on health spending. Over time, these effects on health spending could be quite large – lowering premiums and further increasing the demand for health insurance.

Furman goes on to describe how other policy, such as pooling mechanisms, can combine with this one to fully insure everyone. Some of these policies are included in the Obama plan, and it seems to me that intersecting the two candidates' plans is better than either individually.

Wednesday, September 17, 2008

A Government Without Taxes

I know, I just blamed the government for handing out too many bailouts. But the recent loan guarantee to AIG is very punishing--8.5% above market rate--and the Fed and Treasury may very well stand to make some money from the deal.

In my ideal world, the government would use its public status as the sole means of revenue. As in the AIG case, that involves acting like a hedge fund specializing in catastrophe arbitrage. A simple cyclical rule--buy low, sell high--could presumably yield large profits and generate a social return too. Market actors can't do this as well due to liquidity constraints. Also, property rents from energy extraction, externality taxes, and wireless spectrum auctions could contribute money as well. Maybe a war here and there that paid for itself.

Tuesday, September 16, 2008

Industrial Policy

Dani Rodrik's latest book--One Economics, Many Recipes--is one of the best I've read recently. The nature of book-binding fits manuscripts to a certain page rage, regardless of the actual length needs of the discussion. Combined with poor writing and editing, a majority of books contain a high fat/content ratio. I've wondered about the empirical distribution of that ratio and the theoretical minimum. On the basis of no analysis, I conclude that the fat ratio follows a gamma distribution, with a mean at around 60% fat tailing to a 15% minimum. I imagine 20% fat is around optimal; The Economist has somewhat more fat than this but is one of the leanest publications around. Fat-avoidance has shaped my shift from consuming books to size-constrained blogs and articles.

Rodrik's book is written as a series of self-contained articles, greatly lowering the fat count as each chapter makes stand alone claims. These are grouped into three sets, the third of which, on global institutional frameworks and similar esoterica, I will ignore.

The first set of arguments concern the failure of successive iterations of development policy. Rodrick concludes that a basic framework--proper competitive incentives, a good macroeconomic situation, globalized outlook, and social insurance--is common to all successful economies, but that particular institutional designs vary. Instead of the Washington Consensus transplant approach of grafting overseas best-practices over every local organ, Rodrik adopts an "optimize what you optimize" mentality; use diagnostics to identify the functional hurdles preventing the rise of the productive sector of the economy, and improvise local solutions. This is great stuff, worth more than the cumulative total of all economic randomized trials ever conducted.

The second bit covers industrial policy. As Tyler Cowen notes, the substance of his proposals is actually fairly limited, while the rhetoric of railing against fundamentalist economists is overblown and against the humble spirit of the book. This is because Rodrik has a strong agenda of normalizing industrial policy as another piece of the government tool-box.

Rodrik presents a sophisticated case for viable government interventions in a complicated world, but I am skeptical. The historical examples rely heavily on East Asian examples. It's fair to say that the debate over industrial policy is basically a debate over government practices between 1950-1970 in East Asian economies. Of course, in this period virtually every other developing country attempted industrial policy in some form or another and all of them failed. The key counterfactual is to what degree the peninsulas and islands of Asia would have prospered without industrial policy, and the pressing policy question is to what degree other developing countries can replicate such planning institutions.

I suspect that the success of Asian economies is due more to government success in human and physical capital, oppenness to foreign trade, and competitive markets rather than successful industrial policy; and that more pluralistic, democratic countries will find it difficult to replicate their institutional structures (these countries find it hard enough to deliver basic government goods) . Here are some critical assessments of Eas Asian industrial policy. In several cases, the bulk of government subsidy was not directed at the most productive sectors but rather the more politically sensitive ones. So in Taiwan you have government subsidized heavy industry while the small and medium scale firms did the bulk of the production, and in Japan you see large subsidies for rural development and the postal banks. Korean policy was perhaps the most extensive, but some people disagree that it was effective relative to doing nothing.

It's also worth pointing out that all East Asian post-WWII successes were ethnically homogeneous, and were either city-states with strong British influence (Singapore, Hong Kong) or former Japanese colonies (Korea, Taiwan), giving these countries strong legacy institutions.

Rodrik also commends China and India's gradualism. But, given their large disparity in income relative to developed countries, convergence was inevitable and the question is how much did gradualism help economically, even if it was great politically. In China, much of the federal outlay was directed at Soviet-style large industry, while the small and medium size firms that drove the economy were more independent (though they maintained close ties to local Party officials). Indian industrial policy was absolutely catastrophic, and success in biotech and information technology is due greatly to the fact that these sectors did not exist when regulations were drawn up. The scope of Asian markets will continue to attract business regardless of failure or success of government policy.

