Thursday, December 23, 2010

Growth vs. Population

Economists believe increasing population increases growth. It does increase gdp, but it does not generally increase gdp per capita. It can create larger markets and more specialization over time, but before it does so it also increases the supply of labor, lowers its income share, and diminishes the incentive for most technological advancement, labor saving rather than material saving. Population growth did not contribute to gdp per capita growth during the Malthusian Era. Only technology did that and population is better considered the result of growth than the cause of it.

The UK has had a stable population for over 30 years and has grown gdp per capita at rates greater than the US over that period. When population lags, investment in human capital becomes more attractive and takes up some of the slack. An aging population does slow demand growth, but still increases demand relative to supply of labor. They still need product even if they no longer need jobs. Growth slows but steadies. Transfers will rise, but government less transfers should steady or even fall with productivity as expansion is no longer necessary but sustainment still is. It does tend to be deflationary, but labor will do better than capital in such an environment. Nothing to fear, but something to expect. Need I say, deflation is (almost) always and everywhere a monetary phenomena?

In a world of more or less free trade, the question of whether population growth here is good is an anachronism. The real question lurking beneath the surface is if it were, why wouldn't population be growing on its own as a result? I am sure economists can come up with some excuses, but they fall flat in the face of evidence.

Wednesday, December 8, 2010

Welcome to the Antipodes

There is an argument that follows from the standard New Keynesian monetary model in cutting the payroll tax one should favor the employer over the employee. The reason being that current real wages are too high, so by lowering them to the employer, the employer will be encouraged to expand hiring, while increasing real after tax incomes of employees will just make them more high. Normally this would be correct, but not during a depression. The key element of a depression is the demand for money and its preference to the demand for goods. Cutting employer costs will increase their profits but their demand for money will override their demand for goods, investment or otherwise. They will not invest it unless they see demand increase which this won't do. Cutting employee costs will increase their take home cash and their demand for money would override their demand for goods, but they are frequently credit constrained. As they are more likely to be credit constrained, increasing their cash flow will lead to more demand for goods to which employers will respond. This is a demand, not supply problem, the demand for money. Giving money to those that need it most is most stimulative of demand. Given the regressiveness of the payroll tax, and the greater credit constraints of the employees, giving money to the employees is most effective. This would not be the case if demand were growing sufficiently, but will be until the demand for money is satisfied.

Friday, December 3, 2010

Employment for a Day

The problem as I see it, is unemployment. There are two approaches, blame the unemployed for their unemployment, saying what they produce is no longer desired and they must accept whatever they can find or go without resulting in deflation, or blame the employed, saying their wages are now too high and allow inflation to lower them and raise employment. The former attempts to preserve the value of debt but erodes the amount through default while the latter erodes the value of debt but preserves its amount. What do the employed owe the unemployed? What is the moral position and what will produce the best outcomes? Will real growth increase before inflation as well?

Deflation can work to a point, generally to the extent of productivity growth so nominal wages don't have to be reduced. Beyond that it doesn't. Deflation increases real debt faster than default can eliminate it. It is not effective in the face of high unemployment. Inflation can work to a point. That point is where most resources, or at least critical resources, are in use and it is anticipated. It is effective in the face of abundant unused resources. More inflation is warranted here and now.

Ideally, there is a middle ground that lets the most heavily indebted default, the burdened have their loads lightened, and promotes sufficient growth to ease unemployment. The same level of unemployment may not be reachable if the real output potential of the economy has fallen, but the only way high unemployment can be sustained is through both market failure and monetary failure.

Wednesday, November 10, 2010

Why is America Great?

While there are many measures of greatness, let us take one of the simplest, income. America does have one of the highest median household incomes in the world. It may not look as good if you consider income distribution, hours worked, benefits provided, or other security or quality of life issues, but it would still be very high. So why do Americans have such high incomes?

Culture and institutions undoubtedly have an effect. Immigration was proposed as an answer, but immigration is really an effect rather than a cause. People want to move to where they can earn higher incomes. One of the reasons they have higher incomes here is because there are fewer people for the available productive resources, natural and otherwise, relative to those elsewhere in the world. Immigration can be beneficial in bringing in resources, but only if it brings in more than it consumes or competes with others already here. Immigration is beneficial to immigrants or they would not chose to come, but is only beneficial to existing inhabitants if the immigrants are above the average inhabitant, whether in achievement, skills, or resources. Unlimited immigration would be a negative as population would rise to equalize endowments and incomes would fall towards average, until no one more would want to immigrate here. For some, all that matters is whether the immigrant is better off, but most will consider whether they are better off as well, both individually and collectively. Some, especially those above average, may be better off as there will be more below them, but they may not be if social cohesion disintegrates, neighborhoods deteriorate, and the country declines to third world status. What even will the immigrant have gained if they no longer have anywhere they would want to immigrate to or would not want to do so again? Immigration can be good, but there can be too much a good thing. The downside can be in the stagnation and lack of progress of country left behind.

Tuesday, August 31, 2010

Economics and Growth

Economists favor trade and wider markets to promote economies of scale and higher degrees of specialization. Yet trade increased widely from the feudal period to the modern period without producing sufficient growth to lift the world out of its Mathusian state, only technology did that. They prefer to side with consumers over producers, at least when they don't have ulterior motives, and often favor lower wages to lower costs and raise productivity. Yet wages were lower in the east, but the industrial revolution occurred in the west. Lower wages reduce the incentive to develop technology. Economic policies do not give enough attention to technology and do not always promote growth.

