Musings of an Econ Student

Bankers: The Height of Evil and Stupid

2009-03-28T17:56:00.003-05:00

It's been 3 weeks, so maybe I should make another post!

The subject line really does appear to be one of the popular political lines drawn these days, though it's rarely explicitly laid at as such.

For instance, consider the following links:
1. Bankers are immoral
2. Bankers are stupid

Alright, I'm mis-characterizing #2 a little bit. The larger point of the IF post is that we need to regulate maximum bank size, because big banks have negative side-effects that carry real costs, without much obvious benefit. But one line does stand out:

Bankers are famous lemmings, and a whole lot of small banks who pile into the same poor investment can fail together like one really big bank

I am not entirely sure that this is going to be an effective rallying cry. First, one can hardly call the bankers "immoral" and then blame the lack of their morals for the current economic crisis. Now, certainly, there may be bad eggs among them, but the same could be said for any industry (Doctors still have to evaluate the moral importance of this guy, after all). The difference being that, in finance, a few bad regulations and a few bad apples can lead to major problems. In finance, one guy can lose $7 billion. It's very difficult for a single doctor, even if he is exceedingly incompetent, to start an epidemic. He would have to be consciously evil and stealing biological weapons from the US government.
There is also the obvious issue of making a bad bet. Let's say that the financiers were perfectly socially conscious. They might find their securitization of subprime loans to be a great social good, because they honestly thought that they were reducing risk while also providing houses to people who historically could not afford them. The African-American home ownership rate probably went up quite a bit during the Housing boom. That's a good thing, right?
Well, it's not a good thing if you realize that the bets you were making were bad. But then the error isn't of morals, but of information. Our bankers didn't cause a massive system collapse because they were immoral: they caused it because they were wrong.

There is also the issue of incentives; people were paid to do things that were wrong. Mortgage originators and their employees were paid by volume, leading to them selling lots of mortgages in an attempt to make more money. The same applies to other professions as well: doctors pushing drugs because they are paid to by drug companies, for example, or Arthur Andersen helping to cook the books at Enron. It's hard to be good when people are dangling a big paycheck to be evil. But that doesn't mean the industry as a whole failed because they were bad people, so trying to instill a sense of "wider social purpose" would be bad. We want them to be smarter.

And that's not to say bankers are totally stupid, either. For this, I'll outsource the arguments to Megan McArdle

"A Vast Remaking"

2009-03-07T19:03:00.002-06:00

So Sayeth the New York Times.

The summary of the article can be basically expressed as this in the layman's sense:

“These jobs aren’t coming back,” said John E. Silvia, chief economist at Wachovia in Charlotte, N.C. “A lot of production either isn’t going to happen at all, or it’s going to happen somewhere other than the United States. There are going to be fewer stores, fewer factories, fewer financial services operations. Firms are making strategic decisions that they don’t want to be in their businesses.”

Or, this in the slightly more technical sense:

For decades, the government has reacted to downturns by handing out temporary unemployment insurance checks, relying upon the resumption of economic growth to restore the jobs lost. This time, the government needs to place a greater emphasis on retraining workers for other careers, these economists say.

Basically, the idea is that the crisis is exposing a lot of major cracks in how the American economy has been working over the past several decades, and there ain't no more Internet-Real Estate Bubble-Caulk to pretend the holes aren't there anymore. We fundamentally produced wrong: we are too focused on building new homes, new cars, and selling financial services. So now the recession is showing how weak we are, we need to reallocate our workers and our resources to other industries to get our economy on sounder footing.

To some extent, yes. The bigger issue isn't just what we produce, though, it's how we consume. Our savings rate has steadily been declining, and people have been taking on greater and greater debt loads to increase their own personal consumption. We wouldn't be building so many houses and so many cars if people actually saved more money instead of spending: they wouldn't be able to afford such massive extravagances.

So, yes...while we have to retool our industries, we also need to be thinking about how to ratchet down our consumption, so we go back to an economy based on the sound principles of productivity, capital, hard work, and growth.

Pledge Classes Begin Again-Economic Thoughts, Hazing included

2009-03-07T18:20:00.004-06:00

Alpha Kappa Psi-Eta Rho Chapter begun teaching new pledges this past week.

Pledging for a fraternity can be a tough experience, even if you are attempting to pledge a chapter that ISN'T hazing you. And trust me, you don't want to be hazed, because it can be quite brutal. Some of the "milder" examples:
-Having to hold a match while saying the Greek Alphabet multiple times
-Underwear inspections to ensure you are not "wearing the colors" (pledges are not allowed to wear the official colors in some frats/sororities).
-Being forced to run many miles before an initiation ritual in order to induce exhaustion.

And hazing can even result in deaths.

We don't do any of that at AK Psi, but it's still tough. Here's what we require:
-Passing of 5 quizzes and 1 exam (about 70 questions)
-Attendance of at least 2 events of the following type: fundraising, social, philanthropy, professional
-Completion of a "signature book," meaning the pledges must get 2 signatures from every member of the local chapter
-Completion of a pledge project

And did I mention this all has to get done in 5 weeks? Eta Rho traditionally has an accelerated pledge program (5 weeks is actually the minimum allowed by the fraternity).
It can be very stressful. Not everyone makes it, and some that do are often extremely tense during those 5, 6, 7 week periods.

The reason we do this is obvious: we wish to impose high costs on potential members, so we can identify people that are not committed and weed them out. It's significantly easier to kick a pledge out of the program than to expel a full member who isn't pulling his/her weight, and in a school organization, there is actually a lot of weight that needs to be pulled. Particularly when it comes to fundraising. Our chapter has had some real disasters in the past with trying to procure funds, and it's not something we want to repeat.

One might think that pledges would be willing to drop out of the process, but historically this has not been the case. I should know: I've been the pledge educator at the Eta Rho chapter for a year, and I pledged myself. We usually have one or two people drop out in a semester, and we usually have more pledges that are cut from the program by vote of the full members. One pledge who was cut from the program is even back again!
So, it really does show that our pledges do actually have a high perceived value of the fraternity.

So, to think of it:
MBpledge>MCpledge>MCbrother. We work our pledges harder than our Brothers to ensure they are committed, but they are committed regardless.

Hazing actually takes this concept and applies it to some extent, but warping it. Hazing imposes a REALLY high marginal cost, implying that people that jump through those hoops must be REALLY committed.
However, my impression is that hazing really acts more through the mechanism of cognitive dissonance. People who have already jumped through the hoops find out that the frat they joined really ain't that hot...this confuses them and makes them feel uncomfortable, but they end up resolving this dispute in their mind by thinking "THIS FRAT IS REALLY UBER-COOL!"
Actually, that was a study cited in the first edition of "The Social Animal." People who had to sacrifice a lot to get into a dinner meeting of high people evaluted the dinner as great, whereas people who walked right in thought of it as "boring."
In essence, hazing is really more about mind-warping than proving your worth.
So it's a damn good thing our frat doesn't do it.

Plus, why would you want to hurt your family?

Underemployment

2009-03-01T12:27:00.002-06:00

If this doesn't qualify, I don't know what does!

Nine months ago he lost his job as the security manager for the western United States for a Fortune 500 company, overseeing a budget of $1.2 million and earning about $70,000 a year. Now he is grateful for the $12 an hour he makes in what is known in unemployment circles as a “survival job” at a friend’s janitorial services company. But that does not make the work any easier.

People have always been talking about the "real" unemployment rate in our society, going back to the early jobless recovery years of the Bush administration. A lot of talk about "hamburger flipper" jobs instead of actual well-paying jobs in the economy.

Tyler Cowen recently commented about underemployment as well, wondering whether if "unemployment" was still a good measure of a recession.

Tyler does appear to be right. When a society has a lot of different workers with different skill-sets, underemployment becomes a lot more "real" than a society where everyone is a front-line factory worker. And we supposedly have a lot of different skill-sets today. That's part of the reason over Robert Reich's concerns that stimulus money not go entirely to white construction workers.

However, I wonder how "heterogeneous" our labor supply actually is. I'll take a comment from an internet forum I frequent:

I think it's generally understood that college teaches you very little real world skill. Recruiters hire you out of college because you're young and you've proven you can accomplish something but not because you actually know what you're doing.

I remember when my ex girlfriend was completing her MBA and we ended up at the local bar with the recruiter for IBM. He said no companies he knows hires PHD's anymore only graduate students. Primarily because PHD's will analyze a problem way past the point where action against it is even relevant. They wanted smart people who can act.

He understood that people right out of college really have their heads up their asses. No real world experience. But they wanted young people with energy, people who at the very least, proved they can accomplish something difficult. That's what your degree is worth. Getting a good job afterwards relies on your charisma.

I didn't agree with everything, but there is anecdotal evidence that a lot of people end up in jobs that they didn't study for in college at all. Obviously, this isn't as big of a concern for "specialized" majors like engineering, but a lot of the education system is supposed to provide a more generalized knowledge that builds up your "transferrable skills." Basically, it teaches how you to do any job well, but not enough specific skill to be super-awesome-employee right out of college.

That's hardly heterogeneous!

On the other hand, we are probably more specialized than we were in the post. The investment bankers on Wall Street aren't going to be having too many more finance jobs in the future, since the economy needs to adjust away from finance. The point isn't that we don't face any underemployment, though. It's that I believe a lot of people are underestimating the flexibility of the labor force.
And, secondly, we need to ask ourselves what this is really a function of: are we having more specialized jobs (finance) because our economy is naturally tending towards that direction, or because our regulatory system helps create bubbles that then become the basis of real economic activity.
Tricky, tricky.

The second part of Tyler's argument, which is arguably more important, is spot-on. Basically, Tyler is saying that the unemployment measure isn't what it used to be, because these days the labor market is faster and people can fill up any vacant jobs at Target a lot more quickly than we could in the 1960s. This produces a lower measured unemployment rate, but that doesn't mean the recession isn't that bad: it just means that people that are unemployed can find SOME work.

Fixed Costs vs. Variable Costs

2009-02-28T19:50:00.003-06:00

Colleges unlikely to cut financial aid, because they need enrollment to bring in money

Students considering a wide range of private schools, as well as those who are already enrolled, can expect to get more aid this year, not less.

The increases highlight the hand-to-mouth existence of many of the nation’s smaller and less well-known institutions. With only tiny endowments, they need full enrollment to survive, and they are anxious to prevent top students from going elsewhere.

Falling even a few students short of expectations can mean laying off faculty, eliminating courses or shelving planned expansions.

This makes sense, I suppose. Most of your costs at a college should logically be relatively fixed: it's probably a lot harder to lay off your professors than it is for non-unionized companies to lay off line employees. And that labor cost likely is a big portion of the budget: then you have your normal fixed costs (like buildings).

But what's surprising is that these students receiving aid, on the margin, are not costs to the university...they are actually assets, because the marginal cost of adding a few more students isn't very significant. What's the extra cost of moving a lecture from 100 to 101 students, after all? Sure thing, we'll take $10,000 per year in tuition for that!

It's a result that surprised me, anyways.

And US Growth revised downwards!

2009-02-27T16:24:00.003-06:00

Remember when I mentioned that Europe was falling faster than the US? Turns out that was wrong!

From the BEA:

Real gross domestic product -- the output of goods and services produced by labor and property
located in the United States -- decreased at an annual rate of 6.2 percent in the fourth quarter of 2008,
(that is, from the third quarter to the fourth quarter), according to preliminary estimates released by the
Bureau of Economic Analysis.

And in other news, more free money for Citi

Swap Data on European Bank

2009-02-27T16:08:00.002-06:00

Via the Baseline Scenario

It's costing a lot to insure debt at some major European banks. This isn't surprising because, as is commonly known by now, European banks are highly leveraged compared to major American banks.

Obama's Savings

2009-02-27T15:25:00.002-06:00

Health Care Savings -$316
Limit Tax Deductions for High Earners -$318
Carbon Permit Auctions -$646
Close Tax Loopholes -$354
End War in Iraq -$1,490
Allow Upper-Income Tax Cuts to Expire -$637
Deficit-Reducing Policies -$3,761

From CRFB

I commend President Obama for his plan to cut the deficit, but the War in Iraq savings are partially inflated. As has been mentioned many times over the past couple days:

Assuming that war spending will continue at FY2008 levels (adjusted for
inflation) – an amount even beyond what President Bush’s policy would have
required – strikes us as a gimmick to build up the spending amount in order to
reduce it and claim “savings”. We believe the Administration should have
included war costs at the levels they are proposing.