I do see the potential for market failure, and Rodrik details some plausible scenarios. Much like how the path of immigrant migrations follows the intitial migrants rather than the fundamentals, corporate development tends to follow the path set by the first-movers. But the potential for government failure is also strong, and I am skeptical of the degree to which future governments can target the money properly. Broad-based, universally accessible policy such as research, investments in education and infrastructure, and a pro-growth, low tax environment lift all boats, but is perhaps better discussed under the label of "good governance" than "industrial policy."

Monday, September 15, 2008

The Karmic Theory of Academia

Academics are born with a certain amount of merit, corresponding to the degree of higher-level thinking they can cope with.  Universities exist to sort people into their correct group.  The ordering goes:

Humanities --> Psychology --> Anthropology --> Sociology --> Political Science --> Economics --> Biology --> Physics --> Mathematics

If you are successful in mastering a greater degree of abstract thinking, you are reborn into a higher discipline.  If you are not, you descend.   Those who master mathematical truths are reborn as artists.  Those who cannot handle the Humanities become businessmen.  

This is in no way self-serving.

(With credit to Krugman.  Also see xkcd)

Finally Throwing Up

Frankly, this has been a disappointing time for global capitalism.  Consumers have made poor decisions, companies have mispriced risk, and investment decisions have not been made on the basis of fundamentals.  The savings that fled emerging markets to Wall Street was justified on the premise that modern finance is correctly regulated and quite efficiently allocates resources through advanced financial engineering.  Clearly these assumptions were not warranted; though keeping money in BRIC stock markets doesn't seem like a great idea either.  

The federal response to the crisis has been troubling as well.  Successive rounds of bailouts and guarantees for companies such as Bear Sterns, Fannie/Freddie, and the Auto manufacturers.  It's hard to criticize any individual action--Bear Sterns' collapse was very rapid, Fannie/Freddie had an implicit government guarantee--but the net effect has involved the government postponing the difficult acts of failure necessary for a properly functioning capitalist system.

The big fear is that the housing market crash and credit crunch will be followed by a decade-long stagnation as happened in Japan.  In some ways, the fundamentals in the US are even worse than those faced by Japan--savings are essentially zero, there is no room for either a fiscal or monetary expansion, the housing boom was financed with low down-payment mortgages, and growth has been anemeic the last decade as it is.  

The economic post-mortem of the Japanese crisis has placed the blame on Japanese policymakers and bankers who enabled delayed writting off bad assets.  Instead of clearing the books, taking the hits, and moving on; the Japanese banking system remained in stasis.  Failure to direct resources to the most productive sections of the economy and keeping zombie loans in the essentially valueless portion of the economy prevented revival.  The American federal response--trying to keep institutions alive as much as possible and feeding Wall Street through guarantees, rate cuts, and liquidity--has echoed Japan's response.  The corporate response, involving poor board governance, opaque balance sheets, and a reluctance to mark assets to market has also been disappointing.

I don't claim to understand even a portion of what's going on, and have little idea of what to do now.  But I'm glad to see Lehman fail.  Finally: A poorly run firm that failed to take its medicine comes begging to Paulson and Bernake, the government says no, and the firm pays the consequences of taking risk.  I don't know if this will seriously deter firms in the future, but it's healthy to see anyway.

This response and the outpouring of blood in the streets makes me very optimistic about the future.  AIG's fall isn't going to be the last, but life will go on.  Also, how nice is Goldman Sachs sitting right now?  They've been profitable the whole way and currently operate in a duopoly.  I await the poorly thought out regulatory responses from Presidential nominees with great interest.

Update: A talking head on CNBC says, "This has been like having food poisoning without throwing up for three weeks, and we finally did."  I wish I thought of that phrasing.    

The Politics of Resentment

I was thinking through some pieces from The Atlantic's conservative bloggers when I came across another article by my former professor Wendy Doniger.  The first set of authors make the point that liberal condescension towards evangelicals and rednecks is annoying and dooms Democrats at the polls.  My experience is that liberals are about as intolerant as conservatives--How many of your friends would rejoice an evangelical pro-life child?--but they tend to be more self-satisfied about it.  Then you have the issue that liberals dominate a good chunk of the media and academia and so eminate this disgust into the heartland, causing a status issue as well.

I know, this is more red/blue state garbage, which you've heard and rejected.  Perhaps you support a Presidental candidate who promises to take us beyond all of that.  But the resentment aspect--those working class who vote their values--is real and not unlike the support African-Americans give to the Democrats.  It's at work with the Palin nomination, in which liberals the coasts over race to see who can shoot themselves in the foot fastest over crazy ways to denigrate Palin's life and drive as many people out of the party as possible.  Doniger's piece is an excellent example in this genre.  

