Tuesday
Aug172010

Still here

I haven't posted for more than two weeks primarily because my computer broke and isn't yet fixed.  I can get to the internet with my backup machine, but my drafts, backup materials, RSS feeds, etc. are all on the broken machine.  I don't expect to get it back before August 20.  Perhaps I'll have something to post next week. 

Wednesday
Jul282010

If trade liberalization makes America better off, how much better off?

Yves Smith is on vacation and has rerun here an excellent post from 2007 discussing estimates of how much trade liberalization may increase GDP.  She draws from a Dani Rodrik post showing deep flaws in the work of Bradford, et al. who presented large estimates of gains from trade liberalization.  What gives the Bradford work public policy significance is that it had been cited approvingly by Ben Bernanke in a then-recent speech. Smith also did some of her own analysis and linked to other work calculating total US gains as low as 0.1% of GDP from fully open global merchandise trade. That's the upside when the real world is functioning as imagined, not with its actual imperfections. 

The Smith/Rodrik work aligns with Paul Krugman who is telling current students this:

1. Major growth effects from trade policy, if they exist, must come from unconventional channels. Conventional trade theory DOES NOT justify claims of huge positive payoffs from free trade.

2.  In the politics of trade policy, distributional effects can easily swamp concerns about efficiency.

(Emphasis in original.)  It's worth keeping in mind that Krugman's Nobel Prize was for his contributions to modern trade theory. 

The gains from trade liberalization--if they are there at all--come at the social and economic cost of shifting distribution of income and wealth away from ordinary Americans and to capital and MNCs.  Clearly, we paid those costs, but whether there were any overall gains is questionable at best. 

Saturday
Jul242010

The interests of nation-states and global companies have diverged.

There was a time when the fortunes of the biggest companies rose and fell with the fortunes of their home nations.  That is why Charlie Wilson could credibly say in 1953 that "What's good for General Motors is good for the country," and why it would have been hard to imagine GM wanting to weaken America economically or in any other way.  However, those days are gone, says Zachary Karabell in Time magazine's Curious Capitalist column.

The companies of the S&P 500 now make about half of their sales outside the U.S., and if you remove geography-bound utilities and railroads, regional banks and a fair number of retailers, the percentage is higher. Tech and industrial firms such as 3M, Hewlett-Packard and Intel derive two-thirds or more of their sales beyond the U.S. That means that even if the U.S. economy is a total wash, they can access other markets to maintain their growth. The same might be said of a German conglomerate like Siemens, a Dutch powerhouse like Philips or a Korean company like Samsung.

These global companies can be very profitable even if the economy in their "home" nation is in the dumper. A rise in their earnings and stock prices is no longer a leading indicator for an economic recovery at home.  They do not need to support national policies that are good for the economy as a whole, or for the broad population or the government itself.  Indeed, such policies are likely to be antithetical to the interests of these companies.  Karabell concludes:

As companies report their earnings for the second quarter of 2010, it will be harder than ever to escape the fact that corporations now inhabit their own thriving economy, unencumbered by many of the ills of nation-states. That may be exhilarating (if you're an investor) or troubling (if you're a citizen), but either way, it's time to let go of the false belief that as goes the economy, so go companies and their stocks.

Thursday
Jul222010

Keeping Senatorial candidates under a microscope 24/7

The Democratic Senatorial Campaign Committee has launched a very clever and cheap negative campaigning tactic.  At We Couldn't Make This Stuff Up--Republicans in Their Own Words, is a US map which, if you click on a State, opens quotations of stupid, outrageous, or goofy things the GOP Senate candidate in that State has said.  You can even sign up to get text message updates of candidates working against themselves. One thing that seems attractive about this text subscription is that you'll (presumably) get only the juicy bits that you can laugh at or get outraged about, and can enjoy passing on virally without including a lot dull stuff and, dare one hope, without a DSCC plea for money.  Presumably, this doesn't reach directly swing voters in large numbers, although they may get the quotations virally, but I would think this has great potential to help energize the base.  Me?  I've turned off the text message service on my mobile phone. 

Tuesday
Jul202010

“I believe in order to understand.”

The title quotation is usually attributed to early Christian philosophers St. Augustine and St. Anslem who stressed faith over reason in that great philosophical debate, but I'm more interested in Spinoza's version that belief is the first step in the process of reasoning. Disagreeing with Descartes, Spinoza argued that the way our minds work on new ideas is a two-step process—first, accept a statement as true, i.e., believe it, and then in a second process, which may not occur for various reasons, subject the new belief to critical reasoning and confirm, modify, or reject it.

Edward Harrison writes about this in Spinoza, Descartes and suspension of disbelief in the ivory tower of economics.

Descartes was of the view that people process information for accuracy before filing it away in memory. Spinoza made the opposite claim, that people must suspend disbelief in order to process information. The two competing ideas were put to the test; and it appears that Spinoza was right about the need for naïve belief, something that has grave implications for investing, the subject of Montier's essay [from which Harrison quotes at length].

Harvard psychology professor Daniel Gilbert has pitted Descartes against Spinoza in the laboratory. The experiments involved giving the subjects information and then immediately subjecting some of the subjects to distractions that, it was hypothesized, would interfere with the second, truth-testing and pruning step. It worked; more of the distracted subjects believed as true the untrue information. Harrison accepts the empirical evidence that belief is a precondition to understanding a la Spinoza, but says we have deeper—he says lizard brain—resistance to considering challenges to pre-existing beliefs that are important to us.

What Gilbert, Petty, and Montier have demonstrated is that human beings have to suspend disbelief to process information and make judgments based on that information. Unfortunately, distractions (think bread and circuses) can lead people to believe something is true when in fact it is not – with grave implications for investing.