New Treasury Plan: Just as bad as the old one?

2009-02-26T22:52:00.003-06:00

Well, we all know what a total cluster**** TARP turned out to be. $350 billion doled out with virtually no strings attached, not even the requirement that banks actually be able to account for the money that they took. Several months later, we learn that banks paid out large bonuses, acquired other banks and financial services companies, and didn't really increase lending at all.

Oops!

Well, the new Treasury plan, hopefully, would have gotten around some of that.

Unfortunately, it doesn't. Rather than giving the government the right to convert the preferred stocks into common shares, the new program seems to actually give banks the right to convert government equity into common shares, opening up the possibility for all sorts of shenanigans.

Of course, I'm not overwhelmingly concerned...the goal of the plan is to recapitalize banks by giving them money after all. I'm increasingly wondering whether there is a point to that strategy anymore, though.

GM sacrifices to the Money God

2009-02-26T21:57:00.002-06:00

Or at least that's what the headline should read.

General Motors lost $31 billion last year, a much greater loss than was expected, largely due to a truly horrific 4th quarter. That shouldn't be surprising to anyone, after Japan posted a more than 10% drop in GDP (annualized) for the same period. But the magnitude of GM's issues is a bit concerning. Consider the following:

Output at GM’s European plants was 53 per cent lower in the fourth quarter than a year earlier

Demand really is plunging. And worse, GM's pension is now underfunded by $12.4 billion, which the US taxpayer is probably going to be on the hook for.

Another bad year like this and it wouldn't be surprising to see $50 billion in cash being devoted to keeping GM afloat. GM's market cap, for comparison's sake, is presently $1.45 billion.

One wonders if there is even a point anymore, and whether we should just go ahead with full-scale nationalization.

Europe falling faster than the US

2009-02-23T18:50:00.004-06:00

EDIT: Picture removed
From the Atlantic Business Channel

Some in the past were suggesting that the EU would be able to scoot past this crisis, but unfortunately it looks like they've been tangled up even worse than the US.

Looks as if I copy-paste, the picture directly links to the Atlantic Business Channel display graph on their site.

Woops!

More on Required Classes

2009-02-22T16:17:00.002-06:00

The last post was to address what the professors seemed to concern about. This post is what I think needs to be improved.

First, I thing there needs to be more emphasis on risk management, especially in light of recent economic events. We don't actually deal with a whole lot of risk and uncertainty in our business classes. The most the business core ever really requires students to understand is the concept of "standard deviation" in our advanced quantitative classes (to you non-UIC people, that means math classes!) with a bit of sensitivity analysis in IDS 355 Operations Management.
I had never heard the term "Sharpe Ratio" before my Finance 472 real estate class.
Business majors need to have an understanding of how to handle uncertainty, because no plan survives first contact with the enemy/the economy. UIC should pay some more attention teaching us that. I would suggest some more effort in looking at risk in different ways, much like finance classes look at profitability of projects in different ways.

Second, Econ 221 Intermediate MacroEconomics should be a required course. Business majors should have a more solid understanding of macroeconomics than what it is offered in Econ 130. Specifically, they should be more aware of the debate between Neo-classical economists and Keyensian economists, since both have arguments that apply at different points in time. Econ 221 provides a higher level of analysis than Econ 130, and pays attention to these debates. Understanding the arguments should lead to a better understanding of the economic environment underlying the business environment, hopefully beyond "tax cuts=higher growth!" and "No, government spending=higher growth!" kind of thinking.

Third, it seems the business core pays little attention to ethics. It is rarely mentioned beyond the passing phrase "ethics are good" and "don't be Enron!" with some attention paid to the subject in Management 350 (which mostly seems to be a Business Law course, so ethics are not exactly the topic of the class). Perhaps a 1 hour per week class on ethics with a workload similar to BA 100 would be a good idea, or requiring every student to attend to an ethics workshop prior to graduation.

Finally, I would reevaluate IDS 200. This is not meant to offend the professors, but I remember so little about the class that I wonder how much it actually accomplished. This may be a result of my own bias (I have never taken an IDS course beyond the required curriculum). However, from what I recall, it seems that the topic of the class was the effect of digital technology on the business environment. This is a topic that is hammered to death in every class, and I think discussing the effects of the Information Revolution is better addressed in those general classes than having a class specifically devoted to the Information Revolution. Eg: I think I can learn a lot more about the role of IT in marketing while attending a marketing class than studying it in IDS 200.
Of course, there ARE some aspects of the class that aren't covered in other ones...there was a lot more specific information on types of networks and different programming languages, for instance. To be certain, students lose something if we don't teach them this, but I am not sure what it is.
I'm not saying we should drop the class. I simply think it needs to have some more attention paid to it.

Core Business Classes

2009-02-20T10:56:00.003-06:00

Summary and Recommendations at bottom

Our Finance professor, Mary Brown, commented in class yesterday that she was on a committee responsible for reviewing the Business core curriculum.

A core curriculum consists of the classes that every business major must take. The idea is to ensure that every student has a good understanding of every field of business, so he/she can make good business decisions in a management capacity (or just from a business perspective). Professor Brown specifically mentioned two things:

1. UIC students apparently aren't performing well on case presentations. This is when someone gives you a big file about a problem a company is having, and you have to make a recommendation

2. Teachers wonder how much UIC students are actually retaining of the core curriculum.

2 makes sense if 1 is a problem. After all, maybe the reason that students can't analyze a business case is because they don't actually remember anything about business! That would be very disappointing, and would cast some doubts about UIC's current teaching style.

Now I can't really SOLVE the problem, in part because I don't know the problem fully. I would have to obtain a lot more information if I was going to try to make UIC students astoundingly better. I have some ideas which I like floating around with Alpha Kappa Psi members sometimes (because I can more directly influence AK Psi than I can UIC), but nothing very concrete and well-researched.

Still, Professor Brown asked for thoughts. And there is no such thing as a BAD thought, so I figure I'll give it a go.

If they think retention is a problem, they are probably right. Information learned but not used is not retained very well, especially when it is only studied for a test. That's not to say that it is totally lost: for instance, I took psychology 3 years ago, and if I took a psyc test on the spot right now, I'd fail. But I can still talk about positive reinforcement a bit, and since I once learned "shaping" back then, I can pick it up faster now.

The problem is that business majors can't immediately access all of the information they have because they don't use it often enough. But they probably still have the fundamentals down to some extent, so they can relearn quickly if they need to.
On a case, though, they need to know it RIGHT NOW. They don't have time to relearn it all. So the thing we want to do is increase their understanding more than right now, preferably through making them use it often.

Another possibility: it might be the case that 2 is not really the problem. Rather, the issue might be that students can't think very well. They UNDERSTAND how marketing works, they understand how finance works, and they understand how accounting works. They just can't put it all together, and they can't analyze information put in front of their face and put what they know to work.

While I think retention is a problem, I also think this other problem, which I will call "critical thinking," is a major one. First, cases can be extremely intimidating, especially if you have never ever studied one.
For example, if you've spent your entire life writing essays and giving lectures, you might be thrown totally off-guard when you take a test for the first time. Just as you can learn good test-taking skills, so can you learn good case skills.
UIC, though, has pretty much NO case studies. All my experience in them comes from two sources:

1. AP tests in high school, which had things called Document Based Questions. They weren't business cases, but somewhat like them.

2. Consumer Behavior (Marketing 462, I believe) with Professor Rosa. The entire class consisted of one Mid-Term, two case studies, and a consumer interview.

UIC business classes, on the other hand, teach a lot like other academic classes. You are lectured 2 or 3 days a week, and have an exam once every few weeks. You have homework assignments in some classes, you have papers in a lot of other classes. My gut instinct is that this is a bad approach, and generally leads to our students being unable to do cases because they are trained more like professors than decision-makers.

There are two counter-arguments to this:

1. The Document Based Question-item, which is something that non-business people do with ease, is a lot like a case.

2. The papers students do in class should train them to think critically.

The first is very true, but those types of questions were rather difficult for high school students, enough so that our history teacher, Matt Whipple, gave us an example question before the exam so we should be prepared. It wasn't something that came naturally to us, because tests are about converging on a right answer, while cases are more about diverging, analyzing, and choosing. You need to think of possibilities (diverging), figure out the merits of each one (analyzing), and pick the best one (choosing).

On the second, papers HELP, since they are much less about convergent thinking than tests are. A student can, if he/she chooses, dazzle a professor with brilliance. However, papers tend to be graded a bit softly for my tastes. I can remember writing numerous papers on the night before a due date and getting near-perfect scores. The only teachers that have actually graded harshly are Professor Thompson (who I had for Compensation Management) and Professor Rosa (who I had for Consumer Behavior, as previously mentioned).
We need to grade tougher if we want students to develop better writing skills, and we need MORE. Just like other skills, writing improves when practiced. My own writing skills have been honed through countless hours of posting on internet forums and internet blogs, something that most other students simply don't have.
Another problem with papers is that they aren't really integrative. Writing a paper for my management class doesn't usually require me drawing upon my marketing and finance knowledge, which doesn't make much sense if we want our students to understand business as a whole.

The other aspect of "critical thinking" is that students just don't seem to have good reasoning abilities. Their arguments are SOMEWHAT sensible, but they are not really good enough or developed enough. So...all they really have is an idea, not a truly defensible position, and it would crumble upon closer inspection. See, for instance, my remarks on my experience with the bank simulation.

If students can't construct logical arguments because they simply don't have those skills, then they will fail even if they are trained in cases and retain knowledge. So UIC needs to be more concerned about developing those skills.
I find the best method to doing this is taking a student's position and simply pointing out all the logical flaws and why they are logical flaws. Learn through experience.

Summary
So...if we want our students to do better...we actually have three different problems:
1. Students retain knowledge, but not well enough to access it on demand.
2. Students do not have much experience putting different business ideas together.
3. Students do not have strong reasoning abilities.

Remedies
There are a couple different approaches we could take, but as my time is running out, I will simply say what I would do.

First, I would require case competitions every year by UIC students, to be done in very small teams (2-3 people max). They will be required to come up with some sort of product idea and explain how they would sell it. This would be graded and put on the transcript, like any other course. Guidance would be minimal: sink or swim on your own.
Hopefully this will keep students integrating and using new knowledge every single year. That helps out with problems 1 and 2. Small teams are a must to ensure that there are no shirkers (which occurs in every group, but especially among any group above 4 people in my experience at UIC).

This may be difficult to accomplish, so I would be perfectly happy with an addition to 495, but a class devoted entirely to case studies of actual strategic management. These case studies would be done individually.

Second, to address problem #3, I would make a new, required class (BA 250?). Every day, a different student will be required to give a presentation on a topic that the professor assigns. The other students will then be required to agree or disagree, with the professor facilitating discussion towards the "disagree" side. The onus will be on the presenter to both identify the weakness in his/her own arguments and be able to address any questions or counter-points other students would have. I imagine a 3 hour, twice a week course would be sufficient for this.

Margins and Profit

2009-02-18T11:10:00.004-06:00

Before you go any farther, going to let you know up-front: This isn't economics or politics. It's business.

But it's a simple business concept that everyone should understand.

Let me explain the situation. Around a week ago, I met up with some group-mates from my finance class in a lounge around campus. After munching on some delicious Wendy's burgers, we got down to work: we were responsible for running a bank through a simulated economy against the other groups in our class. And we planned on taking it seriously, for a couple reasons.

1. The project is a large portion of our grade. It doesn't matter if we LOSE money, but we need to explain how we arrived at the decisions we did.
2. The winner (IE, the group with the highest stock price at the end) will not have to take the final, and will get to meet the head of the Finance department...hopefully leading to some job connections!