First, there is the old secular idea that separation of church and state is ironclad; that religion ought to be checked at the door much the same ways car keys are at bars.  I'm fine with this, but I also don't call people who believe the contrary "out of their mind" because, well, that's what I'd believe too if I genuinely believed in God.  As Rick Warren says,
I believe in the separation of church and state, but I do not believe in the separation of politics from religion.  Faith is simply a worldview. A person who says he puts his faith on the shelf when he's making decisions is either an idiot or a liar. It's entirely appropriate for me to ask what is their frame of reference. 
I respect Doniger as an excellent teacher and a wonderful person.  But it's painful to watch her reject Warren's worldview as unift for civil life (which it clearly has not been for the majority of American politics), and fail to make an argument against Palin without going into bits like:

Her greatest hypocrisy is in her pretense that she is a woman. The Republican party's cynical calculation that because she has a womb and makes lots and lots of babies (and drives them to school! wow!) she speaks for the women of America, and will capture their hearts and their votes, has driven thousands of real women to take to their computers in outrage. She does not speak for women; she has no sympathy for the problems of other women, particularly working class women.

And as for religion, I'd love to know precisely how the Good Lord conveyed to her so clearly his intention to destroy the environment (global warming, she thinks, is not the work of human hands, so it must be the work of You Know Who), the lives of untold thousands of soldiers and innocent bystanders (He is apparently rooting for this, too, she says), and, incidentally, a lot of polar bears and wolves, not to mention all the people who will be shot with the guns that she thinks other people ought to have.

Wow.  I'm no Palin fanatic, but I can at least understand how people in good faith can admire someone like Palin.  Remember, this is all written under the name of "not forcing beliefs on others."  This attempt to deny womanhood and dismiss a rather common set of beliefs as claptrap would really annoy me were I in a different demographic.  

One reason I bring is up is in regards to the infamous Doniger egg-fly incident and related charges.  The backstory is that Western Hinduism scholars analyze some texts in Freudian fashion, many people make idle threats, and reasonable people lose respect for everyone involved.  Many of the critics have no idea what they are talking about, but a few make interesting arguments that Freudian analysis doesn't really make sense when applied to Vedic scripture.  Doniger and company never really respond beyond "psychoanalysis is the most sophisticated language we have to talk about questions" (really?) but go on to link every online hooligan with a vast right-wing Hindu conspiracy arrayed against their academic freedom.  

I just want to note that the commentators on Doniger's page are every bit as vile as her detractors elsewhere; this is just something people do when they feel their beliefs are threatened.  That's why you shouldn't take their empty threats too seriously, and why you should disagree with your political opponents--as Obama does--without openly disrespecting them.

Sunday, September 14, 2008

Calling A Bottom

Looking around, it looks like people have stopped calling a bottom on the stock market.  My prediction: The next few days will see a bottom.  

Saturday, September 13, 2008


People often blame unrestrained capitalism for income inequality.  Nordic countries, however, have free labor markets and free trade but low inequality; while both capitalist England and regulated France have relatively high inequality.  A better fit is the portion of high school dropouts; the more people fail to graduate high school, the greater the inequality.  

A pair of articles suggest that differing educational attainment is the source of higher American inequality.  The returns to education have risen in tandem with technology, but educational attainment has stagnated, resulting in an education gap.  This happened during a period in which the global workforce expanded to include more women and the ex-Leftist countries, pushing down the wages of unskilled labor relative to skilled labor and capital.  So the problem is that people can't complete school despite financial incentives.  And the reasons for that vary from poor teaching, bad family environments, culture, and the fact that many people don't like school. 

A contrary argument, that inequality is explained by lowering labor barganing power, begs the question.  It also relies on basically two data points, one in which there was high competition and skimy compensation (recently) and another (after WWII) in which unions extorted highly profitable firms facing low competition.  It doesn't look like unions are a great way to raise wages looking forward; just look at highly unionized industries today.

Education is the big issue, but many people complain about gains going to the top 1%.  This is the philosophy behind Obama's economic plan: The economy's basically fine, but the richest make too much money.  Some of this gain is the superstar effect, that top performers can reach a wide audience.  Much of this went to the finance industry, but obviously this compensation is down sharply.  Some of this is also tied up with the fact that small businesses are increasingly registering as individuals to avoid the double taxation of corporate taxes; first at one of the highest corporate tax rate in the world, and then again as capital gains.  

Mobility is a bigger concern than inequality, as lower mobility hurts people while greater inequality makes them more insecure at parties.  As for this notion that concentrated wealth destroys politics, it seems to me that political interest groups--against abortion, immigration, or what have you--are more powerful at mobilizing votes and getting legislation passed than the "monied class" as a whole.  The broader narrative on mobility is that the American Dream is dying and America is worse than Europe in this regard.