However, that's not what happens with strongly-held beliefs at all. I remember talking to my mother about the Montier post, asking her about her own strongly held views on religion. Her answers were interesting because it demonstrated to me an unwillingness to even process information that ran counter to her most cherished and strongly-held beliefs. She admitted this interpretation was correct when we discussed it afterward.  Remember what Montier said "in order for somebody to understand something, belief is a necessary precondition." The point was that she didn't even process the information – such an existential threat it was to her.

Human beings have a very clear view of self and this is strongly intertwined with a belief system which generates what we describe as core values. So, if you attack those core values, you are likely to get an irrational and reptilian response. There is no processing of information as I described in "Through a glass darkly: the economy and confirmation bias in the econoblogosphere" going on; the cognitive dissonance is too great. Instead what you get is fear and an irrational defence. This is what my mother described.

Spinoza's view has profound implications everywhere, and certainly in the areas of my greatest interest, economic theory, politics, and education. One implication is that the beliefs one naively accepts as true in the first step of the reasoning process are critically important because many of them are likely never to be re-examined.  It would be interesting to know if naive beliefs become more entrenched over time.  I suspect they are, especially if they become enmeshed within a "system" of related beliefs.

Wednesday
Jul142010

Save the planet by NOT burning biomass.

[Corrected 7/15/10 at 0952.]

One of the things we all "know" about global warming is that if we burn "renewable" biomass instead of coal, we can have clean energy that does not contribute to global warming. I've been suspicious about that, and then last week this caught my eye: Massachusetts is revising its rules to disallow to certain biomass combustion plants "green credits" toward the Commonwealth's goal of reducing its carbon footprint. I decided to do some calculations, and it turns out that burning dead trees and some other biomass sources does not necessarily reduce CO2 emissions and may actually increases them, at least in the short term. It's all about inventories of sequestered CO2, as I'll explain.

Assume we have a self-renewing "forest" of 40 trees, each of which sprouted in a different year and each of which will die on its 40th birthday (sproutday?). Assume further that each tree grows at a linear rate and incorporates into its structure 5 tons of CO2 by the day it dies, i.e., 250 pounds per year. Finally, assume that Uupon its death, each tree decays at a linear rate of 500 pounds per year, with the assistance of termites, fungi, and other critters, and 20 years after its death has released all of its CO2 back to the atmosphere. Thus, while our forest is in this steady state, we have 40 live trees containing an average of 2.5 tons of CO2 each, for a total of 100 tons, and 20 dead trees each containing an average of 2.5 tons of CO2, another 100 50 tons. Our little forest keeps sequestered, year after year, 200 150 tons of CO2.

Now, let's build a biomass combustion facility at the edge of our forest. Each year we will harvest the tree that died that year and burn it to produce electricity, releasing 5 tons of CO2 to the atmosphere. The trees that died in prior years go on naturally decomposing, but after 20 years they are all gone, and 100 50 tons of CO2 formerly sequestered in our stock of dead trees is all back in the atmosphere. After that, burning each tree as it dies will not further increase the amount of CO2 in the atmosphere, because the rest of the forest assimilates 5 tons per year of CO2. However, to get to that new steady state we will have destroyed the 100 50-ton CO2 dead-tree sink, the same size as the one in our live trees. The planet will be worse off by 100 50 tons of CO2.

Would the planet nevertheless be better off if the wood burning backed out some coal combustion? That would clearly be true in the 21st and later years after loss of the dead-tree CO2 sink, but what about during those first 20 years? When wood is burned, it releases less energy than coal because the carbon in wood is already "partially oxidized" from pure C to cellulose, a polymer of glucose (C6 H10 O5) units. Wood pulp has a higher heating value of 7,510 Btu/lb and will release 1.630 lbs of CO2 (1 x 264/162). Pure carbon, which is responsible for nearly all the energy content in coal, yields 14,500 Btu/lb and releases 3.667 lbs of CO2 (1 x 44/12). Thus, burning wood releases 86% as much CO2 as burning coal for the same energy output, not a very big advantage. (By similar calculations, one can show that burning natural gas is far better for the planet in the short term than burning dead trees, because natural gas releases only about 56% as much CO2 per unit of energy as does coal.)

One general lesson to take away from this model is that, in steady-state conditions, there may be as much CO2 sequestered in dead biomass as in live biomass—as in any plant the CO2 content goes from zero to maximum and then back to zero. (If the growth and/or decay processes are non-linear, the two sectors may not have exactly equal CO2 content.) The dead tree sink could be either larger or smaller than the live-tree sink, depending on rates of growth and decay which, of course, are probably not linear.  I assume tree decay is relatively rapid in the tropics and relatively slow in high latitudes. My impression (only an impression—I haven't done my homework on this) is that some folks consider only the CO2 content of live biomass in their efforts to show project benefits. Oh, and here's another counter-intuitive fact: Turning trees into lumber and incorporating them into long-lived structures may be better for the planet than letting the trees die and decay more quickly in their natural habitats.

This analysis does not necessarily indict every "biomass" project. For example, if barren desert were covered with tanks of cultivated algae to produce biofuels, there would be no destruction of existing sinks of CO2, and the process could be very "climate friendly" if it displaced fossil fuels. However, one should perhaps compare that project with providing water to the area to develop a self-sustaining forest as a CO2 sink, which might be an even better way to slow down global warming. I mean only to show that one cannot assume biomass projects are climate friendly—you have to do your homework and get the accounting right. Heads up to my friends in northern Michigan: Traverse City Power & Light is moving ahead with two projects based on biomass from trees.

Wednesday
Jul142010

No living American has experienced unemployment even nearly as bad as now.

Scott Winship has plotted here the number of unemployed persons in the labor force divided by the number of advertized job openings from 1951 to 2010. In good times, there were more advertized job openings than unemployed persons in the labor force. In bad times, the ratio of unemployed to job openings rose as high as 2.5. In the Great Recession, the ratio has been 4, 5, and 6.