Manufacturing has been very productive and generally still is. While some services are productive, it is generally more the exception than the rule. Services, for the most part, have not been amenable to automation that produces increasing returns to scale, nor are they scalable for the most part. That is why they are still services and not goods. The differences are significant. Only technology accomplished lifting us out of the Mathusian state and know how itself was never enough but its embedding into tools that could be used without it. Services are costs. This is not to say they aren't desirable or valuable, but by themselves they are consumption rather than production. It is only when they and the knowledge they represent become embedded in the devices and processes of the world that they really become productive. As long as we have agriculture to feed us and industry to enrich us we should prosper. We are moving to a service economy, but that is something to regret, not celebrate. It does, however, offer us the potential of many more creations and discoveries, and many more new products as fewer are necessary to produce them. Due to this, workers are increasingly a cost that only serve to reduce the wages of others, unless they can partake of that creative process.

Tuesday, July 13, 2010

On Uncertainty

When a downturn occurs, the anticipated fails to materialize, our expectations are dashed, and uncertainty increases. The old verities have become less true. We become less sure of our beliefs and of what to believe. Our plans are drawn in, focusing less on the future and more on the present. The good times have gone and we struggle, not knowing how bad times will get, how long they will last, or how fast good times will return. What is uncertain is the future.

With stability and time, our anxieties recede and we become more confident of what tomorrow will bring. It is difficult to believe in the end of the world forever. As our worst fears fail to be realized, we become more sure of our position and its possibilities.

Stability and time can be hard to come by though. Since we were taken by surprise by the downturn, and uncertain about the cause, condition, cure, and what will happen next, we steel ourselves for more surprises, and if they materialize our uncertainty is redoubled. People will seek out uncertainty and take note of it at times like these as justification of their uncertainty and to avoid taking actions, but the real uncertainty is always the future. The search for new truths, for reassurance of familiar patterns, will continue until a new stability and a new time is made.

Monday, July 12, 2010

On Deflation

Deflation is rare but has occurred occasionally through history. As experience with it is very limited and much of common experience fails to apply, many of its features are counterintuitive. Existing theory is heavily flawed as a result. These are critiques of it.

As inflation is a signal to flee money and seek (fixed) debt, deflation is a signal to seek money and flee debt. Commonly, decreasing the price increases demand, but under deflation demand for money is stronger and falling prices allow the conservation of money, so lowering the price reduces demand.

Sticky prices lead to unemployment, but they also lead to, that is, preserve, employment. The problem is flexible prices would not lead to equilibrium in general, but to instability and swings due to everyone trying to anticipate and exceed everyone else's expectations. The problem is not that they are sticky but that they are not uniformly sticky for if everything changed in the same proportion it would be as if they did not change at all. It is really that this is not true initially that creates deflation and the reestablishment of this feature that ends deflation.

As prices fall, real balances rise, but the expectation they will continue to fall induces delay to purchase, not advancement. If you were becoming wealthier at an increasing rate, you would be more inclined to delay, but while sellers may be willing or forced to sell inventory below cost, they are not likely to produce below cost, so eventually price declines reach a limit of wage declines and real balances cease to increase. The duration of the production cycle would throttle the rate of decline. At this point, there is no more incentive to delay. If prices fall, wages also fall, and attempts to save more fail as they do so. It is not rising real balances that turns deflation around but that they cease to rise, or equivalently, it is not that real wages rise but that they eventually cease to rise.

Falling prices do not lead to increased output. Flexible prices would not lead to equilibrium. Rising real balances are the result of deflation, not its end.

Saturday, July 10, 2010

On Barter and Money

Under barter, economic actions are linked, production with consumption, savings with investment, wages with prices. One can trade for mutual benefit or accumulate assets and inventories but that is the only way to separate these functions, speculate, or store wealth. There may be excess or shortages of specific goods but never all goods at the same time. The hazards are vicissitudes of life, nature, and the market.

With money all these actions may be separated and wealth accumulated more conveniently. For these benefits, there is a price to be paid, and that is an shortage or excess of money. A shortage results in deflation while an excess in inflation. Both impair the function of money as a medium of exchange, deflation by elevating its function as a medium of storage at the expense of trade and the economy, inflation by lowering its function as medium of storage diverting it into assets and inventory. Money largely works through interest rates and credit, making investment more or less risky. This has real effects when investments fail or succeed, though they may fail due to the underestimation of risk as well as its increase and succeed due to the overestimation of risk as well as its decrease. Deflation can destroy money by credit contraction, bankruptcy, and making otherwise profitable investments unprofitable. Inflation can create money by credit expansion and making otherwise unprofitable investments profitable, some of which may only be profitable with inflation though these will be realized over time. These can amplify themeselves over time, but if not allowed to do so, economies can adjust and neutralize them over time. Otherwise it can lead to a return to subsistence and barter.

Saturday, June 19, 2010

On Intergenerational Transfers

Finance is simple at sight, whether the question is what a dollar will be worth sometime in the future, what a dollar sometime in the future is worth now, or what the net present value is of an income stream extending far into the future. There are assumptions and unknowns, of course, most of which we can estimate from past experience, if only roughly, and if only assuming some similarity between past and future, but these are the kind of assumptions we must make whenever we approach the future. The predictions we make can be informed and weighed and even reasonably accurate where we are concerned. Without some semblance of predictability, no actions can be planned and no expectations can be formed.