I've been a bit skeptical about this conclusion.  Some papers reviewed by Tyler Cowen argue that mobility has both been constant over time, that there is some correlation of wealth between generations, and much of that comes from transmitting values of hard work and savings.  Another interesting point of view, which I never thought of, is that mobility between income groups is going to be easier in relatively egalitarian societies because the gradients between brackets is lower.  The relevant measure ought to be income mobility, measuring how much people can gain in absolute income, and that is higher in America.  It's harder, for one, for immigrants to get ahead in Europe due to limits on hours worked.  I'm not sure how to interpret changes in mobility over time, but my gut tells me that it's easy today for educated people and more difficult for uneducated people.  

Friday, September 12, 2008


David Brooks happens to be my favorite New York Times columnist.  Granted, the competition isn't exactly fierce.  You've got Thomas Friedman, who I like to think of as an extremely perceptive five-year old, a handful of crazies in either direction, and a Manhattan cocktail party to reckon with.  

His last article, though, was just horrible.  He's been doing the communitarian thing for some time, which can be good, but which he takes too far.  "The individualist description of human nature seems to be wrong"?  Ignore for a moment that social scientist models are no more vulnerable to this critique than the ideal gas law is to the odd movements of individual molecules; that both deserve to be judged on the basis of empirical predictions, which he does not discuss beyond saying that there was a financial crisis. 

The larger issue is that the case for individualist politics is not predicated on empirical claims about people's autonomy.  But apparently giving people choices and lowering taxes is a mismatch between reality and ideology.  This would be news to Sweden, which has a robust private school system founded on vouchers, or Singapore, which has a healthcare system based on individual choice, or Ireland, which has thrived due to lower taxes.  Individual-friendly policies build healthy communities; collectivist ideas can ignore personal choice.  There's nothing wrong with paying attention to institutions--as he approves of Cameron for doing--and if that's all the argument is then I agree.  

The disturbing part is when Brooks goes on to talk about this in the context of McCain.  The national service, cause greater than yourself bit has, I suspect, been a big part of Brooks' consistent advocacy for McCain.  But where Brooks sees as wellspring of cultural revival, I see a toxic militant nationalism better suited for 300 than a modern democratic polity.  It's also a bit inconsistent with his pro-free trade, supply-side economics stance, but maybe McCain just really believes in the invisible hand.  This is as good a time as any to link to P.J. O'Rourke's brilliant commencement speech.

Correlation Not Quite the Same as Causation

I've talked before about the silliness of comparing conditions under Republicans versus Democrats and pronouncing one to be better.  After all, you have a sample size of around six, and without a causal pathway between the President and tangible policies, you're looking at noise.  

In interest of balance, I should point out that a University of Chicago professor, of all people, goes down this route in a WSJ article arguing that Republicans reduce the wage gap.  Granted, he's also written a paper which I haven't read, which may have more substance.  But the editorial is absolutely horrible.  There's no discussion of any policies that could drive this trend or even a thought given to the possibility that we have a Legislature which passes laws and partisan identity might matter there as well.  

This is one example of why data isn't everything.  Granted, small sample size is wildly skewing these results, and there might be something behind a more robust finding across, say, conservative parties worldwide.  Or it could be noise, or driven by some other factor (maybe people prefer a party in times of plenty; maybe they have an anti-incumbency bias in bad times).  Theory isn't dead, and that's something you might expect a Chicago professor to know.  

Thursday, September 11, 2008


Asia's wealth is largely tied up in its cities.  Cities such as Hong Kong, Singapore, Shanghai, Batavia, and Bombay were important colonial entrepots.  The first two escaped repatriation and became modern autonomous prosperous city-states.  Since then, Dubai and Abu Dhabi have joined the list, while Ireland and the Baltic states are similar in some respects.  These states enjoy solid institutions and good governance.  Without large hinterlands to wield political clout, they have joined a globalized world and focused on core competencies.  The key advantange is institutional arbitrage; neighboring areas have strong economic fundamentals but generally poor governance.  This leads to natural strengths in finance, commerce, and shipping.

I've been on the lookout for the next such state because they fulfill key niches.  Many countries are poor and have bad governance.  The gap between the richest and poorest remains large and may be widening in some places--increasing the gains from managing convergence.  And there is plenty of global capital in search of the next bubble.  Djibouti has been on my list, and things there are looking much better.  

The area is fairly significant.  South of the straits you have Punt; to the north Arabia Felix.  Fans of Orson Scott Card's lesser known works recognize the area as the site of the original fallen society.  It's also where modern humans first left Africa.  A key hub along the Egypt-India trade routes, it's hosted Roman, British, French, and American troops.   
Aside from American strategic interests, you have bin Laden's relatives looking into building a bridge across the Red Sea with world-class cities on either end.  It's an extravagant plan, likely to never take off.  Plans for more daily travellers than the Golden Gate Bridge are perhaps a little extreme.  But Djibouti has considerable potential, and its tough neighborhood sets a low bar for becoming the most investor-friendly location in East Africa.  I imagine a top-notch port, currently operated by the Dubai firm which caused a furor earlier in America, tapping into global markets.  A wide-ranging rail and road system stretching deep into Sudan and south to Tanzania, allows land-locked countries to trade overseas.  Special Economic Zones could be manned by migrant workers from Somalia and Ethiopia.  Key industries could include petrochemical plants for Sudanese oil, food processing units for Yemen and Ethiopia, garment industries, and French call centers.  With regulation currently fairly light, devaluing the currency, improving international presence, and investing in infrastructure ought to be priorities.  Security will guaranteed by the French and Americans.  With time, it could become a corporate and financial hub for North/East Africa and the Middle East.  Cash in now.  