In recent months the ratio has started to drop, but at least some of that is because discouraged workers have dropped out of the work force, which they tend to do when their unemployment compensation benefit periods have expired. Despite this, there is no shortage of Marie Antoinettes, e.g. this candidate for governor of Pennsylvania, arguing to stop unemployment benefits because they make people stop looking for work. What? All six people eligible for that one job stayed on "vacation" and the job went unfilled? These elitist pols and pundits need to get out of their echo chamber occasionally.

Hat tip to Mark Thoma.

Monday
Jul122010

JFK on conventional wisdom

Yves Smith begins the Introduction to her 2010 book ECONned: How Unenlightened Self Interest Damaged Democracy and Corrupted Capitalizm with this quotation, attributed to John F. Kennedy:

The great enemy of the truth is very often not the lie—deliberate, contrived, and dishonest—but the myth, persistent, persuasive, and unrealistic. Belief in myths allows the comfort of opinion without the discomfort of thought.

I haven't read the book yet, but from skimming the Introduction online it appears her reasons for writing are very much the same as mine. Yves is ex-Goldman, ex-McKinsey, ex-Sumitomo, and has worked 25 years in financial services.  I follow her excellent blog Naked Capitalism.

Sunday
Jul112010

America has an industrial policy. Should we change it?

US "industrial policy" is back in the news after a long, long absence. Mohamed El-Erian, chief executive and co-chief investment officer of Pimco, wrote about getting beyond the false growth vs austerity debate in the Financial Times, which I discussed here. Andy Grove (retired CEO and chairman of Intel) says in How to Make an American Job Before It's Too Late that we have to emulate the successes of our Asian competitors by adopting policies that create millions of domestic jobs, which I discussed here. Michael Spence, winner of the 2001 Nobel memorial prize in economics and chair of the Commission on Growth and Development, says America needs a growth strategy. Mark Thoma reacts with this observation:

There appears to be a change in thinking underway among economists on these issues, particularly industrial policy. There are some who will oppose this change with all the shrillness they can muster. If this trend continues, and it looks like it will, there will be big fight within the [economist] profession -- more so than now -- about these ideas.

No doubt, shrill defenders of the status quo will say we have no "industrial policy" now and should never have one because, for a variety of reasons, "governments should not pick winners and losers." In fact, however, economic activity is a game that requires rules. Most of the rules need to be, and are, made and enforced by governments. Rules cannot be neutral but always confer advantages on some participants and disadvantages on others. We may not wish to call it industrial policy but, whatever we call it, we have one now—and it's very different from America before the Reagan Revolution.

Today's industrial policy favors capital over labor, the financial economy over the real economy, multinational firms over domestic firms, exploitation of the environment and the commons over conservation and protection, sellers over buyers, oligopolies and big firms with market power over multiple small participants, short term results over long term, speculation over investment, lower incomes and benefits for sole performers instead of higher, entrenched interests over innovators, open borders instead of tariffs and immigration controls, redistribution upward instead of downward, putting elected officials more in the thrall of the highest bidders instead of less. All that has happened in the last 30 years not just because governments have abdicated some fields but because government policies structure and enforce these outcomes.

We have a definite industrial policy. The question is whether we want a different one.

Monday
Jul052010

Why does Andy Grove want a trade war with China?

In How to Make an American Job Before It's Too Late, Andy Grove explains that America cannot be an innovation powerhouse if it does not do manufacturing at home and says US policies need to change. Grove was Intel's chief executive officer or chairman from 1987 until 2005 and is now a senior advisor.

He starts by pointing out that "the great Silicon Valley innovation machine hasn't been creating many jobs of late -- unless you are counting Asia, where American technology companies have been adding jobs like mad for years." He says it matters critically where the hard and expensive work of scaling up an innovation to commercial size is done.

The underlying problem isn't simply lower Asian costs [for manufacturing and engineering]. It's our own misplaced faith in the power of startups to create U.S. jobs.

. . . .

Startups are a wonderful thing, but they cannot by themselves increase tech employment. Equally important is what comes after that mythical moment of creation in the garage, as technology goes from prototype to mass production. This is the phase where companies scale up. They work out design details, figure out how to make things affordably, build factories, and hire people by the thousands. Scaling is hard work but necessary to make innovation matter.

The scaling process is no longer happening in the U.S. And as long as that's the case, plowing capital into young companies that build their factories elsewhere will continue to yield a bad return in terms of American jobs.

American tech companies have largely completed the transition to doing the scaling and manufacturing work in Asia, with the result that there are roughly 10 Asian jobs for every American job created for each new product.

Until a recent spate of suicides at Foxconn's giant factory complex in Shenzhen, China, few Americans had heard of the company. But most know the products it makes: computers for Dell and HP, Nokia Oyj cell phones, Microsoft Xbox 360 consoles, Intel motherboards, and countless other familiar gadgets. Some 250,000 Foxconn employees in southern China produce Apple's products. Apple, meanwhile, has about 25,000 employees in the U.S. -- that means for every Apple worker in the U.S. there are 10 people in China working on iMacs, iPods and iPhones. The same roughly 10-to-1 relationship holds for Dell, disk-drive maker Seagate Technology, and other U.S. tech companies.

Since the early days of Silicon Valley, the money invested in companies has increased dramatically, only to produce fewer jobs. Simply put, the U.S. has become wildly inefficient at creating American tech jobs. . . .

Already the decline has been marked. It may be measured by way of a simple calculation: an estimate of the employment cost-effectiveness of a company. First, take the initial investment plus the investment during a company's IPO. Then divide that by the number of employees working in that company 10 years later. For Intel, this worked out to be about $650 per job -- $3,600 adjusted for inflation. National Semiconductor Corp., another chip company, was even more efficient at $2,000 per job.