It is easy to believe that adding up everyone's expectations is sufficient to extend this to society and assume the same, but it would be wrong. The assumptions and unknowns that individuals face within a society are of an entirely different order than the assumptions and unknowns a society must face. Each of us is a small enough part of the whole that our actions and expectations do not much effect that of the whole, but the whole of us is broadly affected by the whole of our actions and expectations. As individuals we can estimate savings rates, inflation rates, interest rates, discount rates, return rates, and tax rates, but a society cannot because their actions and expectations are not independent of one another.

Finance is much more complex at heart, and a dollar in time is as illusory as our ability to predict the distant future. A society cannot assume a rate of return, they must produce it. A dollar in time will be worth whatever society will make it worth. Assets require considerable reinvestment over time to maintain their usefulness. Few have lives even approaching that of individuals, and changes in circumstance and technology can make them obsolete even before then. We inherit the natural environment, our knowledge and technology, our institutions and society, and the state of world as it exists, but remarkably little else over a lifetime. We have done well if we leave it improved.

We can acquire assets in other societies, but this is dependent on someone having the means and desire to acquire them in the future and not every society can have a positive net balance with every other society so these may be a poor store of value, but everything may be a poor store of value.

Money and time are considerations for work, debt, savings, transfers, and retirement. For an individual, societal rank is often more important than absolute level as it will determine their call on societal resources, and this is what their savings provides. For societies, absolute level is usually more important since others are more distant and this will determine their call on world resources and their standard of living. Most of what we consume must be produced shortly before, from perishable food, worn clothing, household maintenance, depreciating autos and equipment, and deteriorating shelter. Shelter and furnishings are among our longest lived personal assets and both require regular maintenance and upkeep. Little can be stockpiled and stored in any sizable amount for any considerable time. Our main choice, if it is a choice, is whether or when we transition from work to retirement. Even that is transfer in part since remaining in the workforce will lower the real wages of other workers. Dependents always live on the efforts of the independent. How well they live is largely dependent on the productivity and numbers of those providing for them. Debt, savings, and transfers are largely how we divide this output and all are burdens on producers, but production limits what can be divided. The lower the transfers the higher debt and savings and asset prices, and the higher the transfers the lower the debt and savings and asset prices. People retire on the economy they create and live off its product. Society may prosper or suffer and this is the greatest threat to work and retirement, not some numerical return that results.

Sunday, June 13, 2010

On Demand Curves

Normal demand curves are downward sloping. Lower prices will increase the quantity demanded and higher prices will decrease them. How do monetary conditions affect this? Deflation tells us prices will be lower in the future and falling prices tell us to seek liquidity and delay our purchases, inducing them to fall further. Inflation tells us prices will be higher in the future and rising prices tell us to flee liquidity advance our purchases, inducing them to rise further. Significant monetary conditions can invert normal demand curves and negate normal elasticities. Falling prices can lead to falling demand and output. Rising prices can lead to rising demand and output. They just can't do so predictably indefinitely because our expectations will adapt, but they can do so on the cusp of reversing.

Monetary conditions can be altered and are a necessary condition to a reversal, but are not sufficient in themselves. Expectations must also be changed. It is not enough to change the present if most do not believe you have the power or will to change the future. It is not enough to change the present if expectations are it will all be abandoned and reversed in the future. Demonstrations of power and will, of dedication and persistence, are not purchased cheaply. That can be difficult if you have built your reputation on fighting the opposite problem and don't want to lose it. You can't forget to seek stability, but you have to remember that involves fighting instability of both ends and persisting in this as the job is never done.

Tuesday, June 1, 2010

A Balancing Act

Economic growth has been very slow and risks returning to retrograde. The appropriate solution depends on the diagnosis of the problem.

If one views the recession as one of demand, a financial one, the problem is nominal and the solution is to provide more money. This could be the monetary authority purchasing other assets increasing their prices and introducing more money to the system, the fiscal authority running larger deficits whether spending more or purchasing other assets similarly. If the fiscal authority fears larger deficits or the monetary authority's willingness to absorb them, there is no reason they can't subsume some of the monetary authority's powers, suspend borrowing and merely credit their accounts with any amounts they deem necessary. We have no reason to fear deflation other than our own unwillingness to do what is necessary.

If one views the recession as one of supply, a resource one, specifically oil, the problem is real and the solution much more difficult. Oil is fairly unique in this regard. No other resource is as abundant in use and as difficult to substitute with substitutes generally being much more expensive. Its price seeps throughout the economy into everything. While inflation is low and unemployment is high, oil is still high at 2005 levels. Inflation could increase growth but even moderate growth could cause us to hit the supply wall and cause oil prices to increase faster than the economy can grow. They doubled over 2006-2008 and will do so again. The economy can adjust to moderate price increases, but prices can always increase by more than this. They must, since that is the only way for the market to balance demand and supply since supply is lagging. So unemployment may be the cost of keeping demand in check. Now inflation is low and somewhat higher inflation could be tolerated, but it could also shorten the time until we next hit that supply wall. The solution in this case is to accelerate development of alternatives though it is difficult to accelerate what is already urgent.

Let me say that I do not believe oil caused this recession. I do believe it could cause one though. I believe it lowered the growth rate to near zero and that we are growing now because it has fallen and if we grow much faster it will double again causing growth to collapse again and that we won't be able to grow solidly again without oil collapsing or competitive alternatives.

So does one increase inflation and growth now at the risk of a recession sooner or try to buy time for alternatives and supply to increase before one hits at the risk of incurring one now? It a balancing act.