Healthcare Inflation in Action

There's been a real shift in how much things cost. In general, goods have become cheaper through advances in productivity, offshoring, logistics, and retail, while services dependent on on-site humans have become more expensive. Soon advanced economies will produce all agriculture and industrial goods with perhaps five percent of the workforce, with prices approaching marginal cost for non-branded items (the surplus for branded items will be largely captured in rich countries--see the smiley curve). Higher commodity prices are disturbing this picture a little, as could increased protectionism, but basically you will pay less for your next computer than your current one.

Services such as education and healthcare are an entirely different world, and their costs have been rapidly escalating as technology improves.  Soon the other 95% of the workforce will work in these sectors. You'll notice Democrats talking about this issue a lot.  It's been a little puzzling why these costs continue to rise even under quasi-market conditions (though elective surgery, such as for lasik, shows the usual technology lowering price phenomenon).

Well, I'm currently working at a healthcare clinic and I can see a proximate cause.  For a given procedure, there is a Medicare-approved amount.  My office bills about twice this (other offices do three times this) to the insurance company, with the notion that most will approve about the Medicare amount.  But sometimes you get a clueless company that will pay out the full price.   Patients paying out-of-pocket or with a deductible pay the full, artificially high, price. Eventually, the insurance companies notice that everyone is billing them a higher amount and raise the amount they're willing to cover.

There are two good ways to solve this problem, and the American medical system is unique in that it pursues neither. The first is good old government price rationing, as happens in European systems.  That is unlikely to be politically feasible in this country.  The government, as Medicare does here, regulates prices to clamp down on inflation.  There are severe costs to innovation under this system, which would probably not persist without the massive research that goes in America.  A variant of this involves insurance HMOs directly negotiating with doctors and refusing claims.  This held down health care inflation in the 90s but was very unpopular.

The second method is consumer directed healthcare.  This happens to a large extent in Singapore, which maintains an excellent privatized healthcare system.  You pay into a health savings accounts--of the sort Bush championed--with some government covered catastrophic insurance.  A famous RAND study, however, found that such deductibles force patients to cut back on all spending, not just the wasteful kind, but there were some failures in the design (many patients dropped out of the study).

Ultimately high costs for healthcare are not bad.  Much of the money goes towards life-preserving care or consumption in hospitals (big screen TVs), and advances in technology--though costly--have improved life expectancy.  I'm somewhat committed to the notion that medicine is unhealthy, so I'll also say that medcine is different from health, and on net behavior impacts health more than medicine does.  But the problem is that so much of spending, at the margin, is wasteful, and is directly responsible for stagnating wages.   A great Cato dialogue calls for heathcare spending to be cut in half, which seems about right.  These savings can come from the fact that healthcare spending, even measured by Medicare reimbursements, vary dramatically around the country with little impact on treatment, combined with bloated administrative costs and the fact that American doctors have bizzarely failed to update to advanced information systems.

I have little faith that anyone will seriously make healthcare less wasteful and more affordable.  As I've mentioned, McCain's plan to end preferential tax treatment for employer-provided insurance is laudible, though he has little else to say.  In the end, Democrats will control Congress and they need to figure out how to prevent healthcare from dominating the entire economy.  We've heard how Bush's ridiculously bloated Medicare bill is insufficiently generous, and how it'd be great if more people had health insurance, but not a whole lot on how to pay for it other than "we'll modernize things." I really like the bit on evidence-based medicine, since I like anything that begins with "evidence-based," and healthcare can use it more than most, but it'd also be great if I could spend the rest of my life not dishing out a fifth of my income on healthcare.  

Wednesday, September 10, 2008

The Easterlin Paradox

One of the many reasons people dislike economists is this idea that they favor growing the pie rather than redistribution.  The resulting wealth inequality is a problem for some people, who argue that relative income is a bigger deal and equality is a moral value.  Many of these people choose to earn less money than they could.    

There's a good deal of truth to this.  Clearly people tend to compare themselves to a reference group.  But I've always been skeptical of this theory, because it doesn't seem to explain migration.  