I had spent the previous day staring at the financial statements of the bank for the previous two quarters. And, believe me, it was confusing for a long time. Even if you know the basics of the financial statements, new parts that you've never seen can confuse you if they aren't explained properly. Considering we were just handed statements with numbers on them, yep, I was confused.

But I managed to figure out what was going on with the statements. Our bank didn't seem particularly strong (we were hemorrhaging deposits, losing 5% every quarter. Those are basically personal bank accounts people put in your bank that you use to make money elsewhere), but there was a good opportunity for growth in retail banking by creating mortgages. This basically meant that we will have to open more branches, shift effort away from appealing to business customers, and start focusing and trying to get customer deposits back to get more money to invest,

The story we were given was that consumers are not price-sensitive, so I naturally said that we should advertise a lot, tell our bankers to spend more effort on getting more residential customers, and charge higher rates so we could have better margins.

My friend asked me "So we're going to advertise that we have higher mortgage rates?"

There ain't nothing wrong with asking the question and thinking like a businessman, which includes thinking competitively. It's so common sense that people all across the nation can think like this: cut prices, and that way you can attract more customers and beat your competition. But there are limitations to this kind of thinking.

For example, the most obvious one is that customers might not care about price very much. Starbucks can charge $4 for a cup of coffee, when I can make my own at home for 30 cents. Obviously, price isn't the biggest factor.

Scale can also be a big factor. Sure, by reducing your prices, you might get more customers. What happens if your store or bank cannot handle all those customers? Just as there are economies of scale, so there are diseconomies of scale. Once you are producing beyond a certain point, your costs actually start to rise.

For a bank, you might not have enough employees, so your quality of service suffers. That's REALLY bad if customers also care more about service than price, so you are driving them right in the arms of your competitors. You might also lose the ability to exercise due diligence on loans: you can't spend 6 hours vetting every single person asking for a mortgage when you have one guy to approve them and 1,000 people begging for loans because you are charing 6% whereas everyone else is charging 10%.

And you can't hire more workers either: your bank is only so big! Buying another bank? Extremely expensive, and can't do it because you can't make money when you are charging 6% for a mortgage and giving out 5% on savings accounts. Or, if you CAN make money, it's extremely risky...if you don't get as many loans as you want, your stuck with two banks. Which means you might very go well bankrupt. Plus, hiring more employees means you lose your own personal control. You can't watch over 30 managers as easily as you can watch over 10.

So, if your company is running into trouble, the idea of cutting your prices seems very attractive. Often times, though, it's really a trap and might put your company even more into the dumps.

On Moral Hazard

2009-02-02T18:22:00.003-06:00

Thoma rounds up an excellent series of articles describing how concern about moral hazard is overrated.

From a psychological perspective, at least some of the argument about moral hazard seems fundamentally overstated: you will be more likely to undertake risky behavior if you are rescued by someone else, true. However, two points:

1. These banks are not really getting "bailed out." Rather, TARP gave money to the banks in return for preferred stock, most of which, I believe, carried rather high interest rates (10%). So, if BofA receives $50 billion from the feds, they will be paying out $5 billion to the federal government every year for the rest of time. It's not costless. And this is at the expense of other stockholders, because those dividends COULD have been going to the common stockholders.

2. We tend to focus a lot on our own personal losses. For instance, you might say that having rescue helicopters picking up hikers from mountains is "moral hazard" because they don't have a high chance of dying. Well, having a 20% chance of dying is still pretty high to me, and spending a couple months in a hospital isn't fun at all, either.
Some people suggest that we value gains only half as much as losses, meaning that we would need to gain $100 to off-set a $200 loss (in terms of making us happy). If true, that means most people are risk-avoiding, and perhaps a bit of "moral hazard" to encourage risk-taking isn't such a bad idea.

Anti-Business Attorney General

2009-01-31T17:55:00.002-06:00

It seems like it is a distinct possibility

The memo encourages companies to withdraw legal support from employees accused by the federal government of crimes, lest they be considered "uncooperative" and face further punitive measures from Uncle Sam themselves. If you believe the government is wrongly prosecuting your employees, in other words, you'll pay a price if you fight back.

This is very concerning. We don't want the government to be an adversary of business, yet this would be a major step in that direction, as government would be exercising its sizable power against all resisters.

Well...this isn't good

2009-01-30T20:51:00.003-06:00

So, US GDP fell at a 3.8% annualized rate in Q4.

Problem being that economists expected a much worse report, and the reason it wasn't as bad as we thought is because businesses had more inventory.

Essentially meaning that businesses produced a heck of a lot of product that they weren't able to sell.

Guess we are going to be seeing a lot more layoffs...

Fannie and Freddie to halt Foreclosures

2009-01-30T20:32:00.002-06:00

Well, we knew that was coming. It seems that Fannie essentially will act as a landlord, with people living on month-to-month leases (IE, the status quo). But they're coming up with new plans to keep the houses in better repair, among other things.

House Parties for Stimulus!

2009-01-30T20:26:00.002-06:00

If you like the stimulus, invite some friends and get drunk!

The strategists on Friday called on supporters to host ``economic recovery house meetings" next weekend, marking the first call to action for the network in support of the White House policy agenda.

The email was sent today by Mitch Stewart, director of the network that was recently renamed Organizing for America, a takeoff of Obama's presidential campaign, which was called Obama for America.

Wish I had thought of this, though "partying for the stimulus!" seems like a very stupid idea: we're supposed to blow cash on extravagance when we might lose our jobs tomorrow...and need to spend almost a trillion dollars to revitalize the economy? Okay, maybe we need to spend more, but perhaps on something other than a party?

Plus, I don't think "stimulus parties" are going to be very popular...

Fear: How do we kill it?

2009-01-30T14:29:00.002-06:00

According to a lot of economists, one of the biggest problems (if not the biggest problem) in the economy right now is a massive feeling of uncertainty in the economy. You may remember that I mentioned it a little while ago, suggesting that the stock market will fall because there is no actual recovery yet.

Well, uncertainty is the subject of a roundtable discussion at the Economist today. Here is IMF Chief Economist Olivier Blanchard leading the discussion:

At the start was the realisation that many of the new complex assets were in fact much riskier than they had seemed. This realisation has now morphed into a general worry about nearly all risky assets, and about the balance-sheets of the institutions that hold them. “Better safe than sorry” is the motto. Unfortunately, while the motto may make sense for individual investors, it is having catastrophic macroeconomic consequences for the world. It is triggering enormous spreads on risky assets, a credit crunch in advanced economies, and major capital outflows from emerging countries.

So, the solution to the crisis is to eliminate some of the uncertainty in the economy, and, more generally, fear of losses.

The REAL question is the following: How the hell do you accomplish that?

That's the subject of the economists responding to the article, who seem to largely agree with Blanchard.

Some of the economists agree with the general concept with a sizable stimulus package, and agree that we shouldn't be too concerned about what might happen down the right (at least in terms of over-stimulating the economy).
The fiscal stimulus would send the message that the government is committed to solving the crisis.

Many also agree with focusing on restoring the health of the financial system, though Thoma says that isn't actually enough.

Tyler Cowen says if we are just going to have policies to make things LOOK better, we should apply a cost-benefit test towards their symbolic value and try to find highly visible-yet-cheap projects that make it seem that the economy is getting better and government is committed to keeping it that way. That's a LOT different from the idea that we should build roads because they improve the economy: Instead, we should build a single road paved with gold, because that is REALLY indicative of a recovering economy (that example is mine, not Tyler's). Boosting things like unemployment insurance would be a good idea, too, since they are automatic stabilizers...meaning that the government is automatically increasing the money it is spending in a crisis, instead of sitting around talking about massive stimulus packages

One commenter added that we perhaps insuring all loans made across the country would be a good idea. I believe this is what was used in Sweden, but I am not entirely sure.

So, how do we reduce uncertainty?

That's a toughy and involves a lot of psychology. Quite frankly, it's not something we're trained to think about at the undergraduate level (and any solution I could come up with is probably much worse than what academic economists propose).

I would devote a lot of effort into the financial system. At this point, I have absolutely no idea how to get this done in an acceptable manner. We could simply buy back all the assets, but that could take an outlay of $4 trillion, and is a bit of a giveaway to banks. Direct recapitalization is a more plausible measure, but it doesn't look like it worked very well with TARP.

Nationalization is probably out of the question.
Forced liquidation (IE, seizing the banks, selling off the good assets to good banks and keeping the bad assets in a government chartered "bad bank") might set the financial system back decades by destroying a lot of banks and scaring private investors away from investing in new banks.

But the financial system is ground zero and that's where we need to be focused. I don't moving them off the balance sheet would be very good at all: a bank that is insolvent is still going to be insolvent, and it will just scare investors even MORE since they don't know which banks have the bad assets.

I would have a sizable, diversfied fiscal stimulus (IE, not just giving jobs to white male construction workers). That will get more people back to work across a broader swathe of the economy...hopefully reducing uncertainty to some extent.

I would increase unemployment insurance as well. Not entirely sure how it works, but tagging it to your income prior to being fired seems pretty reasonable in an economic downturn (IE, you get 60% of your former income from the government). In a strong economy, not so good of a plan. In a downturn, making sure people don't keep too much money on hand because they are scared they will lose their jobs is more important than worrying about people not going back to work because they are living on the government dole.

Unorthodox monetary policy by the Fed is also important

Broader government insurance of loans may be feasible, too. Perhaps not insuring EVERY loan in the country, but offering to sell insurance to private companies on high-rated debt would probably encourage more lending.

Of course, if housing prices continue to plummet and we end up with 2/3 of the nation's households with more mortgage debt than house value, I have no idea if any of the above are going to be enough

Differences in Colleges

2009-01-29T22:44:00.002-06:00

The first row of my Latin American History class: students who have their heads buried in books, reading the chapter we're discussing next week

The first row of my business classes: about as crowded as a church service during the Super Bowl

God I love it

But why should they LEND it?!

2009-01-28T15:07:00.004-06:00

Or at least that's what Rebecca Wilder says

TARP definitely has its problems, but it was developed to prevent a systemic crisis, and not to force lending. Were it not for TARP, more banks may have failed, and lending would be negligible, if not falling precipitously.

She then goes on to say that:

A necessary condition for an economic recovery is not a fully functioning credit system, but rather the other way around. In order for the credit system to heal, it must be on firm economic ground.

So we have a bit of a chicken-and-egg scenario...we really need a strong economy before banks are willing to hand out money. That's why these banks aren't lending out money, because the economy sucks and they will likely lose cash.

Yet, how can we have an economic recovery when people can't even get credit? It's no surprise that automakers were pounded all through 2008 and housing similarly suffered: both have a large chunk of their customers relying on credit to afford product, and with credit markets shutting down, there was no way to buy product. For a long time, the rest of the economy was chugging along just fine while autos and housing and financials were getting absolutely pounded.

If the crisis in the economy is really a crisis of confidence, then perhaps that means the banks are under-estimating the returns they will get on new loans...forcing them to do so and then a realization that "hey, it ain't so bad" will convince other people to dive into the credit pool and we'll start getting the economy back on track.

Of course, this isn't really possible if the banks are facing massive losses. But if the banks are insolvent even after a massive $350 billion capital infusion, then:
A. The government should not be subsidizing banks buying other financial service companies. So far, 2008 and 2009 look like a movie called "How Bank of America and JP Morgan convinced the government to help them buy every bank in the US"
B. The banks should be nationalized out-right so we can essentially hit the "reset" button, without massive giveaways to the shareholders and creditors.

Either way, giving banks hundreds of billions of dollars just to sit on them seems, to me anyways, like a very bad policy.

The Baseline Scenario

2009-01-28T14:48:00.004-06:00

An interesting webpage, pointed out by Tyler Cowen, which seems to be advocating the view point that this economic recession is going to be a lot more protracted than most seem to suggest (IE, several years, instead of turning around in mid-2009). You can read their worldview here.