Saturday, May 8, 2010

On Experiential Goods

Experiences are isolated episodes in our past. They have beginnings and endings and are intangible, existing only in our memories. This can make them more enduring than the tangible goods, more inclusive and encompassing of our lives in general, and more pleasurable as perception filters out the discomforting, the inconvenient, and the imperfect. We don't focus on what preceded or followed it, or even what annoyed or bothered us during it, only savoring the selective pleasures of it. Often you don't realize how much you enjoy something until it's gone, yet its absence makes the heart grow fonder. It is what makes it an experience in the first place and we focus more on gain than the loss of it. Then the fondness grows through reminiscence while familiarity breeds contempt or at least the discount of neglect of our present surroundings.

Products fulfill ongoing needs extending over time and are usually replaced by newer, better products that displace those of older ones. Products form a part of the substance of our experiences, but experience encompasses much more whose cost is often only the time to appreciate it such as nature or people. Aren't the best things in life free? Is there anything better than free? Experience endures through memory as products are consumed and deteriorate. Yet, I can still recall the satisfaction and memories of an old jacket lovingly worn out after twenty five years, or the comfort of a well worn pair of shoes that endured for years. How difficult it is to anticipate these though. Sometimes newer isn't better, and products end up as losses over time, reminding us of the transitoriness of existence.

Saturday, May 1, 2010

On Investment Singularities

The Gordon Dividend Discount Model establishes the price, P, of a stock based on dividends, D, at a required rate of return, r, that grow at rate g in perpetuity as P = D/(r-g). This has a singularity at r = g. While this may occur asymptotically or temporarily, it can never do so forever and always in a finite universe. There is always a finite number of people to bid for it, amount of money to buy it, or borrow against it. At most it would be potentially infinite with a trade off between those so wealthy they have no other outlet for their money and those for whom it is so much that the alternatives are as pleasant or even more so in case of boredom, and the impermanence of life and division between heirs or absence of them.

Consider too if our estimate of r-g were off by 1% or if when we wished to liquidate our investment it were off by 1% or if it drifted away by 1% over time. P would drop all the way from infinite to 100 D, so even if we thought we were getting a bargain, it could easily end up not being one. Our best estimate may be that of the next best alternative. Who would ever want to sell such an investment? Wouldn't the income flow ever be enough? If we were immortal, if our tastes never changed, if our investment never changed, perhaps not, but those are not that likely.

Saturday, April 24, 2010

On Downturns

This is a continuation of the analysis of downturns and managers in Productivity Sense and Nonsense, and More Productivity Sense. In essence, a sizable portion of the economy that was generating, thought to be generating, or thought it would generate substantial profits is discovered no longer, not to, wasn't, or won't, be generating them. Assets may have to be marked down and past investments written off, present ones reduced, and future ones abandoned. May be because these may be dependent on interest rates which may restore or increase profitability as they fall. The economy has had a hole blown in it that cannot be filled in short order.

As we left it, prices and wages are unchanged but quantity and profit has been reduced. In addition, due to fixed costs, profitability has been reduced. In the worst case, this can lead to high rates, loan calls, default, bankruptcy, asset liquidation, mergers, and sale of firms, when values are already distressed, but set this aside for now. Fallen assets and wealth, lowered profits and profitability, and excess capacity and reduced future expectations delay recovery. Prices and wages are sticky, and this can result in unemployment for some time, but this does not cause output to fall or prevent it from falling initially.

Managers would like to sell more to increase their profits and profitability, but as most everything is overcapacity, they can do so only at the expense of others. They may be tempted to lower prices to increase quantity, but this is by no means certain. If their customers come to expect lower prices in the future they may delay rather than accelerate purchases setting up deflationary expectations. Cuts in prices and wages may further intensify this into a downward spiral.

If real wages rose at an increasing rate, buyers would be more inclined to delay, but while sellers may be willing or forced to sell inventory below cost, they are not likely to produce below cost, so eventually price declines reach a limit of wage declines. Prices, initially more elastic than wages, would fall to the point their elasticity matched that of wages. The duration of the production cycle would throttle the rate of decline since sellers will want to make sure their costs are covered. Only when prices and wages have stabilized will the downturn end. At this point, there is little more incentive to delay. If prices fall, wages also fall, and attempts to save more fail as they do so. In this case, rising real wages do not terminate deflation but are triggered by it, and that they eventually cease to rise that end it. So while sticky wages result in unemployment, and less sticky prices can result in deflation, sticky prices and wages eventually prevent total implosion.

Finally employment income and output stabilizes at its new lower level. The workforce continues to increase and productivity rises, leading to increasing output and rising unemployment until output grows fast enough to add more workers than by which the workforce is growing.

Monday, April 19, 2010

On Minimum Wages

Most of the poor do not earn the minimum wage and most of those that do are not poor, so raising the minimum wage may not be the most efficient means of helping the poor.
If you want to help the poor give them money. The easiest way of doing that is giving everyone a minimum amount of money and taxing back that above the minimum. The reason this is done through wages rather than directly is to encourage productive work. The down side is it misses those unable to do so. No solution is without its problems. Providing money without a minimum wage would discourage work. A negative income tax would be more efficient in distribution but less efficient in collection. Encouraging lower productivity work would encourage employment but discourage innovation.

We could use more information on the poor that don't earn the minimum wage, and whether they are retired, disabled, unemployed/unemployable, employed at higher wages but seasonally or limited hours, students, single parents, large families, or experienced a capital loss. Just as low wage may be a poor measure, poor may be as well.