As far as I'm aware, most people move accross or within countries in order to make more money, even if their relative standing drops substantially.  The reverse movement--people trading up in relative income but lower in absolute income--seems rarer.  Many people move to poorer countries, but such moves often increase opportunity or consumption.  It's always possible that people retain their peer group at home as a reference group.  But if reference groups are relatively fixed, a wealth-maximizing theory will yield better predictions of behavior.  
And now you have some evidence against this theory in the form of happiness surveys.  Sure, the whole happiness studies field is a little wooly, but numbers are awesome.  Kahneman, that radical right-winger, argues that income differences explain differences in reported happiness.  A more comprehensive study from some smart people at Wharton makes the same point with the same survey.  Some 90% of people with incomes over $250,000 count themselves very happy; something only 42% of people with incomes under $30,000 feel.  That group would not be happier if transplanted into a poorer country.  

It's easy to say that money doesn't make people happy, but development changes countries in all sorts of ways.  There are moral changes encouraging fellow-feeling, less discrimination, and the general spread of progressive values.  It's worth pointing out that liberals champion these values, while decrying the process by which they spread through society, and conservatives support the process, while harboring sentiments incongruent with the realization of an affluent society.  

My Dad the Political Analyst

He emailed Kerry to advise him to do the following strategy: Promise to not seek re-election unless he caught Osama bin Laden.  In general, I think that since people expect so little of politicians, genuinely selfless behavior is taken as proof of authenticity.  It's a good part of the appeal of the current Republican ticket; the prisoner of war and mother of a child with Downs syndrome.  Of course the "maverick" image, as well as the "putbull with lipstick" persona, are manufactured, but they really resonate with many people and will continue to do so despite all evidence.  At one point, McCain was considering a one-term pledge, and while clearly political self-interest prevailed, it would have been a great gesture.  

Tuesday, September 9, 2008

You Hooligans

Aside from the fall of communism, there's recently been plenty for libertarians to deplore.  The anti-fun liberal fascist conservative armada of Bloomberg-Giulianni-Biden has been doing a good job of scaring people and taking away things they enjoy.  Britain has been ground zero for this intrusive nanny state, what with their ID cards, CCTV cameras, and lack of guns.  I really hope this can be linked to the fact that the British are hooligans who roam the rest of the continent starting fights.  That is, in a pluralistic society, overly burdensome regulations may infantilize people instead of leading them to self-reliance.  

This is an issue in academia as well (beyond the fact that excessive education changes your brain to keep you mentally immature).  Say what you like about old economic research; at least it had pro-autonomy consequences.  These days, they look at your brain or drag some hungover undergraduates into a lab, pronounce them silly, and justify some extreme government intervention for a supposed ill.  The first case is especially strange.  Even supposing that we make decisions with either our impulsive mind or our calm mind; once you've decomposed the mind in that fashion, you no longer have space for independently judging one to be "better" than the other.  Or for judging bureaucrats to be less enfeebled than ordinary folk.  Nudging is very fashionable today, but I suspect it's just a way to make meddling less transparent.   

Let's talk about Social Security

I really dislike Social Security, both for personal and philosophical reasons.  And you should too.  Imagine for a moment that you are a progressive.  The taxes used to pay Social Security are perhaps the most regressive in the country.  12.4% of payroll income up till around a hundred thousand is taxed away, meaning that the poorest working families are hit hardest, and passed to a group wealther than average.  Something like 90% of Americans earn less than this anyway, so it's a virtual 12.4% tax.  There is no equity in charging a migrant farmworker this amount to give to people who have earned millions over their lives.

The program also happens to be racist, sexist, and generationist.  Life expectancy for blacks and hispanics is below average, so they get far less from the program than others.  Women tend to both work less in the formal sector and live longer, so they are disadvantaged as well.  Social Security is great for the current crop of old people, who--because of the baby boomers--enjoy a rate of return on their Social Security contributions far in excess of any other asset class in which they could have invested.  By all accounts, future generations are going to receive far less.  It's hard to estimate how much less, but it's been argued that young people currently paying into the system will receive perhaps 75% of their money back (promised benefits will have to be cut by about that amount in several decades).  Forget stocks or bonds--keeping the money in a matress under your bed would be a better savings option.  

Then there's the efficiency issue.  Savings money through other financial instruments--stocks, bonds, gold, baseball cards--would all generate higher returns for people.  Investment also gives people bank accounts and assets which they can transfer to others.

Now suppose that you are fiscally minded.  Social Security is going to wreck the government books as it becomes insolvent.  The scale of this problem is possibly exaggerated, and Medicare is potentially a bigger concern.  But the increase in the portion of beneficiaries to contributors will make this liability more and more difficult to pay off over time.

Political clout from old people prevents any serious reform, but simple fixes such as higher taxes and lower benefits can certainly bring the system back to solvency.  But they don't address glaring issues of equity and efficiency that ought to concern both liberals and conservatives.  