They argue that the crisis was really started in the 1980s, with the Great Moderation. Having a more predictable economy made finance a much more attractive field and credit a lot easier to obtain, leading to a massive build-up in debt. This is seen in the graph below which has been making the rounds around the econ blogopshere:
EDIT: Apparently the right half of the picture is cut off. Click on it and you'll see the whole picture

Too much of a bubble leads to a clamp-down in credit, which is where we were up till Mid-September. But after AIG was taken over (essentially wiping out the shareholders and I guess the creditors too) and Lehman was allowed to fail, a panic was sparked, which has led to people, corporations, and governments all over the world starting to limit the amount of debt they have, and increasing their savings.

Essentially, we are in one massive, global, Paradox of Thrift situation. And it may be a llllooooonnnnngggg time before debt levels reach a new equilibrium, which means it will be a long time before the global economy starts to recover. And unlike Japan, we can't export our way out of this problem, since the Martian market for financial services really hasn't taken off yet.

Stimulus isn't enough: We need realignment

2009-01-26T12:10:00.002-06:00

The Anglos had a party by living beyond their means, and Asia began to get rich while Germany got even richer. But the Anglo consumers were borrowing heavily against their credit cards and the equity in their houses to pay for the party. There was bound to be a moment when they couldn’t borrow any more. When it came last year, not only was their party over, but the whole world was suddenly plunged into crisis. It is because stimulus alone would simply perpetuate this unsustainable dynamic that rebalancing must be its companion.

This is easy to say, but readjusting aggregate global demand will be no easy task. Of course, the United States and the other deficit countries are already adjusting as their consumers stop buying and rediscover saving, hence their need for stimulus. But the surplus countries need to boost their domestic demand as well. Indeed, because they have excess production capacity that can no longer be easily exported, they actually need more stimulus than the trade deficit countries. And this is where things are getting very difficult.

That from the Smart Globalist.

In essence, we are paying excessive amounts of attention on the domestic situation. In reality, this problem is global in scope and is going to require economic cooperation on a hitherto unknown level to prevent crises like these from happening again. Unfortunately, it really looks like some nations don't want to play ball. Protectionism is on the rise, and nations like Germany don't even want to engage in fiscal stimulus (essentially meaning Germany will be free-riding on the backs of European and American taxpayers).

It's tough to imagine how this won't happen again in the future. We may be looking at the late 1800s and early 1900s all over again (which, of course, ended with the global economy getting shut down after depression, two world wars, and large trading barriers)

The American Freshman, Politics, and Engagement in the Obama Years

2009-01-25T19:33:00.005-06:00

He/She is getting more political

A record number of incoming college students are politically engaged, with 85.9 percent reporting that they frequently or occasionally discussed politics inthe last year.

According to that self-reported statistic, freshmen have never been more politically active. They came close in the 1992 and 1968 elections, but 2008 still edges them out (continuing the trend of increasing involvement since the 2000 election).

But don't get too excited: even if they talk about politics, it doesn't actually mean that they actually care about political issues...

After a record low of 28.1 percent was reported in 2000, post-9/11 freshmen have shown increased interest in keeping up to date in political affairs, rising to 39.5 percent in 2008. At the same time, however, these students have not yet surpassed their parents’generation (baby boomers): Over 60 percent of students in 1966 reported that keeping up to date with politicalaffairs was an important personal goal.

See, talking about politics isn't the same as actually being politically engaged. To some extent, we should obviously expect this increase in political table conversation, given the historic significance of this past election: we had the first viable woman and black candidates running for President this election cycle. Plus, there was the opportunity for a major shift in political policy, as we have already seen in the first couple days of the Obama administration.

However, it's still rather disturbing to see such ambivalence about political issues among college students. Part of the promise of the Obama presidency was that it would re-engage parts of the political spectrum that had become depressed with the political scene. If college freshman are any indication, massive engagement is not really viable: all politics really consists of is table-talk, which becomes even more dangerous when you consider other trends:

Trends also indicate that fewer students today characterize themselves as middle-of-the road in terms of their overall political view. This category has steadily declined and is at an all time low (43.3 percent), returning to roughly the same percentage as in 1970.

Which isn't surprising. If you just talk about politics, but don't actually care to learn about issues, you probably just created an echo chamber.

We're all screwed!

2009-01-24T22:34:00.002-06:00

Or at least that's what Megan says

The idea behind stimulus is basically that the government will step in and take up the responsibility for the borrowing and spending that was being done by consumers, except instead of a Wii we'll get a high-speed rail line between LA and San Francisco, and hopefully the potholes filled in front of my house. At 0% interest rates, proponents argue, plausibly, that this borrowing is hardly going to crush the taxpayer under its onerous weight.

But that 0% is not on 30 year bonds; it's on shorter term debt that will eventually come due. What will our interest rate be when it's time to roll that debt over? It won't be pretty if the government is still having to fill in the output gap with heavy borrowing.

Fiscal stimulus has no great evidence of working (hell, we've only had so many recessions since Keynes even wrote the General Theory), and we're up a creek of massive debt (or more like a raging rapid) without so much as lifejacket. Adding on a bunch of debt that's sure to be mighty expensive to repay (and, keep in mind, interest is already one of the largest expenditures today) for something of questionable value seems like a surefire way to mismanage a trillion dollars.

NY Times starts talking about buying Assets again

2009-01-18T12:08:00.002-06:00

Several months, I expressed some reservations about the plan to recapitalize the banking industry. The idea, basically, was to give the banks a bunch of money so they would start lending, instead of doing the original plan, which was to buy up bad assets and simply remove them balance sheets.

Given the numerous difficulties this plan has been facing (namely, banks not actually lending the money that they have received), the NY Times is starting to talk about actually buying bad assets being on the table today.

Hopefully, buying away the bad assets will provide a cleansing effect, much like taking a bunch of antibiotics to cure an illness. The flip side is that we have no idea how to value these bad assets, and it doesn't punish the debtholders and stockholders of the banks anymore than they already have been. Essentially, a "give-away."

Bartlett's Advice for Republicans

2009-01-16T17:26:00.002-06:00

He has an article on Forbes today:

nstead of defending the Bush tax cuts, most of which expire next year under laws that Republicans wrote, I think it would be better for them to abandon Bush's tax policies altogether. The evidence is pretty clear that they did little good for the economy. Therefore, getting rid of them will do little harm.

Going forward, I think Republicans should try to be the party of investment, because Democrats are basically the party of consumption.

Basically, I would call this neo-supply side economics. Instead of thinking that mere tax cuts can actually drive growth, the Republicans should embrace the notion that the government can at least target tax cuts in such a way that growth can be enhanced. Bartlett suggests making a permanent Investment Tax Credit that will encourage companies to ramp up investment spending and increase GDP, whereas Democrats are mostly focused on more present-oriented consumption.

Not that I agree with him, and he's also ignoring the pull of social issues: standing strong against immigration reform and asking for the deportation of 12 million people probably isn't going to fly as we undergo "the browning of America." But it would be a helpful change from current Republican political orthodoxy if they could listen to this man.

Markets Recovering

2009-01-16T17:21:00.002-06:00

At least for a little while. Today's news:

Dow 8,281.22 +68.73 (0.84%)
S&P 500 850.12 +6.38 (0.76%)
Nasdaq 1,529.33 +17.49 (1.16%

Not bad gains, all things considered. The Japanese and European markets finished with positive gains, too. Oil has recovered somewhat, gold prices are increasing, both of which we should expect in a recovery.

Problem is that financials finished down half a percent today, as Bank of America looks like it is getting a wallop over the head and isn't anywhere near as stable as it looked. Yields on treasury debt have been falling too: if private investment was really starting to look good, we would expect to see people start running out of Treasuries and back into the market, driving up yield rates.

Not the case: The 10 year is still at 2.32%, a very low level

More Bad News

2009-01-14T20:50:00.002-06:00

So equity markets have taken a tumble around the world since I last wrote about the market. I was expecting to see a January rally, so this bust of sorts came earlier than I expected? Though we still may swing around for a January rally depending on how things go.

And, of course, we've had terrible news since then. 7.2% unemployment, Citigroup essentially being gutted, Alcoa being up a creek without a paddle, and even Bank of America needs more money.

But two things really stuck out to me:
Google laying off workers
House prices to continue to decline until late in 2010

Google is definitely down a lot off its peak of over $600, though the P/E is still pretty high at 19. A higher P/E seems reasonable if the company is expected to grow, but if they start laying off workers, it seems that they are starting to think growth isn't manageable.

And, on the second, if you think housing prices are the root of the problem, then we're still in the thick of this, with no light at the end of the tunnel.

The Broken Windows Fallacy Fallacy

2009-01-14T16:12:00.002-06:00

No, not a type-o. Two fallacies, because it's a fallacy of a fallacy.

Making the rounds is the usual libertarian argument against Keynesian stimulus. It goes a little something like this:
1. Taxes destroy wealth
2. Destroying wealth is bad
3. Taxes are bad
4. Just because the economy is in recession doesn't change 3

And since debt is, essentially, a tax on the future, the stimulus will actually end up decreasing wealth.

The parable goes something like this:
A boy breaks a window of a baker. But people say this is a good thing, since the baker must replace the window, meaning work for a carpenter, who will then employ an automaker, who will employ a banker, etc etc.
But it ignores the fact that the baker would've used that money to instead hire a delivery boy, who then would have hired a carpenter for his house, who would employ an automaker, who will employ a banker, etc etc.

In essence, no matter how you look at it, the boy is still destroying wealth.

Doesn't apply in this situation, though. Because private investors are scared witless about economic prospects, they aren't willing to pump money into the economy, and are actually practically begging for government debt (which is relatively cheap in terms of interest right now). In this sort of environment, government can indeed use this to its advantage, by creating projects that will employ additional workers. There's no actual trade-off, because private investors are too afraid to invest: in fact, they actually PREFER government debt at the moment.

So, the real analogy would be more like the baker asking the boy to destroy his window because he wanted to do some remodeling anyways.

Tyler Cowen asks an important question

2009-01-14T15:44:00.002-06:00

How long is the liquidity trap going to last?

The proposed fiscal stimulus is a big, irreversible investment, which may or may not be needed, and of course it takes some time to get rolling. The traditional economist's recommendation is to apply a very high hurdle rate to such commitments. One alternative is to wait and see if the liquidity trap ends in the near future.

I am not an optimist about the real side of the economy, but I would be surprised if we still were in a liquidity trap one year from now.

Here's the jist of it:

When the economy slides into a recession, the government needs to do something to get it back on track. This can be done through two different ways, monetary and fiscal policy. Monetary policy is basically playing around with the money supply, usually by having the Federal Reserve lowering and raising interest rates.

The problem is that we are in a "liquidity trap," meaning adding additional money to the economy isn't going to create any extra growth in the economy. Monetary policy doesn't work, which is why the Federal Reserve can dump hundreds of billion dollars onto banks without seeing another dime in lending.

So, in such a situation, we can use fiscal stimulus...IE, cutting taxes by a hell of a lot or increasing government spending by a hell of a lot. The problem being that fiscal stimulus carries with it all sorts of issues, like waste, crowding out private investment, etc. Plus, increasing spending tends to lead to permanently higher levels of spending. Once you give the Department of Transportation $2 billion extra because of a recession, it is hard to rein that spending back in.
Plus, there are timing problems. Even if we implement lots more spending now, we won't see gains until late 2009 at the VERY earliest. 2010-2011 is more likely.

So, if the liquidity trap ends within a year, then fiscal stimulus looks like a bad idea, particularly fiscal stimulus focused on spending (as opposed to stimulus focused on tax cuts)

Numbers Can Lie

2009-01-11T17:36:00.003-06:00

One of the first things you should learn when you take a statistics class is how numbers can be twisted around to "prove" any number of theories. In part, this is a good thing: we want to look at the available evidence in as many different ways as possible, so we aren't missing out on the actual reality hiding underneath. For example, in 1800, who could've guessed that the speed of light in a vacuum was fixed? Two decades ago, who knew that diapers and beer are bought at the same time? Etc, etc, etc.

The problem is that we have a habit of jumping to conclusions based on the way a set of numbers look, even though the underlying reality is quite different than it would appear. A good example was a report released in late December, which had people panicking about rising homicide rates among young African-Americans. Numbers are the way we look at a fundamental reality, but we should never confuse those numbers WITH reality.