I can see three scenarios, 1) there are no gains only losses, those with lower productivity lose their jobs, 2) employers are labor short and forced to pay them more than their productivity, there are gains for workers but costs to employers whether passed on to customers or not, or 3) employers are labor short and invest to raise their productivity, gains all around.

I place little emphasis on scenario 2. I don't believe the employer will accept lower profits other than temporarily and if the employer can raise prices, they have raised their productivity. The argument against a higher minimum wage is not that it doesn't much help the poor but that it will mean more unemployment among the unskilled, fortunately that falls mostly on the non-poor. It will help the skilled somewhat, and innovation can help everyone more. Still, there is little evidence lower real wages (due to inflation) increase unskilled employment. Mostly, it just causes people to leave or not enter the workforce, but this is likely due to the minimum being below the market wage in substantial portions of the country.

One should equate wages to the marginal productivity of the work, not that of the worker. This is why raising the minimum wage can increase productivity; it can induce the investment necessary to do so. This is not without cost, and there are limits to what it can achieve, but this may be a better reason to support it than helping the poor.

A minimum wage can be useful if it leads to productivity boosting investment, or as a demarcation between welfare and work, but those are fairly limiting roles for it.

On Rising Debt

Debt service may be a better measure than debt unless one assumes some more or less constant reversion to a mean discount/interest rate. It is at least useful to consider the two, debt service and discount rates, separately. There are, of course, good debts and bad debts though the portion is adjustable through discount rates.

A borrower will look at it in terms of debt service. If it isn't rising neither they or their lender will be too concerned about repayment. If it is rising, they are either optimistic, speculative, or desperate, and the means to turn debt into equity, and the lender better know which, whether reasonable, and what the collateral is valued at.

A lender will look at it in terms of interest rate. Lower rates may mean increased wealth or reduced investment opportunities or increased risk aversion. If it is falling, borrowers are not borrowing enough and it is contractionary for the economy, but will lower debt service and allow the pursuit of lower return or riskier activities. In general I would say it is a case of dismal expectations or people would be investing in equity rather than debt, but perhaps not as dismal as feared, leading to better equity returns in the future.

Since no one is forced to borrow or lend, borrowing, in terms of debt service, must be seen as, a possibly unwarranted, but fundamentally optimistic act, and retreat from it as either the payback of a successful result or a failed one, but one must be wary of exuberance and despair, conscious of the investment being undertaken, and aware it can't grow without limit. A falling rate should be seen as concurrently negative but hopefully prospectively positive event.

Overall, the change is more significant, but the rate can change faster than the debt. Demographics, fiscal and monetary policy, risk aversion, or available investment opportunities may all alter preferred levels so the result can be difficult to interpret.

Is debt good though? Certainly the rate will determine whether it can be repaid or not, but ideally should the amount of debt change? I think not. Ideally, demographics are stable, the economy grows at a steady rate and offers a steady stream of investment opportunities and a steady return, and booms and busts don't occur. In such a world, there would be no reason for debt to change, but it isn't an ideal world. It might be rather boring if it were. What needs to be asked is whether optimism or pessimism is warranted or not. If not, debt should be headed in the opposite direction. Sudden changes may be necessary, but they are suspicious.

More Productivity Sense

A manager, when faced with a reduction in demand, responds with a reduction in supply. He takes his input prices as market driven and by setting the productivity of some to zero, allows the productivity of the rest to stay at or return to their previous level. This frees resources for else where while maintaining competitiveness. This is normally the correct response. The manager knows his demand is falling; he cannot be expected to know most everyone's demand is falling. To expect different behavior under different conditions which are unclear may be to much to ask. Moreover, maximizing employment and work is not the main goal of society; maximizing living standards is. While reducing wages, work sharing, or tax redistribution can increase equality, it is just redistribution and doesn't increase living standards.

In a downturn, the economy itself has become less productive. The engine of the economy has failed and the train is coasting and slowing down. Most of it was only boxcars being pulled along by it and redirecting fuel to the boxcars won't accomplish anything. Only another engine will power the economy. The problem was not that the engine ran into trouble; all engines run into trouble. The problem was there were no other engines to reduce the load on that engine and prevent it from failing and take up the slack from it. About the best that can be done is support and sustain those laid off until the economy can reabsorb them and allow low rates and inflation to promote economic adjustment and growth of small but profitable businesses.

Saturday, April 17, 2010

Changes in the Standard of Living

Comparing standards of living across time is essentially an impossible task due to changes in circumstances, conditions, lifestyles, and technology, but is still fascinating to think about. A clever way of considering this is to ask, if your income and wealth were doubled, but you would have to live in the past, how far back would you be willing to live. By this meaning your rank in society would be equivalent of the current rank of someone with double your current income and wealth. One should assume no future knowledge after being transported back to then. Inevitably there is some preference due to what we know occurred back then, such as growth during the 1950s, but one should try to set this aside as if you did not know. One problem is it may actually be more growth rather than level that attracts someone, but in this case how far in the past would not be a meaningful measure. Assume all consumption would be in the products available then with lifestyles changed to accord with what was available. For example, twenty years ago there would be no internet, or at least world wide web, so all the time spent on it would have to spent on other things like going to the library or on television. For someone that grew up with it, it is probably difficult to imagine what life must have been like without it, so age may limit how far back one is willing to go. Nor should one consider this a vacation, but a permanent one way trip since every time could be interesting if we could always go home. So this is primarily about what value you place on changes in lifestyle and technology over that time and how much you are willing to give up as well as get in exchange. For it is not just a matter of giving things up but appreciating other things like less population and density, more local social activities, and a slower pace of life. While technology changes, there is always some earlier technology to substitute with a reduction in utility like paper for the internet, or landlines for cellphones. So how far in the past would you be willing to go?