Making the same calculations for a number of Silicon Valley companies shows that the cost of creating U.S. jobs grew from a few thousand dollars per position in the early years to $100,000 today. The obvious reason: Companies simply hire fewer employees as more work is done by outside contractors, usually in Asia.

Grove calls it a "tragic mistake" to think we can have "highly paid people doing high-value-added work -- and masses of unemployed." Then he explains why that isn't even possible—without manufacturing, we will lose our edge in innovation and the high-value jobs too, an extremely important point others have made and I have reported here and here.

There's more at stake than exported jobs. With some technologies, both scaling and innovation take place overseas. Such is the case with advanced batteries. It has taken years and many false starts, but finally we are about to witness mass-produced electric cars and trucks. They all rely on lithium-ion batteries. What microprocessors are to computing, batteries are to electric vehicles. Unlike with microprocessors, the U.S. share of lithium-ion battery production is tiny.

That's a problem. A new industry needs an effective ecosystem in which technology knowhow accumulates, experience builds on experience, and close relationships develop between supplier and customer. The U.S. lost its lead in batteries 30 years ago when it stopped making consumer-electronics devices. Whoever made batteries then gained the exposure and relationships needed to learn to supply batteries for the more demanding laptop PC market, and after that, for the even more demanding automobile market. U.S. companies didn't participate in the first phase and consequently weren't in the running for all that followed. I doubt they will ever catch up.

. . . .

Not only did we lose an untold number of jobs, we broke the chain of experience that is so important in technological evolution. As happened with batteries, abandoning today's "commodity" manufacturing can lock you out of tomorrow's emerging industry.

Why are we doing this? Because for operating companies and financiers short-term profitability of individual companies trumps every other consideration.

However, our pursuit of our individual businesses, which often involves transferring manufacturing and a great deal of engineering out of the country, has hindered our ability to bring innovations to scale at home. Without scaling, we don't just lose jobs -- we lose our hold on new technologies. Losing the ability to scale will ultimately damage our capacity to innovate.

. . . .

We got to our current state as a consequence of many of us taking actions focused on our own companies' next milestones. An example: Five years ago, a friend joined a large VC firm as a partner. His responsibility was to make sure that all the startups they funded had a "China strategy," meaning a plan to move what jobs they could to China. . . . [Instead,] VCs should have a partner in charge of every startup's "U.S. strategy."

To counteract these market-driven impulses, American needs a different industrial policy, says Grove.

[J]ob creation must be the No. 1 objective of state economic policy. The government plays a strategic role in setting the priorities and arraying the forces and organization necessary to achieve this goal.

. . . .

Long term, we need a job-centric economic theory -- and job-centric political leadership -- to guide our plans and actions.

. . . .

The first task is to rebuild our industrial commons. We should develop a system of financial incentives: Levy an extra tax on the product of offshored labor. (If the result is a trade war, treat it like other wars -- fight to win.) Keep that money separate. Deposit it in the coffers of what we might call the Scaling Bank of the U.S. and make these sums available to companies that will scale their American operations. Such a system would be a daily reminder that while pursuing our company goals, all of us in business have a responsibility to maintain the industrial base on which we depend and the society whose adaptability -- and stability -- we may have taken for granted.

Hat tip to Yves Smith.

Thursday
Jul012010

Is it bloggers or the Fed fouling up economic policy?

Last month, an economist at the Richmond Fed, Kartik Athreya, published an essay complaining that bloggers about economics don't know their stuff and/or oversimplify everything, thus interfering with the serious hard work of properly-credentialed and responsible economists such as him and his colleagues in the Federal Reserve banks.  I won't attempt to provide links to all the pushbacks by prominent economists in their blogs, but this post by Ambrose Evans-Pritchard at the Telegraph is delicious. He provides a snarky review of the important things Fed economists seem not to know or to be able to get right, ending with the revelation that the Ph.D. in economics awarded to The Maestro, Alan Greenspan, was an honorary one 27 years after his M.A. and after he had been Chairman of the Counsel of Economic Advisors to President Ford.  Barron's has that story here.

Wednesday
Jun302010

Amusing Marxist explanation of the global financial and economic crisis

Professor David Harvey has for 40 years taught a course in Marx's Capital at CUNY. In April 2010 he gave a lecture at the Royal Society, available here, listing five conventional wisdom explanations for our ongoing global financial and economic crisis and then explaining it in Marxist terms of "essential internal contradictions of capitalism."  No Marxist solutions--or any solutions--offered, however.  I recommend the 11 minute animated version; click Play in the middle of the cartoon.  The longer, drier version is also available in a link just below. Hat tip to Linda Beale

Friday
Jun252010

Neither Keynesian stimulus nor fiscal austerity will solve our economic problems.

Mohamed El-Erian, chief executive and co-chief investment officer of Pimco, wrote about getting beyond the false growth vs austerity debate in the Financial Times. Paul Krugman says he disagrees, but I don't think he really understood El-Erian's point—that we are not in just another business cycle that will respond to the traditional stimulative tools that Krugman keeps pressing us to use urgently. Here's my comment on Krugman's post:

I think El-Erian is saying that there are actions that should be taken now but that the usual responses to an ordinary business cycle won't work because this is not an ordinary business cycle. He says, "[C]ountries must quickly implement what were once known in the emerging market lexicon as 'second generation structural reforms'. Basically these involve enhancing the longer-term responsiveness of western economies that have had their comparative advantages eroded, and now see their populations stranded on the wrong side of significant global changes."

Loose monetary and fiscal policies will not solve the structural problem that the US has had declining laborforce participation for a full decade. If Keynesian stimulus can only get us back to that trend line, we may as well get started with the adjustment now, instead of first pouring more water into the hot sands of it's-all-going-to-hell-anyway.