This was brought to my attention, when I was watching a rerun of ABC's new series "True Beauty." The show's premise is basically this: gather up 10 hotties, and have them go through tests that measure their physical beauty...but also put them through secret tests that test their kindness. At the end, the winner should be a "true beauty," or a person that has a beautiful body as well as a big heart.
The first test they were put through was a "science" test. A plastic surgeon measured their beauty according to their various facial and bodily attributes, compared them to a set of "ideal" numbers, and gave them an overall score between 1 and 100. All scored above the 85 "good-looking threshold," though only two met the 95 "star quality" threshold.

Within such a narrow range (5 points maximum, on a scale of 1-100), can we really be confident in our results? Because this man's "beauty equation" isn't actually reality. It's a model, or rather, a depiction of what reality SHOULD be. I'm not saying beauty can't be quantified: I'm saying that his model may not be accurate to actually discern the difference between a 90 and a 95, in the same way that most of our eyes really aren't capable of distinguishing between 15/16 of an inch and a full inch.

Models aren't always capable of discerning reality perfectly. Another good example comes from Mankiw's recent article:

If you hire your neighbor for $100 to dig a hole in your backyard and then fill it up, and he hires you to do the same in his yard, the government statisticians report that things are improving. The economy has created two jobs, and the G.D.P. rises by $200. But it is unlikely that, having wasted all that time digging and filling, either of you is better off.

GDP is A measure of economic well-being, but it is by no means all-encompassing.

Really, this should be common-sense: don't trust models and statistics all the time, especially without due diligence. But we do it all the time, especially when it comes to investing. "Let's buy a house because it'll be a good investment, even though real estate values can fluctuate wildly." "Apple's stock price has been rising recently, so let's hop on to the bandwagon!"

It's hard to resist this temptation, especially when you don't know the underlying reality.

What is this I don't Even

2009-01-09T23:15:00.002-06:00

Words simply cannot express the epic fail

Limiting CEO Pay: Fighting Norms

2009-01-09T13:10:00.003-06:00

One of the more notable aspects of various financial bailout plans these days is the outrage at CEO excess and general wasting of money

Examples:
-AIG's infamous "corporate retreat" after receiving $85 billion from the government*
-Auto company CEOs working for $1 a year
-Calls for CEOs to return their outsize paychecks

Basically, it comes down to this: if your company is being driven into the ground, you shouldn't be taking out a giant pay package, large enough to buy a private island . (Actually, according to that website, some of these CEOs have amassed fortunes large enough to buy several and clump them together to form tiny nations!)

And now we have Barney Frank proposing revisions to the TARP bailout to include more oversight, including provisions to limit CEO pay.

One of the likely arguments against this may be that CEO pay is actually a tiny portion of the $350 billion being lent out (actually, some CNBC commentators said that as Barney Frank was on Power Lunch, discussing the revisions). And, to be honest, those critics would be correct, at least on the surface.

However, letting the CEOs have their cake and eat it too may set a bad standard for the market place. If the government deems high CEO pay to be acceptable, then higher CEO wages will increasingly seem to be acceptable. You can look it as supply and demand, but where demand for CEOs increases dramatically simply because people think it should be rising and that it's okay to pay CEOs more.

We call it a "norm," or an unwritten social rule.

Then, rising CEO pay automatically starts factoring into wages of other high-earners (Vice Presidents?). You start to see a marked increase in inequality, and merely because we start to think of CEOs as rock stars.

So, if you think norms are an important part of the story in rising CEO pay, you can entirely be behind Barney's measure to limit CEO pay.

* And here are pictures of where that "corporate retreat" was

Note my previous post here. It's really more of a side issue.

Is Obama tacking towards the center?

2009-01-08T18:46:00.001-06:00

Yes, yes he is

You know that Obama is starting to become more centrist when Democrats start blasting his stimulus plan.

Or even when Larry Kudlow spares a few nice words!

Why did the market crash? And will it crash again?

2009-01-06T22:06:00.003-06:00

This link contains some interesting thoughts

The reason this part of the story matters, at least from the perspective of the stock market, is that even after Lehman Brothers failed (provoking the crisis that Paulson and Bernanke were talking about) stocks initially held up pretty well. While they tumbled right after Lehman failed, the talk of a rescue plan seemed to reassure investors, to the point that the day before the first vote in the House was taken, the S. & P. 500 was only slightly below where it had been before Lehman went under, at around 1213. It was only after Congress failed to pass the bill that the market went into free-fall, tumbling twenty-five per cent in the next ten trading days.

Even after the bailout passed, the market didn't recover. The author argues this is because

Congress’ failure (thanks primarily to House Republicans) to pass the bill was a massive blow to investor confidence, because it told investors that Washington did not understand the magnitude of what was happening and wasn’t ready to do what was necessary to alleviate the crisis...

So, basically, we have a crisis of confidence, because investors have figured that government really isn't totally committed to fixing the problem. Now that the Fed has pretty much pulled out a bazooka and the Obama administration is preparing to drop the fiscal policy equivalent of an atom bomb, markets are recovering somewhat and credit spreads are starting to fall. Since confidence is starting to increase a bit, the market rallies.

However, there are a lot of other actors at play here. For instance, the banks, which are just sitting on money. Unless they start lending again, there ain't going to be a recovery, and rounds of bad sales will start to hammer the economy even harder. Things will get especially bad when consumers start seriously cutting back their consumption in response to falling house prices and job losses, which they already are.

So, if the problem is a crisis of confidence, bad news: The recent market rally is in for a surprise when they realize there simply isn't a recovery yet.

China brings "steel" helicopters to the US

2009-01-06T21:27:00.004-06:00

Or, that's what the headline SHOULD read.

Sorry, no link on this one: just an article out of the Jan 12th edition of Businessweek.

Apparently, since April this year, steel imports from China have been surging. Meanwhile, US steel plants have been operating at under 50% capacity because (duh), we're in a recession. So the US has filed a suit against China in the WTO, alleging that China has been illegally supporting exporters.

The lawyer for the Chinese says that most of the imports were pipes for oil-drilling equipment, and those contracts were signed months ago when prices were high.

Of course there's a nifty little graph here showing how exports in general have been surging all this year.

To me...if it looks like a duck and quacks like a duck...

What happens if Israel wins?

2009-01-04T16:24:00.002-06:00

A bunch of analysts, including this NY Times article, are suggesting that the real reason behind the offensive in Gaza is to remove Hamas as a power in Gaza, as opposed to simply ending the rocket attacks.

In fact, the article argues, even if Israel doesn't WANT to remove Hamas, the mission will inevitably escalate to that point: leaving Gaza with Hamas still in charge would simply leave Hamas emboldened politically, and set themselves up as a lasting feature in Palestinian politics. Since this is obviously NOT what Israel wants, they really don't have a viable choice: Hamas has to go, and it has to go now, or else this fiasco will start looking like a repeat of the 2006 Lebanon war.

This leaves Israel with an interesting decision to make afterwards:

...Israelis may already be facing a kind of mission creep: after all, if enough of Hamas’s infrastructure is destroyed, the prospect of governing Gaza, a densely populated, refugee-filled area whose weak economy has been devastated by the Israeli-led boycott, will be exceedingly difficult.

IE, if Hamas goes down after Gaza has been so devastated, who is going to be left to rule the country? And if Israel doesn't submit an alternative government with real enforcement powers, misery continues, leading to more recruits for a future terrorist organization, and a power vacuum where it can easily arise again. Which is going to require another intervention down the road.

The only viable victory condition for this war is a detailed plan to win the peace afterwards. Unfortunately, Israel isn't motivated to put troops in Gaza for very long, and Fatah doesn't seem to have the ability to govern it. Nor are there any UN peacekeepers ready to pick up the torch.

In the end, this Gaza offensive won't accomplish much.

Oh it feels so bad to be wrong

2009-01-03T16:31:00.001-06:00

Here's an article from Free Exchange, which makes me want to stick a boot up econ's collective behind.

Of course, I was one of the "don't worry, it's gonna be alright!" crowd, so I can't blame others for getting it wrong

Wal-Mart to strongarm Chinese producers

2008-10-26T13:49:00.001-05:00

Into making products safer

The Communist Manifesto

2008-10-23T23:27:00.003-05:00

I have read it today, for the first time. I am passingly familiar with some of the theories of communism, having debated quite a bit with a number of leftist anarchists, and had a lecture on Marxism crammed down my throat at high school (thanks Mr. Whipple!)

I am somewhat unimpressed. The argument depends on the existence of conflict between the proletariat and the capitalists, and that industrial economies will erode all distinctions in society until we get to the point where only these two classes exist. The reason these classes exist is because they are the two inputs into production (labor and capital). As anyone can tell you, this is a bit simplistic: there are many different types of labor and capital, which leads to many different classes, all fighting each other for a piece of the pie.

On Regulation in the Financial Markets

2008-10-23T23:22:00.002-05:00

Some people have suggested to me that regulation is not neccessarily a good solution just because the private market is failing, like in the mortgage crisis. Regulations can be poory applied, or even gamed, thus meaning more wealth for the financial industry (which is what we are trying to avoid).

Well, don't need to listen to me on whether there was regulation that could improve outcomes. Now the Maestro is saying we should have some more regulation, too.

Greenspan softened his longstanding opposition to many forms of financial market regulation, acknowledging in an exchange with Waxman that he was "partially" wrong in his belief that some trading instruments, specifically credit default swaps, did not need oversight.

Economists are still supporting the buying of preferred shares over the mortgage buy-back, though. Guess you can't win 'em all.

Econ Panel Discussion

2008-10-22T23:42:00.002-05:00

Panel Discussion on the Current Financial Crisis, Thursday, October23, 2008, 2:00 pm, Lecture Center A-1. Concerned about the currentstate of the US Economy? The Department of Economics invites all toattend an open panel discussion with UIC faculty including: Lawrence Officer, Houston Stokes, Joe Persky, Paul Pieper, George Karras,Nathan Anderson, Robert Chirinko and others. Moderated by JohnMcDonald, Head of Economics. Sponsored by the Economics Club and the Department of Economics.

Rememinder to Real Estate 371 Students (and possibly other Econ Students): Attendance and a short 1 page paper means extra credit! That oughta spruce up your marginal benefit a bit.

I have had Officer as a Professor and studied income inequality a bit with Persky: Both are very intelligent and quite capable of turning complex ideas into simple ideas.

Lawrence Officer's CSPAN appearance can be found here

Is Europe really looking smart?

2008-10-19T14:04:00.001-05:00

Well, some people seem to think so

Problem being, as you can see when you read later in the article, is that Europe is still having many of the same problems that we have.

An Excellent Line of Thought on HealthCare

2008-10-18T20:16:00.002-05:00

See Ezra

The basic idea is that the placebo effect is extremely powerful.

Does that mean we should give everyone placebos?

No...one of the commenters hits the nail on the head here:

if this is any example of how the left thinks we are really screwed. No one is suggesting we give people placebos. There is no way to ovecome the liability issue. What it proves is when people are not responsible for the cost and spending smeone elses money even faux treatments will garner positive results.

A patient paying for these drugs would make more accurate and informed decisions. It's detaching consumption from responsibility that is killing our system.

Now, other commenters point out that the "placebo effect" doesn't hold for anything besides pain and low-level depression. One wonders, though, how much health care we get that provides little additional value to the person's quality of life because the marginal cost is very low (since insurance covers it, whatever "it" is).

Hence, the rationale behind high deductible health care plans. People have to actually pay for the less costly treatments they need, but, if something REALLY goes wrong, they'll be covered.

Update: Now guest blogging

2008-10-18T19:52:00.002-05:00

On Pulp is taken
The blog will be moving to a separate website, but it's pretty darn interesting. Good insight into the mind of a Chicago-area art lover

Pledging Process...

2008-10-18T19:42:00.002-05:00

We're now two weeks into the pledge process here at the Eta Rho chapter of Alpha Kappa Psi. We're on a bit of an accelerated pace...6 weeks instead of the normal 7, since the designated first week meeting became a party for the pledges to get to know the Brothers.

What do our pledges have to do? Well, I'm glad you asked...