I don't see much of a problem going back 30 years for double the income and wealth despite the vast changes the lack of the internet and primitiveness of pcs would impose. I could do without gps and cellphones. On the other hand 50 years with its lack of air conditioning and microwaves would be pushing it although I could live in some pretty nice areas and eat out to compensate. Going through the energy crisis again wouldn't be much fun though, not only the crisis itself but the poor growth of the period as well. From this, I subjectively judge the real growth rate of the standard of living to be more than 1/50, 2%, but less than 1/30, 3.3%, which is quite close to measured real gdp per capita changes. Thus I see little mismeasurement in the official statistics as a result. Your feelings may differ.

Productivity Sense and Nonsense

One often hears "workers are paid according to their productivity" and "the least productive workers are laid off first". These are mutually incompatible statements as commonly used. Either workers are paid according to their productivity, meaning no productivity basis exists for determining which are laid off, or they are paid on bases other than their productivity and laid off on that basis. Productivity is just output over input. If workers are paid for their productivity, the input, their wages, has been adjusted to equalize productivity among workers, so how can some be less productive than others? Individual productivity may be difficult or even impossible to measure, but that would just mean it is irrelevant to pay and both statements are false. It may be difficult to anticipate when hiring, but new hires that don't work out are often terminated, and if not, wages can be adjusted by raises or their absence over time. There is only one sense in which these statements can be understood together.

In a downturn, what changes is the relative desirability or values of outputs, not inputs. The price usually doesn't even change much, but the quantity demanded. It is the work that becomes less productive, not the worker. Prices are sticky and wages are even more sticky. The worker that is laid off is no less productive than the co-worker that stays behind, rather, the workers that suffer layoffs are less productive in the sense of being less desired than workers that don't suffer layoffs. Productivity is an industry concept, only wages are an individual one. It is not productivity the manager uses in selecting which workers to lay off, rather, it is desirability the market uses in selecting which industries to reduce. Managers could reduce prices and wages to maintain quantity and employment, but some costs are fixed, some work has to be done, and some are other inputs over which they have no control, so it is easiest to treat both prices and wages as fixed and allow quantity and employment to fall. So what criteria do managers use in layoffs when all their workers have become less productive in the sense of desired? They may choose to layoff those with the highest wages to minimize number of layoffs and keep those more able to improve or less likely to demand their productivity or cause trouble, or they may select on connections or influence, pliability or sociability, seniority, or even age, race, and sex, but it is not productivity, per se, in the common sense of the meaning. Layoffs are fundamentally about discrimination. This is probably why most managers dislike doing it, or at least the good ones.

Thursday, March 18, 2010

Formative Books

I have read so much that few books rise above the rest. While I have read my share of fiction which often has deeper and truer ideas than nonfiction, mostly I read nonfiction and more recent works often leave a more vivid memory.

1. The Foundation Trilogy, Isaac Asimov. Like Paul Krugman, I did find the conception of psychohistorians captivating.
2. Louis XIV, John Wolf. A tale of power, wealth, and the fragility of life. Puts life into context when the most powerful man on earth is succeeded by his great great grandson, faith restoring for me.
3. The American Class Structure in an Age of Growing Inequality, Dennis Gilbert. The distribution of income and wealth as a parade of midgets.
4. The Wealth of Nations, Adam Smith. Perceptive in observation, reasoned in analysis, careful in conclusions, pragmatic in application, a true philosopher at work.
5. General Theory of Employment, Interest, and Money, John Maynard Keynes. The sum can be more than its parts, economic relativity.
6. The Worldly Philosophers, the Lives, Times, and Ideas of the Great Economic Thinkers, Robert Heilbroner. A history of economic ideas and placement of them in context, revealing in scale and scope, there is progress.
7. Adam's Fallacy: A Guide to Economic Theology, Duncan Foley. Some of the problems of his followers.
8. Economics and Evolution, Geoffrey Hodgson. When action in self interest is in common interest.
9. Guns, Germs, and Steel, Jared Diamond. Human civilization.
10. Farewell to Alms, Gregory Clark. Economic archeology overturning theory with fact.

Some formative video series, I usually read the book afterwards.
1. Cosmos, Carl Sagan. The universe.
2. Life on Earth, David Attenborough. The evolution of life.
3. A Glorious Accident, Understanding Our Place in the Cosmic Puzzle, Wim Kayser. Human consciousness and thought.
4. The Power of Myth, Joseph Campbell. Human culture and eternal verities.
5. Guns, Germs, and Steel, Jared Diamond. Human civilization.

Tuesday, March 16, 2010

Ricardian Equivalence Holding

For Ricardian Equivalence to hold, fiscal policy must be exogeneous and that can only occur if it is unexpected; if it is expected then such policy actions will have already been anticipated and incorporated into actions. Ricardian Equivalence cannot hold for an event it is already holding for. The problem here is the government action is not exogeneous because it is anticipated, but rather than an argument against stimulus, it is an argument that the government has no choice but to stimulate because that is what is expected of it. If government starts raising taxes during a recession or cuts spending during a surplus, pays down debt during a recession, or increases borrowing during a boom, it may hold, otherwise there is nothing unexpected about such actions and they do not constitute an exogeneous event. After more than a half century of Keynesian stimulus, the idea fiscal stimulus can be unexpected is incredulous. Rather, lack of stimulus would be unexpected forcing people to modify their behavior accordingly if they are capable of doing so, which they may not be able to if they are credit constrained. The real surprise may be that combining state and federal spending, there has been no stimulus.