One of the fundamental problems for America to address is whether we're going to continue to permit and encourage the shift of job growth to developing nations at our expense and the convergence of our wage levels with theirs. El-Erian calls for more education and increased productivity, but those old remedies will not be effective in our new predicament--American jobs are not going offshore because Asian workers are better educated but because they are paid less. In the US, 12 percent of mail carriers, a quarter of travel agents and retail-sales supervisors, a third of flight attendants, and nearly half of aerobics instructors have B.A. degrees. Only 2 of the 10 job categories projected by BLS to grow the fastest require college degrees. States and nations that have a high percentage of college educated people do not necessarily have faster economic growth, and at least one study found a negative correlation. http://www.realitybase.org/journal/2008/5/22/education-is-doing-a-lot-less-for-the-economy-than-we-all-th.html

So, Paul, you and El-Erian agree stimulative actions should be taken now, but he says (and I agree) that your specific proposals are insufficient to the task. He also says, and here I heartily disagree, that we are "stranded on the wrong side of global changes" and must remain there. Americans are looking for policies and leadership that gets us out of our big, long-term, stagnating, job-shedding, deflationary mire. Who better than Paul Krugman to take on that larger problem?

Thursday
Jun172010

Forty years of US energy policy

The dinosaurs did not die in vain. John Stewart explains here

Monday
Jun142010

Being clearer about the Realitybase mission.

This blog has a new and more directly descriptive subtitle.  At the same time, I fussed with the font colors and sizes with the intent of improving readability.  If you're reading a feed instead of the blog itself, you won't see the changes unless you click through.  Why not do that once and then tell me what you think? 

When I set up this blog in October 2007, I used this quotation from Josh Billings as the subtitle: 

The trouble with people is not that they don't know but that they know so much that ain't so."

When I asked for comments, Mike and Peter (and maybe others) said they couldn't see the point and that I needed to explain more directly what this blog is about. I finally got around to that in the last few days, aided by an evolution and sharpening of my own understanding about what I'm doing here. I find that I am most often motivated to post to point out the objective wrongness of some bit of conventional wisdom that seems to be driving public policy problem descriptions and/or solutions. My m.o. is to marshal facts and analyses to refute the error and then stop.  I generally don't have an alternative theory or ideology that I'm promoting--other than, of course, the idea that rationality and an accurate understanding of the real world should rule.  So, while I may propose what I consider a better way of understanding a problem, there is usually more than one plausible solution and I don't usually offer one.  Regrettably, I am well aware, as my posts on epistemology attest, that it is very hard to dislodge beliefs with mere facts or, as the saying goes, "It takes a theory to beat a theory."

Sunday
Jun132010

"Identity economics" explains why people don't always make selfishly rational economic decisions.

Nobel laureate in economics George Akerlof and Rachael Kranton have a new book, Identity Economics: How Our Identities Shape Our Work, Wages, and Well-Being, which they summarize here.  They note that real people in large numbers often confound mainstream economists by making decisions contrary to obvious economic incentives measured in money. That basic insight is not new; it is central to “behavioral economics” and assumed by sociologists, psychologists, and political scientists. Still, it’s interesting when one of the high priests of economics joins in pulling away the homo economicus foundations of the mainstream economics theory temple.  This paragraph encapsulates the authors’ explanation for these common but economically irrational behaviors: 

When we examine people’s decisions from the perspective of their individual identities and social norms, we get new answers to many different economic questions. Who people are and how they think of themselves is key to the decisions that they make. Their identities and norms are basic motivations. We call this approach identity economics.

They provide several examples of behavior that cannot be explained by mainstream economic theory and then suggest how to get employees and students to be productive and successful without traditional economic rewards. 

Men and women in the United States smoked cigarettes at vastly different rates at the beginning of the twentieth century, but these rates largely converged by the 1980s. Women now smoke just as much as men. 

Overall military pay is relatively flat—that is, it does not go up and down depending on performance, and it is also lower than for comparable positions in civilian firms. Nothing in standard economic analysis can make sense of such a pay structure—or of the rituals that are central to military tradition.

. . . .

In organizations that function well, employees identify with their work and their organizations. If employees feel more like insiders—a key purpose of military rituals—there is little need for incentive pay or pay-for-performance schemes. The military changes the identity of its recruits, inculcating in them values such as duty and service. In the civilian world, too, the most important determinant of whether an organization functions well is not the monetary incentive system, as standard economic models would imply, but whether its workers identify with the organization and with their job within it. If they do not, they will seek to game the incentive system, rather than to meet the organization’s goals.

Likewise, good schooling occurs not as a result of monetary rewards and costs—the stock-in-trade of conventional economics—but because students, parents, and teachers identify with their schools, and because that identification is associated with learning. Moreover, whether students identify with being in school becomes the major determinant of whether they stay or drop out.

Given this, education policy should look at what some successful programs have done to establish a school identity that motivates students and teachers to work according to a common purpose. If we focus on training teachers in how to inspire their students to identify with their school—rather than teaching students to take standardized tests—we just might be able to reproduce these schools’ great results.

Saturday
Jun122010

How much of our chronic unemployment problem is due to automation? 

Martin Ford, author of The Lights in the Tunnel: Automation, Accelerating Technology and the Economy of the Future, is another who thinks America is not just in a recession but that there are long-term structural problems causing high unemployment with resulting stagnant or shrinking economic growth.  Whereas I have identified globalization as an underlying contributor to this problem, Ford focuses on the significant contribution of automation. 

As both hardware and software evolve, virtually every employment sector will be increasingly -- and simultaneously -- susceptible to automation. That's a very different story from past technological advances. In the last century, mechanization destroyed millions of jobs in agriculture, and that resulted in a transition to factory-based employment.