They are required to attend two professional, two social, and two philanthropy events. Gotta give back to the community, gotta get to know the Brothers, and gotta learn how to be a good business person. They are responsible for putting on their events...each pledge has been put onto a committee so that the workload can be divvied up.

They also are required to fill out signature books. Hopefully I can get a picture of one...basically, they are little pamphlets that the Pledges have to decorate, and then acquire two signatures from all 40 Brothers in the fraternity. The process is designed to get the pledges in contact with the Brothers, so everyone gets to know each other.

Pledges are also responsible for raising $2000 in total, and to get gifts for their Big Brothers.

It's a stressful 6 week practice...but it's worth it.

And we don't haze ;)

Change We Can Believe In!

2008-10-18T19:18:00.001-05:00

Mr. Obama is now outadvertising Senator John McCain nationwide by a ratio of at least four to one, according to CMAG, a service that monitors political advertising. That difference is even larger in several closely contested states.

Apparently, "change" means spamming my television set. Truly, a noble campaign.

Effective Risk Management

2008-10-12T15:09:00.002-05:00

Recently, this video has been making the rounds, causing quite a stir on various internet message boards.

While I fully appreciate the efforts of the author to explain global Climate Change through the lens of risk management, the problem is that risk management is inherently...well...risky?

Risk management involves assigning probabilities to various outcomes and analyzing the cost of different types of failures, plus factoring the all-important "unforeseen" instances. It's not an easy task: if it were, insurance would be a zero profit business and people wouldn't have to go to college to work for Allstate.

Even expert physicists and mathematicians can fail in managing risk effectively

Paulson ends up channeling the Economists, too

2008-10-12T11:54:00.001-05:00

Well, this author has it nailed it down pat

They said a wiser course -- the one the Treasury now seems to have come around to -- was for government to rebuild the badly depleted cash levels on bank balance sheets. That would cushion institutions against future losses, giving them the wherewithal to lend again

That's alright, at least something is getting done.

Channeling the Bulk of Economists...

2008-10-04T16:18:00.003-05:00

Alex at MR points out that many noted economists, from both sides of the aisle, do not support the Paulson Plan, which passed after the addition of many sweeteners

But, looking through the links, I see a serious misconception that could kill many ideas, and a fatally flawed assumption that would sink most of the others:

1. Krugman and his ilk appear to be ignoring the significant adverse selection process going on. He suggests that instead of purchasing assets, we should instead focus buy preferred stock. This gives us a permanent equity stake, acts directly on the balance sheet, and should even hurt stockholders. However, it does nothing to actually reveal which banks are exposed to bad debt, and which are solvent. That's the biggest problem we have in the financial sector right now: no one really wants to lend out money to someone who can't pay it back, and you don't know if the other guy can't pay it back if you don't know how many assets he has that are linked to the subprime market.

The Paulson plan, in theory, avoids this by buying up a lot of those assets, and creating a market for others to buy them (follow the leader, so to speak?). We can theoretically make money by paying the "Hold to maturity value." Bankers can't hold these assets to maturity because they have significant problems with upholding certain capital ratios: they will have to sell the bad assets at firesale prices.

That's the misconception

2. Because of that, a lot of economists, like Tyler Cowen, state that we need to figure out which banks are insolvent. The problem is that, even knowing which banks are insolvent won't actually help...hence the need for speed bankruptcy. A bank that goes through "speed bankruptcy" can have a payment plan forced down its throat and can force its creditors to accept it through the force of law, and have it done relatively fast: this means that someone new can take over the business, and market operations can return to normal.

The important bit is the "speed" part. Bankruptcy proceedings usually last a very, very long time, and, with all the complex derivatives, will likely take even longer for a modern bank. If you can't get a speed bankruptcy, we end up totally screwed, like in the LDC debt crisis: people fight for years over who gets what, and, in the meantime, the bank can't get capital. So, operations are hampered, and the economy suffers.

But, even if the "speed" part works, we will still have to wait for the banks to fail...even a failing one can keep itself afloat for a while, since not everyone knows that it is in danger and someone is still going to be lending...how do we solve that?

The Paulson plan, for all it's flaws, addresses those two fundamental concerns. It may not do anything, being a drop in an ocean of debt, but it's a lot better than nothing, and a lot better than most alternatives.

Oil prices do not create inflation

2008-10-04T14:49:00.004-05:00

So says a new letter from the Fed Bank of San Francisco

Should make sense. Here's some BLS CPI data:

Any influence total inflation seems to have on core inflation seems small at best. Admittedly, this includes food prices as well, but energy prices have been jumping over the past several years, and the chart, to some extent, should account for that.

And Mark Thoma on why we use Core Inflation:

.... this paper finds that predictions of future inflation based upon core measures are more accurate than predictions based upon total inflation.

Hat-tip to Economist's View.

Update on Mid-terms

2008-10-04T14:44:00.002-05:00

The Upcoming:

Western History: October 22nd
Law and Economics: October 21st
Real Estate Finance 2: Monday

And the ones that have been taken:
Real Estate 1: 97%
Managerial Finance: 96%

I've noticed a lot more studying among my peers recently. I am not sure whether to attribute this to taking harder classes, or being scared silly about the financial crisis.

In my case, the effect of the second is considerably stronger than the first.

Is the deficit "too high" to do the bailout?

2008-10-01T19:13:00.006-05:00

Summary at bottom

One of the big arguments I see against the bailout package is that it will just kill us in the long-run: not because of the moral hazard problems, not because it doesn't actually solve the credit crunch, but because the government will have to issue $700 billion in additional debt, which is supposed to be "just too high."

Well, admittedly, there could be some problems with crowding out of investments and interplay with foreign exchange rates, but in terms of actual direct impacts on our standard of living? $700 billion isn't likely to break the bank.

The problem with debt spending is that debts have to eventually be repaid. This means, in the long run, either higher taxes or lower government spending: there is no way around it.

But what cuts will we expect?

Let's assume that we will pay for this $700 billion bailout entirely with ten year treasury bonds. Let's also assume that this massive drop of money instantly causes the market to raise interest rates dramatically, so that we have to pay double the current interest rate: that'd be 7.54%.

What would we end up paying over the next 10 years? Using handy-dandy financial calculators, and assuming semiannual compounding, this becomes a cinch: $50.46 billion per year for the next ten years, or about $168 per American.
But we probably won't pay it all in 10 years. Some of that debt will be paid for with NEW debt...meaning that we will end up paying for this over a longer period of time than just 10 years.
So, let's assume we are paying over the next 60 years. What becomes the payment then? $26.7 billion per year, or a paltry $89 per American.

Now contrast that with a recession: What are going to we lose if we wind up in a recession for even one year? Negative 1% growth is a reasonable estimate, meaning, essentially, 4% of the economy is lost (that's because the economy should be growing at 3%)
4% of $13.794 trillion is approximately $551.8 billion.
But...we're not done. If that GDP growth had occurred in the first place, then we would be growing from THAT level: IE, we would be growing 3% on that $551.8 billion, so we lose another

Over the course of, say, 60 years, how much growth will be losing?
Let's assume 3% growth. Hell, let's assume things go bad and we grow only 2%. How much growth is lost? The answer is a cool $1.77 trillion.

"But," I hear people complain, "the increase in increase rates will hurt the private sector and drive down growth!"
The argument is that by printing more debt, the government crowds out private investment. And perhaps it does...in theory.
Looking at the past 50 years, though, we'd be hardpressed to see the story.

Here's a look at real interest rates on US 10 year bonds since 1953. I made this one myself from:
Misery Index
Federal Reserve Documents

And now let's look at the per-person deficit (not a perfect measure, I know, but better than nothing, right?):

Real Interest Rates did indeed increase with the massive increase of the deficit...in the first year of Reagan. They then fell, and continued to fall. Even today, with the Bush deficits, treasury rates don't seem to be moving anywhere in a northerly direction. Rather, rates remain relatively low (3.77% for a 10 year bond)

So, government deficits...don't really drive up interest rates. Or at least, I don't see evidence that it's doing so right now, or has in the past. Theoretically, it is possible: the government may just not be putting enough T-bonds on the market yet

Summary:
-Cost of bailout: $89 per person over the 60 years (that's a high estimate)
-Cost of depression: $2.2 trillion (that's a low estimate_
-Real interest rates don't seem to be driven by government deficits

Addendum:
-Discount rates aren't used in this. Discount rates mean that a dollar in the future isn't worth as much to you as a dollar now. That's not adjusting for inflation, it just means you'd rather have a corvette NOW than 10 years from now. People prefer consuming in the present. If discount rates are used, then bailout looks a lot less attractive, since the $700 billion has to be paid out NOW.
-I am also ignoring that we will probably recoup a large amount of the $700 billion outlay
-I am also ignoring the direct effect on public finances, and looking only at social costs. In the short-term, taking on this debt will mean a lot less flexibility, and it means public finances will be in worse position until the debt is fully paid off (or, rather, the tax revenues from increased production pay off). That means that the "break-even" point for the government is later on than it is for society as a whole

What I am learning about war

2008-09-28T22:25:00.002-05:00

From the book "What do we know about war?"

1. Territorial disputes are far more likely to lead to war than other disputes. This is probably because such disputes are highly visible, don't give much room for policy maneuveuring, and lend themselves to military fights (since armies are designed to capture ground)

2. Alliances have generally led to increased war, but there are fundamentally different kind of alliances. An alliance between Peru and Ecuador to take over Europe doesn't really matter. Similarly, a non-aggression pact between France and Germany because they just settled an old dispute generally does not lead to increased violence. On the other hand, an alliance between two unhappy states, or states that have a big difference in power, lead to war. The first because neither country likes the status quo, and the second because states generally do not ally with other states that have more power or less power than them...a new alliance would imply war soon.

3. Democracies behave differently. They make alliances for non-strategic reasons, ally with other democracies, have longer alliances, and escalate more when facing non-democracies.

4. Military buildup increases the chances of conflict, especially when the international order is in flux and when the defense budget is high.

This is getting ridiculous

2008-09-28T21:47:00.002-05:00

Absolutely ridiculous.

CNN just had breaking news about some key breakthroughs on the bailout...highlights were mostly about executive compensation.

A LOT of anger has been coming out lately about executives getting untold amounts of money. I can't say I blame them: executive compensation is getting wildly out of control, and a lot of it seems based on...nothing at all. They even get massive aid packages when their companies fail and let the CEOs go due to bad results: the so-called "golden parachute" that many worry about.

However...this really is not the time to be addressing those issues. This discussion about the bailout package should largely be focused on the economic ramifications of dishing out $700 billion to the private sector: will the program even work? What happens if it doesn't? How will we finance it? What is being given up to fund it? Who should manage the assets and how should we value them?

Instead of that, we hear loud cries against bailouts, saying let the whole system collapse and force CEOs to live in cardboard boxes forever.

Looks like "proof beyond a reasonable doubt" doesn't apply if you are rich. And rational discussion can't get done if even a spot of cash gets sent to "the rich."

Funny how many people support tax cuts, though...

Career Fair

2008-09-27T18:05:00.002-05:00

Last Thursday, the University of Illinois at Chicago hosted the Fall Diversity Career Fair at the new Forum building.

It was a pretty nice get-up, all in all. Entrance was speedy, as usual, despite the fact that the actual fair floor was literally wall to wall people (especially around the bigger name companies, like Allstate). However, most all of the representatives there were genuinely nice, despite the heat and the noise. A good experience.

To would-be job-seekers, though, I would offer the following advice:

1. Actually dress up. I saw a number of people (though a small minority) that came in nothing but a t-shirt and jeans. Seriously, folks, that's not the kind of image you want to be sending to potential employers!

2. Follow-up, follow-up, follow-up. If you have a business card, send a thank-you email immediately. Get on your computer and log onto the company website RIGHT NOW. Go down to the career center and sign up for one of their seminars if you haven't already. The biggest problem people have is keeping up the momentmum after they feel pumped up: don't let this happen to you!

3. Calm down, folks. Relax, have a little bit of fun. It's a job fair, but you're also in college, and everyone (including employers) likes someone sociable. If you're standing in a long line for an employer, talk to the people around you. Crack a few jokes.