These problems ultimately come from the fact that Social Security is a pay-as-you-go system, rather than a defined contribution scheme.  A few countries have moved towards the second option, such as Chile, England, and Sweden.  I find Chile's system most appealing; you are forced to contribute a certain amount of your salary, which is then invested in various ways.  The returns have enabled millions to retire early.  Sweden also has an interesting plan, combining a partially privatized system (in which people are nudged to invest correctly) with a pay-as-you-go component which turns into an annuity, guaranteeing future solvency.  If you are liberal, or otherwise wish to limit or shape people's choices, there are plenty of ways to do so within the context of a private account.  Clinton reportedly tried to introduce a privatized component (which has become a suprisingly dirty way to say "you get to keep your money"), as of course did the second Bush.  McCain is unlikely to push this isssue, and Obama is for changes which will cost me even more over time.  I have little faith that this program will get any better, and cry a little on the inside every time I see my tax form.

Rumor Has it Obama is Popular in Other Countries

There happen to be many good reasons to vote for Obama over McCain, and I would probably make use of one if I were not currently disenfranchised. But there are even more bad reasons to vote for Obama, such as this idea that Obama is popular overseas while McCain is a Republican.

Take the example of France. As has been pointed out, though France overwhelmingly supports Obama, they made a different choice in their own curiously familiar election. A forceful, pro-American conservative from the unpopular ruling party battles a hopeful liberal in an election focused on transition and the economy. Sarkozy's success was based on his talking point that both parties want change, but conservative change is better and he can deliver it. Several people have pointed out that McCain needs to do something similar, and his convention speech was a step in this direction. But to the extent we care about the French, we should care about how they behaved when it come to a decision for which they bore consequences. On that choice, the French choose McCain.

But maybe overseas popularity is important because it suggests that people will like America again and bloodshed will stop. There are several issues with this. One, people just don't like America in general, as it's a unilateral power. People hated America when Bill Clinton was in office, and Obama signs on to the same platform of humanitarian intervention. Two, it doesn't seem like popularity among the masses matters as much as connections with leaders and geopolitics. That article discusses a bit how American policy towards Europe shows significant continuity between Clinton and Bush against popular wishes by local residents. Third, terrorists, like countries, behave on the basis of fundamentals, not Presidential identity. The candidate with better policies will face less animus. Last, Bush has been surprisingly effective in foreign policy his last few years. From improving relations with Japan, to nuclear deals with North Korea, to shoring up relations with China, to signing a Nuclear Deal with India--this is not what reasonable people expected to happen in Bush's lame-duck years. An Obama administration may very well turn out to be more effective on foreign policy than a McCain administration. But there are other issues at play.

Economics of the Iraq War

The first Gulf War was interesting in many ways. Baudrillard called it a war that "did not take place," suggesting that it was closer to a media event than a true conflict. It certainly showed the power of computers and television, and above all, of economic influence. It is one of the few wars to have come close to paying for itself.

The second Gulf War is, of course, very different, and a bustling cottage industry attempts to quantify its consequences. A sign in my liberal hometown (the crowd laughs with Stephen Pinker as he details Republican efforts to scrub profanity from the airwaves) records the number of dead U.S. servicemen, but the last I checked they had given up. As for Iraqis, an influential Lancet study estimated roughly 600,000 additional deaths as a result of the war, a figure that may be too high by a factor of four. By way of comparison, anywhere from 100,000 to 1.5 million Iraqis died as a result of economic sanctions and perhaps a million died during the Iran-Iraq conflict.

Accounting for the economic costs is also popular; though the fate of the Iraqis is given far less weight. Stigliz's estimate is fairly popular--.7-1.5 billion dollars directly, from which it's a hop skip and a jump to 3 trillion in total, indirect costs. There are many things to fault in his accounting--can we really blame the bulk of increase in oil prices entirely to the Iraq War?--but that's a post of its own. However, one of the biggest exclusions is the opportunity cost, since leaving Saddam in power to the present day presents unique costs. The AEI estimates long run net economic costs, taking some of this into account, on the order of one trillion.

One interesting perspective comes from Murphy and company, which tries to explicitly compare containment with intervention from a point of view before the conflict. I'm skeptical of anything Murphy says as he's a genius capable of convincing me of anything, but he makes a good case that containing Hussein bears costs too.

Whatever the case, ex post costs turn out to be large. But though budgeted costs by the Treasury are on the order of two or three hundred million dollars, there appears to be a relative comfort with the costs of Iraq--compare with Black Hawk Down for instance. I certainly expected a greater outcry, but costs relative to GDP and previous wars are low and are either borne by a disproportionate few or financed through debt. Plus there's no chance of a cost-benefit calculation when terrorism is involved.