More recently, manufacturing automation and globalization were the forces behind our shift to a service-based economy. This time around, we're unlikely to have the luxury of such a sector-by-sector impact on employment: Automation is going to hit hard nearly everywhere.

If structural unemployment increases, there will be very few safe harbors. Today, workers whose skills become obsolete often end up in the jobs of last resort: low-wage service positions at employers like Wal-Mart. The problem is that those jobs won't be there forever -- and certainly not in the numbers required to sustain us.

. . . .

Increasing unemployment and falling consumer confidence would very likely result in stagnant or even falling aggregate demand, raising the risk of a deflationary spiral that might be very difficult to reverse. Social safety nets like unemployment insurance would come under unprecedented pressure, and governments would see dramatically increased demand for services even as tax revenues plummeted. Governments would have little choice except to borrow even more -- making the sovereign debt problems that are already tormenting the developed world just the tip of the iceberg.

The solutions to this mess are politically unthinkable by today's standards. Think about it: Jobs are the primary way that purchasing power gets delivered into the hands of consumers. Consumers without incomes can't drive the economy. If jobs at all levels are destined to evaporate in the face of broad-based automation, radical intervention -- and perhaps even a fundamental rewiring of the way the economy works -- may ultimately be our only alternative.

Mainstream economists are, of course, completely oblivious to such a potential scenario. They remain confident in elaborate mathematical models and assumptions that were put together in the last century -- often on the basis of economic data collected decades ago, when information technology was still in its infancy. What if those assumptions turn out to be just plain wrong?

Ford's point that "jobs are the primary way that purchasing power gets delivered into the hands of consumers" is an extremely important one.  No matter how much automation decreases the cost of making a widget, there is no reason to make any widgets, and no way to make a profit, if automation (and/or other developments) wipe out the customer base.  Henry Ford understood this in 1914, but our national policies have not reflected that fundamental insight in recent decades. I wonder if Martin is related to Henry.

Wednesday
May262010

Should middle class incomes rise, or shall we pursue globalization?  

In the preceding post, I quoted a 1933 John Maynard Keynes lecture in which he discussed some of the underappreciated domestic costs of too much globalization. In our era, we've found that a cost of globalization is that it causes real incomes for a majority of Americans to stagnate or shrink. In a dialog with The Buggy Professor in this thread on Mark Thoma's blog, I posted the following comment about why I think "inequality" is the wrong way to think about stagnating middle class incomes. We have a calculated bipartisan policy of preferring globalization over middle class income growth.

Buggy:

Thanks for all the information, which I took time to take in and consider. Your observation that "the erosion of incomes in the middle relative to the top and bottom" may be due to the middle's particular vulnerability to automation and offshoring rings true. The second bullet under SECOND may have a typo, but seems to say all increases in productivity of all workers were captured by the top 10% of the population, which is consistent with other analyses I've seen.

However, I think the conventional way of discussing "inequality" and the thrust of your NBER paper encourage unproductive discussions that tend to deteriorate into emotional attacks on either the "undeserving, rent-seeking, predatory plutocrats" or the "undeserving, ungrateful, jealous workers" and an argument about whether "redistribution" is or is not Constitutional, moral, and appropriate. I think it's better to focus on the stagnation and decline of middle incomes: If real middle class hourly incomes, which grew at an average annual rate of 2.2% per year from 1947 to 1973, had continued on that trend line, hardly anybody would care if real incomes in the top 1% had grown at twice that rate.

The widespread, steady growth in real incomes in the post-WWII period supported the two-part American Dream: That folks in each generation would, at equivalent life stages, have approximately twice as much income as their parents, and that there was widespread opportunity for individuals to acquire the educations and skills necessary to move upward from the income and class status into which they were born. Neither of those depended upon there being a small gap between themselves and the plutocrats of the day—the key fact was income growth versus stagnation or decline.

Now that the wage growth era is over, except for the last half of the 1990s, the American Dream is dead or dying, and the stagnation is necessarily spreading upward and outward. Strictly domestic businesses (and most are not multinationals) cannot grow their revenues faster than population growth in their market areas because their customers' stagnant money incomes mean stagnant demand. Infrastructure and other public goods cannot be of high quality and well-maintained because people with stagnant real money incomes can't/won't pay the necessary taxes. Subsidies must be withdrawn from education, blocking the upward mobility of those in lower economic and other disadvantaged classes. Government budgets rob Peter to pay Paul. Solemn contractual commitments made in times of growth cannot be met. The number of jobs in the real economy increases more slowly or shrinks. Multitudes stop trying. A shrinking fraction of working people must support the entire population. Talent and investment are diverted to the financial sector or faster-growing foreign markets. Large and increasing parts of the economy don't grow, or they shrink. The economy as a whole does not attain its growth potential, and maybe we have a Japanese-type lost decade or even a long, slow, agonizing downward spiral. In contrast, full employment and steadily increasing real incomes would solve almost all these problems.

Your paper and your comments do not address this fundamental problem of an underperforming domestic economy. To the contrary, the paper is an apology for the status quo. In effect, it says middle class Americans should not complain because they are better off than Swedes and almost as well off as upper income Americans when we understand they have to pay much higher prices for everything. Everything's fine. Most people are getting what they "deserve." No policy changes needed.

Lurking in the background here is a powerful resistance to having real American wage levels rise. Obviously, rising wages put pressure on profits, which could be more than offset by rising demand but that requires a degree of faith that is absent and may be imprudent. Also, being "competitive" in a globalizing economy means competing on price, which means US wages have to go down, not up. [Update: See addendum for how much wages might need to go down.]  A choice has to be made, and the GOP and "business Democrats" both continue to choose globalization (and to deny a choice was made). So, as Krugman is saying in this post today, it's been a political decision and not mysterious forces in the universe that ended the American Dream.