Hope that helps.

P.S. For younger readers: Start the career process now. Go find an internship, talk to companies, etc etc. It helps a lot later on.

Government vs. Private Culpability

2008-09-23T20:39:00.002-05:00

A lot of crap has been flung around over the past couple months among people trying to assign blame to different actors in this crisis. Is it the loan officers? The homebuyers? Wall Street? Fannie Mae? There's a bit of blame for everyone to share here.

One of the biggies, though, is a large group of people blaming government in general and the Federal Reserve in specific for this crisis. According to them, if they had not acted so capriciously and created such easy credit, this crisis never would have been able to get off the ground. Hence, according to these people, the Federal Reserve should be eliminated...or at least have its power restricted.

So, is government culpable for this disaster?

The argument rests upon the creation of easy credit. By decreasing interest rates too much, companies and consumers start loading themselves up with debt. Interest payments are low, expected growth is high, so why the heck not? However, the "easy credit" also implies "irrational exuberance." The government is creating artificially strong business conditions, above where we could produce with a full employment economy. So, once the economy starts cooling down, a lot of the debt that looked good at the time...really isn't. Mr. Time Machine producer who took on a $1 million home equity loan is screwed because he has no market and all these interest payments to service.

In this example, government is the primary villain. By lowering interest rates and making the economy seem better than it actually was, they encourage the entire private sector to over-leverage, thus setting the economy up for a painful readjustment.

But, wait! There's a scenario where private actors make the mistake, and government acts perfectly rational. In this example, the private sector makes the mistake because they take the credit and do stupid things with it.

Consider the example where the government perfectly manages interest rates. The Federal Reserve has just the right Fed Funds rate and just the right amount of T-Bonds on the market, and the economy is producing exactly at full employment. All is well...right?
Well, Mr. Time Machine Producer still ends up getting a $1 million home equity loan, because some bank thought it was a good idea. That still doesn't change the fact that, objectively, his business plan doesn't work because his product cannot possibly exist. So he's going to default.
The point is that markets can still misjudge business ventures and the credit quality of borrowers, even if the economy is functioning perfectly smoothly and government has set interest rates perfectly. No matter if credit was tight, loose, or just right, the private sector would STILL be misallocating resources. And that means painful readjustment.
The questions here are two fold. The first is what size the bubble can possibly be. Many would assume that the bubble can't get very big. This, however, depends entirely on the private sector and its own interpretations. If it reads the market VERY wrong, it's going to misallocate resources VERY wrong.
The second question is one of adjustment. If markets have allocated resources badly, shouldn't they reallocate them very quickly, thus averting recession? That's a question of sticky prices, particularly ones involving the labor market, and therefore tough to answer.

But if the private sector reads the market wrong and the market is slow to adjust, we can be stuck in a long recession, even if the government did everything right.

What about the current crisis?

Well, in my opinion, we probably were overproducing. Unemployment was below 5% and inflation was higher than normal. That suggests an expansionary economy (IE, overproducing), meaning too easy credit, meaning the potential for an overall bubble.

But we've had expansionary economies before. This crisis, though, is the worst since the Great Depression. What gives?

It should be obvious: private failure. The failures have largely concentrated in the mortgage market, especially in the subprime market, which is in turn affecting credit. That means sectors of the economy related to finance and home building are hurting, but the rest of the economy is still chugging along pretty well. That suggest MASSIVE misallocation of resources by severely underpricing risk: a private sector failing by definition.

Less Focus on SATs?

2008-09-22T09:28:00.003-05:00

That's what one commission is suggesting
In my experience, standardized, heavily regulated tests are the only reliable measures to go by. Cheating and work-sharing are rampant, and grade inflation is practically an institution in the American education system at all levels.

If I were an admissions officer, I would consider your 4.0 GPA to be hogwash if you can't get higher than a 26 on the ACT

Central Bank Independence

2008-09-19T23:26:00.002-05:00

Some people seem to think that Bernanke and his band of Merry Economists have overstepped their bounds in their bridge loan to AIG.

Well, they certainly might have...but one wonders why Congressmen whine about the lack of oversight of the Fed when they themselves aren't subject to too much "oversight." I mean, they get a heavy hand in drawing their own districts, right?

Anyways, people seem to increasingly demand the reigning of the Federal Reserve Bank. Problem being that this isn't entirely logical. While the Fed has expanded its powers somewhat, central bank independence is an important pillar of any modern economy. It ensures that the financial system isn't subject to the whims of politics, and instead is a rational process based on the needs of the nation.

It is also important to ensure that policy is prompt. Since the Federal Reserve is subject to less "oversight" it can respond to crises faster. While cutting interest rates in order to stimulate demand is still slow, and only a bit faster than government spending by a bit, the Fed has demonstrated remarakble speed and innovation in moving to avert disaster. For instance, quickly extending a bridge loan to AIG, opening the discount window to Investment Banks, etc etc.

The alternative is to rely on government. Government, at the best of times, is relatively slow-moving, and when it is fast moving it is generally in response to national security issues (like the PATRIOT Act). At the worst of times, IE, right before an election, IE, right now, it is ponderous and incapable of the nimble movement required to navigage modern finance.

Hence, central bank independence=good

Updates

2008-09-19T23:21:00.002-05:00

I am now an Econ-Finance Major. The double major petition was accepted by my university. Hurrah for me.

In related news, campus recruiting kicks off this week as well. Hopefully this double major gets me something better than Burger King!

Thoughts on Finance Classes

2008-09-17T22:30:00.005-05:00

What is most striking to me about the majority of my finance classes is that theory is not really emphasized, while formulas are of the utmost importance.

I don't want to knock math, per se. However, a lot of what we learn ends up feeling a bit disjointed. Attend a class day after day, where one formula gets listed after another, and it's very easy to lose sight of the bigger picture and get lost in variables.

The formulas largely consist of valuations. Bond valuations, stock valuations, etc. They are immensely important to understand the cost of the capital structure, which is in turn important to understanding how the firm makes expansion decisions.

HOWEVER, our finance classes generally fail to highlight the bigger picture. They also generally fail to move a quick pace, meaning that we don't look at weighted average capital costs until late in the semester, when bad grades and the daily grind have generally sapped all interest. This is exacerbated when we don't look at the psychology of firm decision making and look exclusively at finances.

An improvement I would make? What variables would change the factors involved in the equation? What would change the discount rate, the capitalization rate, the stock growth rate, etc etc.

In my opinion, it would go a long way to making the course seem more "real" and generating interest in introductory finance courses.

GSEs and failures

2008-09-17T22:30:00.002-05:00

One the big arguments I see coming out against the Fannie Mae bailout among the more "fringe" group of people (IE, the libertarians) is that the Fannie Mae bailout largely wouldn't affect normal people. Since it wouldn't affect normal people, we shouldn't even worry about Fannie...especially because bailing out Fannie requires taxing the normal people!

Leaving aside how the tax burden actually falls on the population by income bracket, let's look at how Fannie interacts with the "real economy."

Fannie's primary purpose is purcahse mortgages from banks, pacakge them into mortgage-backed securities, and sell them to big-time investors. The function is pretty important in the modern economy. Big investors being able to buy simple securities instead of a hodgepodge of loans means capital infusions into residential real estate, meaning basic people can afford to buy loans...especially in an era when Americans themselves don't save much money anymore.

So, eliminating Fannie=making a lot tougher for normal people to get loans, just based on sheer capital available.

But what about liquidity? Fannie provides liquidity to local banks. Rather than having 30 year assets on their balance sheets, banks can instead have money to make more loans, either to other home buyers or to local businesses. This means a greater amount of money being invested back into the community. That means more local barber shops, more local restaraunts, and more local 7-11s. And it's being enabled, in part, by Fannie Mae.

Those are two very real effects that Fannie Mae has on the "real economy."

Hence, yes, Fannie Mae matters to everyone.

But what about the cost?

But who's actually paying, and who's actually benefiting?

For one, common stockholders aren't, and have been entirely wiped out. The people benefiting are China, big investors, and other big banks that bought preferred stock and mortgage-backed securities. Also benefiting is everyone who is buying a home, or possibly thinking of buying a home, or even renters (since more homeowners should mean less competition for rent). IE, everyone kind of benefits. This might be a bias against wealth, since the least wealthy are the ones most likely to be unable to afford higher interest rates. The least wealthy also are hurt the most when the economy slows down.

Who actually pays the tax burden?
Welly, by and large, two thirds is derived from corporations and income taxes. Taxes on corporations largely hurt corporations and those that own stock/bonds most directly. So that's a bias against wealth, on average

Let's look at income taxes.
Look at Page 22
As we can see, the wealthiest, obviously, shoulder most of the tax burden. The lowest 20% pay almost nothing, and the next 40% pay less than $10,000 annually. And that's just in taxes. Using slightly rounded numbers, the bottom 60% shoulder 28.8% of the tax burden, or $58 billion in this plan. Assuming 100 million households, that's a bit shy of $1 grand per household.

I think a one time payment of $1,000 is well worth lower interest rates. ;)

My own policy positions

2008-09-10T11:49:00.002-05:00

In order of importance:
-Health care reform, based on market principles and changing incentives to reduce the amount of unnecessary health care Americans use. Means limiting doctors to fee-for-service, tax credit for health care, and taxation of employee health benefits.
-Education reform, based on stronger federalism principles. National standards on a national test, an individual tax deduction/voucher that can be used at a licensed school system of the parent's choice, and no federal funding for states that don't sign on to the program
-A harder line stance on Iran that includes the application of hard military power
-A sensible withdrawal of the majority of combat troops from Iraq, with the permanent presence in the nation being minimal
-An extension and regularization of the tax credits for solar and wind energy, plus a renewed effort to completely revamp the nation's power grid
-A hard push to add Ukraine and Georgia to NATO
-A reconciliation with Syria
-A broader and more defined economic policy with China, to include obvious rules for improvements with clear punishments defined, in addition to assistance to help China develop its local administration so it can more effectively police its rogue local governments
-A carbon tax on all power and commercial polluters, coupled with increased CAFE standards (over the increase that is already planned)
-A simplified FAFSA form, and simplified financial aid system at the college level to a single form of loan capped at $10,000 annum, indexed at inflation. Simultaneously, the addition of two years of general education to the normal "high school" system.
-GAAP only. No friggin' International accounting standards, regardless of what the SEC suggests
-A raising of income taxes...50% increase at the upper tax bracket, 15% increase for the lower tax brackets. Implementation of a sales tax at the 10% level nationwide. Similarly, the AMT will be abolished.
-No more public housing
-Adjustment of the tax code to eliminate the mortgage tax deduction, instead only allowing only property taxes to be deducted at a to-be-determined percentage rate (not sure if the government already allows deduction of property taxes)

Missing from the list that may be important:
-Increased/decreased military spending
-Social Security Reform

More in-depth thought later, but for a brief moment, let me explain the rationale:
The idea of this reform system to simultaneously address the long-run issues of a globally competitive environment, sustainable public finances, and preventing the erosion of American health.

Hence, the concentration, by and large, is on education and health care reform, both of which are eating away at the incomes of American families. In addition, the tax burden would likely increase significantly under this particular plan (basically everything raises taxes to some extent), but the tax burden is allocated in such a way that it should address other issues too: issues like low savings rates, overinvestment in real estate, externalities of pollution, and malinvestment in the health care sector.

I think it's a bearable plan. ;)

Experience: Palin and Obama

2008-08-31T13:46:00.002-05:00

Before you get riled up, this isn't about whether either candidate is "experienced enough" to sit as President of the United States. That's a long argument that I personally don't want to get into on this blog at the moment. Suffice to say that I do in fact believe that Obama does not yet have the experience necessary to be the leader of the free world, and neither does Palin.

What I am concerned about, though, are Republicans and other McCain-supporters suggesting that Palin's "executive experience" should count for more than Obama's time in Congress. The idea is that executive decision-making is ultimately completely different from legislative decision making, and therefore Palin's experience is more relevant than Obama's.

But is this neccessarily the case?