Friday, February 26, 2010

Leverage and Risk

Leverage alone doesn't cause recessions, so there is no problem with leverage, right? No. Leverage increases the risk of recession due to an unexpected shock, and adds rigidity to the economy making it more difficult to deal with the result. Leverage is often the symptom of other serious problems such current account imbalances due to mercantilism, or an unwillingness to face the real risk of investing for the future, or subterfuge in submerging real risk beneath the surface. Investors may prefer a lower exchange rate, or saving to investing, or the illusion of risk avoidance, but these are not necessarily in the interest of the country or the economy as a whole. Investor preferences are often the result of government policies themselves, so we need to make sure what we encourage is what we want.

Leverage is a tool and not good or bad in itself. One should expect leverage to grow with more productive opportunities and the income to support it and diminish with fewer of them and reduced prospects. One must be extremely cautious of leverage for other purposes, such as for currency manipulation, or to increase consumption or speculation. Increasing leverage is expansionary while decreasing leverage is contractionary. There can be real dangers to our economic financial well-being due to leverage and risk.

harply increasing leverage demands negative real interest rates to combat it, more inflation, but increasing asset prices can cause bubbles and keep real interest rates too high until they burst. Trying to avoid risk by shoving it onto government isn't avoidance at all. Unless we really want the socialist paradise where government is the only equity owner and everyone else can be debtors and lenders, it is in public policy to discourage it.

Thursday, February 11, 2010


Risk depends on concern and time. If you are unconcerned about the future, or concerned about a loss of future value, you may prefer to consume rather than save, or save rather than invest, or prefer short term to long. If you are unconcerned with the present, or concerned about a loss of future income, you may prefer to invest rather than save, or save rather than consume, or prefer long term to short. These preferences are not fixed but will change with your position, your income and wealth, your attitude, concerns, and expectations for the future, including the expectations of others. Risk varies across assets as well as time and people can differ in their reaction to these different kinds of risk. Often it is not your perception of risk but your perception relative to that of the market that matters. Since income risks, sources, and sinks, range and vary over time, a diversified portfolio generally provides the best match.

Tuesday, February 9, 2010

A Theory of Bubbles

Everyone has a personal discount rate that informs them and determines how much of their income they save and how much they spend, how much they invest and how much risk they will take. This will vary with income and expenses that they have become accustomed to, their wealth, changes in these, and with theirs and others perception of risk. The weighted sum of all these individual rates produce a market discount rate. Those with discount rates greater than the market I will call traders and those with ones less than the market, investors. Individuals may experience individual changes that move them between traders and investors, or changes in the market rate may move them from one to the other. While some movements are conscious and deliberate, others are often accidental and disconcerting and they will adjust their portfolios to return to their relative position.

Investors trade little and are mostly fully invested, but their flows into and out of the market are fairly steady forming slowly changing trends that are part of long term investment fundamentals. Traders trade often setting market prices at any given moment and their shorter term focus leads them towards short term value or momentum investing. An investment that starts out fairly valued according to long term fundamentals may experience a some unexpected good news. Traders will become encouraged and bid up the investment. Others will see the increase and bid it up more. The more that can be persuaded these represent long term fundamentals, the more investors will see it as less risky and join in, raising the price more. Eventually the number of new investors that can be persuaded diminishes, possibly due to exhaustion of supply or some less positive information. Value traders will have begun seeing it as overvalued and began selling. Prices after holding steady for a while will begin to fall. Momentum traders sensing weakness will shift from long to neutral and eventually short causing them to fall further. Some investors realize those weren't long term fundamentals, come to see it as riskier than they thought, or realize their risk tolerance is lower than they thought and sell more. Eventually the number of investors that were actually traders falls through attrition and declines slow. Value traders come to see it as undervalued and begin buying. Momentum traders sensing strength will shift from short to neutral and eventually long. Prices will once again rise to their long term fundamental value. This appears as short term embellishments on long term trends.

The price changes caused by traders are large compared to variations in long term fundamentals but usually small compared to what is called a bubble. Yet these microbubbles seethe almost continuously keeping the market perking. For one to get large by market standards some conditions usually must be present. A long period stability can encourage the dismissal of risk. Lower interest rates can provide a notable initial bump. Innovation and a story can obscure fundamentals and cause investors to believe in a new era and this time is different. A large number of increasingly wealthy but inexperienced traders believing themselves investors that entrain themselves into the bubble without much fear of loss. Once one bursts, it can be difficult to reinflate since they have lost a sizable amount and become highly skeptical of any new one, at least in the same asset class, while those who profited have to resort to trading in a new asset class they are less familiar with in the hope of finding more. Eventually traders are faced with the more difficult prospect of profiting at each others expense, trading success and interest diminish, and after a long while, after it proves itself again, long term investing comes back into favor.

Friday, February 5, 2010

Efficient at what?

The primary problem is people misinterpreting and overinterpreting EMH, often as not its proponents as its opponents. It actually says very little. Like Yglesias, if it were called the unpredictable market hypothesis, it would likely both be more widely accepted and less controversial. The problem is efficiency is equated to rationality but if markets were rational prices would not be subject to tectonic changes, nor would they vary widely from fundamentals. Markets may be efficient at reflecting our beliefs but our beliefs are not necessarily rational. Often people interpret it as markets may not be efficient but they tend towards efficiency (rationality). Yes, markets can stay and increase their irrationality longer than you can stay solvent, and when everyone is being irrational, there is efficiency in being irrational.