One lingering puzzle I have is the relative lack of money on politics. By all accounts, this is going to be the most expensive election on record, with campaign spending of, what, 500 million? That's nothing compared with the magnitude of the costs of Iraq. Or of higher corporate profits resulting from the war--Halliburton went from a net loss in 2002 to profits of 3.5 billion in 2007, and also saw around a 300% appreciation in stock price. They would have done well regardless, but clearly the vast discretion given to the Presidency means that getting your guy to the top moves around billions if not trillions of dollars--yet the office itself goes for mere millions? Maybe campaign donations are stricter than I thought, or people are failing to coordinate their political efforts, or money is simply not that valuable in winning an election. Either way, some market is inefficient, and there's probably a successful trading strategy somewhere. At the very least, there should be more bad fiction on this subject beyond The Manchurian Candidate.

Monday, September 8, 2008

My Spiritual Journey

Recently I attended a talk by a spiritual master, whom I talked to beforehand. I reserve my judgment of him, but you might be able to guess. He had this to say:

Please thank [my mom] for me. Tell her it makes me feel like I am home with family to be with them all. I long to create our Vedic community at Mount Soma where all the people can grow to enlightenment. Also tell her that her son is wonderful and is/will be a great man. The time is coming where he will put everything together for himself. I would love be a part of his journey. The path to God is the path of neti, neti, neti…not that, not that, not that… He is doing very well traversing that path.

Sunday, September 7, 2008

Grand New Party Blogging

I've been meaning to write for some time about Grand New Party, a manifesto from two of my favorite conservative bloggers.  They spend a good deal of time trying, with mixed success, to counter claims that Republicans are racists who win elections by distracting poor people with social conservative flim-flam.  Their policy proposals--from wage subsidies to congestion pricing--are intended to refocus the Republican Party on the working class through market friendly, socially targeted policy.  They bear more than a passing resemblance to Clinton's policies--who, by the way, they give some praise.  I'm glad someone appreciates the degree to which Clinton was effective in passing conservative legislation. 

There is an inherent incoherence in a book aiming for both partisan dominance and policy effectiveness, and though it's hard to disagree with any of their policy ideas (thinly laid out as they may be), it can be hard to imagine the Republican Party moving in this direction.  Certainly Bush did much to advance this model of an activist government with faith upgrades, but his failures suggest problems and concerns with this approach.

First, you have the money problem.  Ross and Reihan are right to suggest that independence comes in many forms and their proposals would decrease overall regulation while perhaps increasing nominal government spending.  But as long as raising taxes is apostasy for a certain portion of the Republican base and curbing defense spending unthinkable for another, it's just not going to be possible to balance the budget, no matter how many earmarks you cut (curbing entitlements is a non-starter for both parties).  And even if consumption, carbon, and congestion taxes balance new spending, there is still the current deficit and exploding entitlements.  

Second, you have the tensions between the "destroy the government" and "reform the government" wings of the Republican Party.  It's easy to forget that Bush sold himself as a reformer with results who would work as a bipartisan fixer--a uniter, not a divider.  Many of the failures to follow can be blamed on partisans in the first set; figures such as Rice, Gates, and Paulson are responsible for Bush successes in the last few years.  So getting GNP right is an issue at least partially of competence.  

Healthcare is obviously a big issue, and I suspect Bush's failure to deliver on this will be remembered as among his worst.  There actually turn out to be a number of conservative options on this issue, as Ross and Reihan point out.  Republicans Romney and Schwarzenegger have tried to insure the uninsured, while even Obama's economic advisor praised the outlines of a plan to end the tax-preference for employer provided health care--that is, McCain's plan.  But it doesn't look like it's feasible for Republicans to present more comprehensive reform; even Romney played down his record in the primaries.  

In fact, Romney's downfall marks another failure of a modern conservatism to emerge from the myth of Reagan.  He first caught my attention as a data-oriented, pragmatic, power-point governor and potential nominee.  Then his pro-choice, Mormon, blue-state presence proved to be sufficiently offputting that he was forced on a righward lurch that both failed to properly endear him to the base and marked him as a flip-flopper to everyone else.  I would argue that Romney's predicament was less that he's a "slimeball" than it was structural; it's tough to be a competent executive, survive the base's gridlock vetoes, and appear genuine.    

In the end, as other reviewers have pointed out, many of these ideas are more likely to appropriated by Democrats rather than Republicans.  Ross and Reihan have a curiously outdated view of current liberal thinking.  In fact, as Clinton demonstrated, it's possibly easier to pursue socially liberal goals through market means than combine a fetish for low taxes with a heartfelt concern for the working classs.  Their agenda isn't unthinkable either--Cameron's Tories are set to accomplish something similar.  But in America, such a change will likely require a transforming persona with both right-wing credentials and a capacity for competent governance.  Bobby Jindal, who I don't just like because he's Indian, is one such figure--combining support from Gingrich with an ever mounting list of achievements, including on healthcare and education.  Sarah Palin may also prove to be another.  John McCain is almost certainly not.