Wednesday
May262010

John Maynard Keynes argued in 1933 that globalization had been oversold.

As late as 1923, John Maynard Keynes was a doctrinaire free trader, who regarded "departures from it as being at the same time an imbecility and an outrage." Yet in April 1933, he gave a formal lecture, National Self-Sufficiency, to acknowledge that, while economic internationalization has important benefits, it also has important costs, and he makes a case for relatively more self-sufficiency. Inter alia, he said the benefits of trade are not as important as they were in the 19th Century because in 1933 tradable goods and services constitute a shrinking part of national economies. "National self-sufficiency, in short, though it costs something, may be becoming a luxury which we can afford, if we happen to want it." He discusses the reasons why we may want it, including the suggestion that, contrary to the assumption just before the start of WWI, when economic globalization was at its highest point ever, peace may be easier to keep if national economies are not highly integrated.

I was brought up, like most Englishmen, to respect free trade not only as an economic doctrine which a rational and instructed person could not doubt, but almost as a part of the moral law. I regarded ordinary departures from it as being at the same time an imbecility and an outrage. I thought England's unshakable free trade convictions, maintained for nearly a hundred years, to be both the explanation before man and the justification before Heaven of her economic supremacy. As lately as 1923 I was writing that free trade was based on fundamental "truths" which, stated with their due qualifications, no one can dispute who is capable of understanding the meaning of the words."

Looking again to-day at the statements of these fundamental truths which I then gave, I do not find myself disputing them. Yet the orientation of my mind is changed; and I share this change of mind with many others. Partly, indeed my background of economic theory is modified; I should not charge Mr. Baldwin, as I did then, with being "a victim of the Protectionist fallacy in its crudest form" because he believed that, in the existing conditions, a tariff might do something to diminish British unemployment. But mainly I attribute my change of outlook to something else--to my hopes and fears and preoccupations, along with those of many or most, I believe, of this generation throughout the world, being different from what they were. . . .

. . . .

What did the nineteenth-century free traders, who were among the most idealistic and disinterested of men, believe that they were accomplishing?

They believed--and perhaps it is fair to put this first--that they were being perfectly sensible, that they alone of men were clear-sighted, and that the policies which sought to interfere with the ideal international division of labor were always the offspring of ignorance out of self-interest.

In the second place, they believed that they were solving the problem of poverty, and solving it for the world as a whole, by putting to their best uses, like a good housekeeper, the world's resources and abilities.

They believed, further, that they were serving, not merely the survival of the economically fittest, but the great cause of liberty, of freedom for personal initiative and individual gift, the cause of inventive art and the glorious fertility of the untrammeled mind against the forces of privilege and monopoly and obsolescence.

They believed, finally, that they were the friends and assurers of peace and international concord and economic justice between nations and the diffusers of the benefits of progress.

. . . .

What fault have we to find with this? Taking it at its surface value--none. Yet we are not, many of us, content with it as a working political theory. What is wrong? . . . .

To begin with the question of peace. We are pacifist today with so much strength of conviction that, if the economic internationalist could win this point, he would soon recapture our support. But it does not now seem obvious that a great concentration of national effort on the capture of foreign trade, that the penetration of a country's economic structure by the resources and the influence of foreign capitalists, and that a close dependence of our own economic life on the fluctuating economic policies of foreign countries are safeguards and assurances of international peace. It is easier, in the light of experience and foresight, to argue quite the contrary. The protection of a country's existing foreign interests, the capture of new markets, the progress of economic imperialism--these are a scarcely avoidable part of a scheme of things which aims at the maximum of international specialization and at the maximum geographical diffusion of capital wherever its seat of ownership. Advisable domestic policies might often be easier to compass, if the phenomenon known as "the flight of capital" could be ruled out. The divorce between ownership and the real responsibility of management is serious within a country, when, as a result of joint stock enterprise, ownership is broken up among innumerable individuals who buy their interest to-day and sell it to-morrow and lack altogether both knowledge and responsibility towards what they momentarily own. But when the same principle is applied internationally, it is, in times of stress, intolerable--I am irresponsible towards what I own and those who operate what I own are irresponsible towards me. There may be some financial calculation which shows it to be advantageous that my savings should be invested in whatever quarter of the habitable globe shows the greatest marginal efficiency of capital or the highest rate of interest. But experience is accumulating that remoteness between ownership and operation is an evil in the relations among men, likely or certain in the long run to set up strains and enmities which will bring to nought the financial calculation.

I sympathize, therefore, with those who would minimize, rather than with those who would maximize, economic entanglement among nations. Ideas, knowledge, science, hospitality, travel--these are the things which should of their nature be international. But let goods be homespun whenever it is reasonably and conveniently possible, and, above all, let finance be primarily national. Yet, at the same time, those who seek to disembarrass a country of its entanglements should be very slow and wary. It should not be a matter of tearing up roots but of slowly training a plant to grow in a different direction.

For these strong reasons, therefore, I am inclined to the belief that, after the transition is accomplished, a greater measure of national self-sufficiency and economic isolation among countries than existed in 1914 may tend to serve the cause of peace, rather than otherwise. At any rate, the age of economic internationalism was not particularly successful in avoiding war; and if its friends retort, that the imperfection of its success never gave it a fair chance, it is reasonable to point out that a greater success is scarcely probable in the coming years.