If one interprets information in an objective sense, then efficiency would imply rationality, but if one interprets it as future expectations, and especially as expectations of others expectations, then there can be no objectivity nor rationality because we are not considering the past but the future, all information concerns the past, and we are free to imagine any possible future. As future becomes past these expectations can swing wildly and imaginations can trample the hardiest of fundamentals. Imaginations are free to soar and plummet even as fundamentals keep us tethered to the realities of the past. Markets are efficient at reflecting our hopes and skepticism, greed and fear, dreams and nightmares.

Progress in Economics

What does it mean to make progress in economics? I was thinking of how Austrians are the logical descendants of the Free Banking School, Monetarists and Keynesians of the Currency School, and Real Business Cyclists of the Banking School, and how little the arguments have changed or disagreements have been settled. There may be more acceptance of a variety of causes of recessions from low interest rates and credit expansions, to high interest rates and credit contractions, to exogeneous shocks, or perhaps not. There may be a broader diffusion of responsibility from government regulation and central banks, to banking and market misjudgments or non judgments, to changes in circumstance and new information, or perhaps not. There may be more ambiguity as to problems and solutions and their effectiveness and efficiency, or perhaps not.

It also brings to mind what is meant by cause. If there is a cause than removal of the cause should prevent the effect, while if many causes it may only shift the source. If the cause may not be removed it may not be possible to prevent the effect, but if the cause may be addressed the effect may be remedied ex poste if not ex ante. If a cause under our control is powerful enough to create an effect, it must also be powerful enough prevent or remedy one, or if not, there is nothing to be done. If one has the power, one also has the responsibility, and while it may be disclaimed, it can never be disavowed. If we are capable of doing bad, we must also be capable of doing good. Causes are often selected more for the remedies they offer rather than their actual effects. This is bad science but can be in one's self interest and difficult to resist.

Science progresses through incorporation of the useful and elimination of the unuseful, and we shouldn't expect valuable insights to disappear, but neither should we expect fringe views to disappear on their own. If there weren't some truth to them they would have never been adopted and if there weren't some utility to the promulgators they would have never been kept. Progress is possible but often painstaking.

Saturday, January 16, 2010

Efficient or not?

If prices are unpredictable, then rational behavior is an impossibility. If rational behavior is possible, they must be at least somewhat predictable. They may be more predictable in the long term than the short, but without predictability no coherent action is possible.

Equating price to value eschews any independent assessment of value. Without any fundamental value, prediction can only be extrapolation, and extrapolation leads more or less directly to bubbles. Extrapolation can take several forms, historical, momentum, or statistical, but they all rely on predicting future price from past price and change in price. Price is not always value. Often it becomes an assessment of the value of others, an assessment subject to wild speculation in the absence of any fundamentals. Stocks have earnings and real property has rents and while these are subject to change, they aren’t totally unpredictable, but once people focus on price and price change, they are no longer investing but speculating. Speculation may be self correcting eventually, but it is not necessarily in the short term. Speculation can feed on itself until the ponzi scheme runs low on new entrants or encounters a sufficient number of defectors. Prices then collapse to or below fundamentals.

It is precisely when people give up making their own prediction and rely instead on the predictions of others that trouble arises. They are no longer interested in the prediction, but what others believe and predict, what others perception of value is. They can then extrapolate that to absurdity.

For debt to be supported, income must exist to repay it. Where was income all these years? Flat to falling. That does not support growing debt. We were well into the ponzi finance stage. The big money is jumping on the bubble while it is inflating and only jumping off and shorting when it is about to decline. That is what makes bubbles unpredictable, not that they don’t exist, but that they require market timing. And there are winners, but fewer than losers or a bubble wouldn’t have inflated in the first place, and the interest of the most knowledgeable is not to counter the bubble but to feed it. Bubbles start in uncertainty, grow to absurdity, and burst unpredictably.

The flaw of efficient markets is to equate price to value, making price the fundamental value, forestalling the real search for value, and defining markets as efficient rather than ask the tough questions of how efficient it is and whether that efficiency is increasing or decreasing. Until we go beyond it, we will get nowhere.

Wednesday, January 13, 2010

Economics and Ethics of Walking Away

Business has perfected limited liability and asset stripping that turns business into one sided options. A non-recourse mortgage is really nothing more than a limited liability company. Now if someone wants to argue in favor of absolute liability and doing away with the corporate structure and business as we know it that is one thing, but to argue business should have privileges and perks unavailable to individuals is grossly inequitable.

After a crisis short of people operating economically rationally, I don’t think encouraging people to continue acting irrationally is reasonable. Let people weigh all the benefits and costs of their actions and decide what is best. We are all better off from such actions, not just some lender that acted irresponsibly in the first place. Some will err and suffer for it as they should, but don't insist people have an ethical duty to act contrary to their interests. Economic thought and behavior needs to be encouraged, not negated, for that is the truly ethical path.

I have no objection to changing the rules, but anyone following them is behaving ethically. If you don't consider something ethical or socially desirable, you should focus on changing the rules, not superimposing an ethics contrary to them and then blaming people for not following them. I do not blame finance for unethical bonuses, but I would for their part in setting the rules that allow them. Economics and ethics in conflict indicate inappropriate rules. Under the rules we have adopted, this is not an ethical decision but an economic one and should be treated as such. It is, and should be, just business.