Let us turn from these questions of doubtful judgment, where each of us will remain entitled to his own opinion, to a matter more purely economic. In the nineteenth century the economic internationalist could probably claim with justice that his policy was tending to the world's great enrichment, that it was promoting economic progress, and that its reversal would have seriously impoverished both ourselves and our neighbors. This raises a question of balance between economic and non-economic advantage which is never easily decided. Poverty is a great evil; and economic advantage is a real good, not to be sacrificed to alternative real goods unless it is clearly of an inferior weight. I am ready to believe that in the nineteenth century two sets of conditions existed which caused the advantages of economic internationalism to outweigh disadvantages of a different kind. At a time when wholesale migrations were populating new continents, it was natural that the men should carry with them into the New Worlds the material fruits of the technique of the Old, embodying the savings of those who were sending them. The investment of British savings in rails and rolling stock to be installed by British engineers to carry British emigrants to new fields and pastures, the fruits of which they would return in due proportion to those whose frugality had made these things possible, was not economic internationalism remotely resembling in its essence the part ownership of a German corporation by a speculator in Chicago, or of the municipal improvements of Rio Janeiro by an English spinster. Yet it was the type of organization necessary to facilitate the former which has eventually ended up in the latter. In the second place, at a time when there were enormous differences in degree in the industrialization and opportunities for technical training in different countries, the advantages of a high degree of national specialization were very considerable.

But I am not persuaded that the economic advantages of the international division of labor to-day are at all comparable with what they were. I must not be understood to carry my argument beyond a certain point. A considerable degree of international specialization is necessary in a rational world in all cases where it is dictated by wide differences of climate, natural resources, native aptitudes, level of culture and density of population. But over an increasingly wide range of industrial products, and perhaps of agricultural products also, I have become doubtful whether the economic loss of national self-sufficiency is great enough to outweigh the other advantages of gradually bringing the product and the consumer within the ambit of the same national, economic, and financial organization. Experience accumulates to prove that most modern processes of mass production can be performed in most countries and climates with almost equal efficiency. Moreover, with greater wealth, both primary and manufactured products play a smaller relative part in the national economy compared with houses, personal services, and local amenities, which are not equally available for international exchange; with the result that a moderate increase in the real cost of primary and manufactured products consequent on greater national self-sufficiency may cease to be of serious consequence when weighed in the balance against advantages of a different kind. National self-sufficiency, in short, though it costs something, may be becoming a luxury which we can afford, if we happen to want it.

. . . .

Thus, regarded from this point of view, the policy of an increased national self-sufficiency is to be considered, not as an ideal in itself, but as directed to the creation of an environment in which other ideals can be safely and conveniently pursued.

. . . .

There is one more explanation, I think, of the re-orientation of our minds. The nineteenth century carried to extravagant lengths the criterion of what one can call for short "the financial results," as a test of the advisability of any course of action sponsored by private or by collective action. The whole conduct of life was made into a sort of parody of an accountant's nightmare. Instead of using their vastly increased material and technical resources to build a wonder city, the men of the nineteenth century built slums; and they thought it right and advisable to build slums because slums, on the test of private enterprise, "paid," whereas the wonder city would, they thought, have been an act of foolish extravagance, which would, in the imbecile idiom of the financial fashion, have "mortgaged the future"--though how the construction to-day of great and glorious works can impoverish the future, no man can see until his mind is beset by false analogies from an irrelevant accountancy. Even to-day I spend my time--half vainly, but also, I must admit, half successfully--in trying to persuade my countrymen that the nation as a whole will assuredly be richer if unemployed men and machines are used to build much needed houses than if they are supported in idleness. For the minds of this generation are still so beclouded by bogus calculations that they distrust conclusions which should be obvious, out of a reliance on a system of financial accounting which casts doubt on whether such an operation will "pay." We have to remain poor because it does not "pay" to be rich. We have to live in hovels, not because we cannot build palaces but because we cannot "afford" them.

The same rule of self-destructive financial calculation governs every walk of life. We destroy the beauty of the countryside because the unappropriated splendors of nature have no economic value. We are capable of shutting off the sun and the stars because they do not pay a dividend. London is one of the richest cities in the history of civilization, but it cannot "afford" the highest standards of achievement of which its own living citizens are capable, because they do not "pay."

If I had the power to-day, I should most deliberately set out to endow our capital cities with all the appurtenances of art and civilization on the highest standards of which the citizens of each were individually capable, convinced that what I could create, I could afford--and believing that money thus spent not only would be better than any dole but would make unnecessary any dole. For with what we have spent on the dole in England since the war we could have made our cities the greatest works of man in the world.

. . . .

To-day we suffer disillusion, not because we are poorer than we were--on the contrary, even to-day we enjoy, in Great Britain at least, a higher standard of life than at any previous period--but because other values seem to have been sacrificed and because they seem to have been sacrificed unnecessarily, inasmuch as our economic system is not, in fact, enabling us to exploit to the utmost the possibilities for economic wealth afforded by the progress of our technique, but falls far short of this, leading us to feel that we might as well have used up the margin in more satisfying ways.

. . . .

Click here to read the whole lecture. Hat tip to Mark Thoma.

Thursday
May202010

Obama is business friendly by choice, not political necessity.

One narrative of Obama's policies is that his personal preferences are to the left but that he has to bend pragmatically--or reasonably judges that he does--to public opinion and Congressional politics and that is the reason his policies seem centrist or even center right.  I've said something like that here.  But in the financial institution legislation pending in the Senate, that seems clearly wrong. Public opinion and even Congressional politics favor tougher legislation than is apparently going to pass the Senate, but the President has weighed in against tougher legislation. In his statement today, he went out of his way to say the consumer protection provisions in the bill would not hurt business. 

And the reform I sign will not stifle the power of the free market -- it will simply bring predictable, responsible, sensible rules into the marketplace.  Unless your business model is based on bilking your customers and skirting the law, you should have nothing to fear from this legislation.

Possibly, he is "correct" on the merits, but he did have lots of political room to move further left on these issues and probably would have gained more support amongst voters and his left-wing base had he done so. In this case, at least, he leaned right by choice.