Don't get me wrong: I would prefer a President to have experience as an executive. That's part of the reason why I supported Mitt Romney in the Republican primaries (though Republicans seemed to prefer McCain instead for some reason!)

Sarah Palin's executive experience, though, is very limited. Her only relevant experience is the governorship of Alaska, but how relevant is that to the United States as a whole?

Let's consider the economy:

The oil and gas industry dominates the Alaskan economy, with more than 80% of the state's revenues derived from petroleum extraction.

Now, let's stop right there. 80% of revenues derived from oil? Alaska's economy more closely resembles a Middle Eastern nation than the United States of America. The lack of diversification makes me wonder how much experience Palin actually has in resolving the various disputes and economic difficulties that the President is going to face.

So, on a major issue (economics) her experience might not be all that relevant.

And what about her foreign policy experience?
Well...uhh...we have no idea if she even has any.

Now contrast this with Barack Obama. While true that he hasn't been directly responsible for the well-being of the entire nation, he has been working in Washington, meaning he has spent the last four years looking at the problems America as a whole is facing directly in the face. So, in fact, he does have some experience with national issues.

Also difficult to gauge is how much wheeling-and-dealing he is doing behind the scenes. Politics is a give-and-take game, relying on compromise, motivating others, and even threatening dissident politicians. In that sense, he also has some experience in negotiating a bureaucracy.

That's two bits of experience that do...sort of qualify Obama to be President. Governor Palin, on the other hand, only has experience with a specialized economy on the fringes of the nation, with no experience in foreign affairs at all.

It's pretty clear who's the winner there, "executive experience" or not.

Make Work, Save the Economy?

2008-08-26T19:14:00.003-05:00

One of the ideas that is getting thrown around a lot at the Democratic Convention is the idea that government can automatically provide "high-paying jobs" to our nation's workers through "rebuilding the national infrastructure" and this is a good thing.

The rationale is that many people are out of work, and that the nation needs infrastructure improvements...put the two and two together, and the answer seems perfectly rational! Woo-hoo! Soon we'll be rolling in the dough!

However, by only looking at "save the environment" and "improved roads" and "higher wages," the Democrats are actually missing a big chunk of the picture, namely the fundamentals of economic growth and productivity, hence preventing them from seeing the fact that, in material terms, we will necessarily have to be poorer to carry out their ambitions.

Let's consider the "save the environment" approach. The Democrat approach can be summed up in the Al Gore approach, which aspires to carbon-free electricity within 10 years. The problem here? Massive retooling of the energy industry must be done in order to accomplish this, which requires untold billions of dollars and tearing down a lot of existing infrastructure that's still useful. Hence, retooling the entire energy industry means we are actually destroying wealth rather than creating, and sacrificing other goods in order to pay for the new "green stuff." While it's true we may be better off in the long-run and even in the short run, as we may avert highly damaging global warming and we greatly value clean air, in the direct material sense, we'll be worse off. That means these workers aren't actually producing anything of direct value to the economy. Since the Democrats are touting this as the solution to our economic problems, I am left scratching my head.

The same logic applies, for the most part, to the reconstruction of the nation's roads as well. It isn't actually adding any value to the economy, since it is only maintaining what we already have as opposed to the construction of new roads and railroads to tie the nation together. It's rather hard to justify an economic policy that is based on merely keeping up with where we are right now.

It IS true that government spending can be helpful during a recession (or near recession). Reimbursements can help alleviate some of the pain of economic adjustments, or specific groups in general. Government spending can also be used to manage demand (IE, kick start it) so the economy starts humming again. Government spending is also helpful if it invests projects that provide the essentials for economic growth, like a strong national defense or a power grid.

However, the Democrats are apparently looking at things from a supply-side perspective: they see the falling wages as endemic to the Bush administration era, which encompasses a rather long economic expansion as well as two "recessions." Hence, they don't view their investment program as a simple means to readjust the economy in the aftermath of the credit crunch. Rather, they see this infrastructure investment as a viable solution to an endemic problem (growing economic inequality).

But how much sense does that really make?

Sorry! I've been gone for a while

2008-08-26T19:11:00.001-05:00

I haven't posted in a while as Cybernations, a game I play rather extensively, is currently in the midst of a major war. While the war continues, the role I play has shrunken appreciably, and I'll be able to start writing again.

Oprah: Worth 1,000,000 Votes

2008-08-05T20:34:00.002-05:00

See here

Our results suggest that Winfrey’s endorsement was responsible forapproximately 1,000,000 additional votes for Obama.

Hat-tip to:
Mankiw
Marginal Revolution

My personal thoughts:
Opinion leadership is very important, but I'm hesitant to think that people are forming opinions just because Oprah is making one. A big factor, as I see it, is the increase in voter participation and voter awareness: getting people to recognize think that the election is important is probably more important than the direct endorsement.

Caution, though: I haven't actually, ya know, READ the paper.

The Death of Doha

2008-08-03T22:08:00.002-05:00

The question is, where do we go from here?

Some have suggested that the obvious alternative is bilateral free trade agreements with more nations (even though Congress seems to be putting up stiff resistance to any new deals).

The problem is that this is a bad solution to the problem of global trade reform AND globalization in general.

First, global trade reform. The idea that bilateral trade agreements by the United States are a prescription for global growth problems is a flawed one, because it ignores a lot of the actual and potential trade that plays a big factor in making us all wealthier. The presence of trade barriers between nations in the Third World means that those nations aren't going to be able to realize their full growth potential. The same problem will exist as long as trade barriers exist between Europe and Africa, Russia and China, or any other two individual nations in the world. Eventually, this negative wealth effect acts on us in a perverse trickle down mechanism, sapping our economic potential as well.

Worldwide agreements and organizations like the WTO lower trade barriers globally: it's why the trade talks are so important.

Another important factor: globalized trade talks allows smaller nations to pool their collective demands, much in the same way that unions allow workers to pool their bargaining power. Bilateral agreements allow larger nations to exploit their advantages over poorer nations: it's not surprise, then, that poorer nations aren't so happy about the Doha Round failing.

The effects of trade barriers between other nations and the exploitation of superior bargaining power becomes a LOT more important when you consider the fact that the fastest growing economies are developing ones, and not developed ones.

Holding down the growth of the developing world matters. A lot.

Second, globalization encompasses more issues than simple trade. Also included are questions regarding technological implantation, like what standards we should use on the Internet and how to apply child pornography laws. It includes pollution, global financing laws, and weaponization of space as well. Another overlooked issue of globalization? Flows of labor, which presently don't have much of any global regulation whatsoever.

Doha, of course, didn't really address any of these issues. However, what Doha represents is a failure of nations to work together, even when their interests should be, theoretically, mostly aligned (everyone gains from free trade). Such hard-headedness signals bad times for the coming century on the many issues that affect everyone on this planet.

Court defends "Exorcism"

2008-07-30T23:39:00.002-05:00

This is just too insane to be true

Basic background: A 17 year old girl (now 29) was abducted and subjected to a 2-day exorcism, where she was pinned to the ground and "pummeled."

So, she did what any sensible person would do: take her assaulters to court. Lowers court ruled in favor of the girl and awarded her $188,000 in damages. Big ol' Daddy Texas Supreme Court comes along and overturns the ruling, arguing that this is a First Amendment case...therefore it would be unconstitutional for the court to make a ruling on a religious environment. It's not a blank check, mind you: churches can't sexually abuse children. But the trauma caused by this particular religious experience was not considered within the jurisdiction of the court.

She's taking her case to the US Supreme Court.

I definitely think the Texas Court is in the wrong here. While I respect the rights of religions to hold their own spiritual practices and am willing to grant them some leeway on "child abuse" (for example, a child fussing about having to wake up at 7 AM on a Sunday would not be an adequate excuse for government intervention), this exorcism ritual crossed the line. Physical abuse and forceful pinning for days is an obvious abuse: what 17 year old wouldn't be afraid of being constrained by multiple others for an extended period of time?

And if it's obvious abuse, it isn't permissible under the law, just like sexual abuse.

No, Virginia, High Oil Prices are BAD!

2008-07-29T22:59:00.003-05:00

Or at least not anywhere near as good as people are implying.

A lot of talk in the media recently has been about the "good side" of high oil prices. For example, a list that a friend recently sent me in an email includes the following "goods" about high gas prices:

1. Globalized Jobs Return Home
2. Sprawl Stalls - 'Across the country, real estate agents are reporting that many home buyers are looking to move closer to cities. Gas prices are shaping their decisions.' -- Did you not call for an increase in population density at one point?
3. Four-Day Workweeks
4. Less pollution -- heart of the matter
5. More Frugality – 'We're all wasting less.' – Also advocated by WFan.
6. Fewer Traffic Deaths
7. Cheaper Insurance
8. Less Traffic
9. More Cops on the Beat
10. Less Obesity

And the most recent Businessweek?
http://www.businessweek.com/magazine/content/08_31/b4094000658012.htm?chan=magazine+channel_top+stories

The Real Question: Should Oil Be Cheap?
Expensive oil hurts, but there's a business case to be made for a floor under the price of crude

The basic idea is pretty simple: low oil prices in the past cause all sorts of bad things that we don't like, such as childhood obesity, reliance on foreign oil, outsourcing of jobs, etc. Since oil prices are now high, people can exercise more, cut back on "frivolous consumption," develop alternatives to oil, and develop public transportation networks.

Don't get me wrong. Oil prices in the 1990s were probably too low. Hell, they are probably too low NOW: the price of gasoline still doesn't include the environmental damage it causes. But that's due to the externalities of oil prices...and, like I just said, the externalities still existed. Other than that, everything represented fundamentals.

When it comes to a good with a price determined exclusively by fundamentals and where the private cost is the total cost of the good (IE, a perfectly competitive market with no externalities), more is ALWAYS better. We call those "supply-side shifts." And as any econ 101 student can tell you, supply side shifts mean more goods at lower prices. People don't care so much about being obese, having awesome public transit, or supplying foreign nations with dollars: they are far, far more concerned about having cheap gasoline. They WANT cheap gasoline.

Or, just take a look at those most hurt by the high gasoline prices: the poor. They cannot afford new hybrid cars, they are not located near public transit, and they can't cut back much on their own driving. It's precisely the reason why economists say that energy taxes need to be paired with lump sum rebates especially targeted towards those with low income: people with low income are hurt worse when gas prices rise.

So, what do we really want? We want cheap oil. What would be REALLY awesome if we had cheap oil that didn't negatively affect the environment. And doesn't that make sense? More of good stuff=good.

So, ARE boys better than girls at math?

2008-07-28T14:57:00.003-05:00

Sometimes, I really don't have to write a thing!

The answer: that's not the question you should be asking.

Rather, you should be asking how the skill level of boys and girls varies by person. If there is a difference in variance, then it means one group will be producing more geniuses (and idiots) than the other. Since certain jobs require a LOT of intelligence, it means that one gender will be over-represented in that field.

Career Education in the United States

2008-07-24T20:59:00.002-05:00

Full Report Here

Here's an interesting bit: we know that more women than men are going to college these days.

Did you know they also are more likely to get additional education when out in the work force?

Higher rates of participation in work-related coursetaking were also observed for (female) than for male adult labor force members in 2004–05 (44 vs. 31 percent)

Scariest sentence this morning

2008-07-24T11:46:00.001-05:00

The White House, citing an urgent need to restore market confidence in the two mortgage giants, Fannie Mae and Freddie Mac, said President Bush would sign the measure despite his opposition to the inclusion of nearly $4 billion in grants for local governments to buy and refurbish foreclosed properties.

Why in the world could you oppose that?

Taken from the NY Times article on the Housing Bill

Echo Chambers and the Modern World

2008-07-23T22:46:00.004-05:00

You know what an echo chamber is? It's where you say something, and all the room does reverbate the sound of your own voice back to you. It's pretty kickass if, like myself, you like the sound of your own voice. Most people seem not to (and I didn't before I got a radio show in high school). But that's another story for another a day.

A lot of us live in a certain kind of echo chamber in our everyday lives, though. The CEO who surrounds himself with nothing but "yes men" only hears his/her ideas echoed back to him. Teachers who conduct anti-drug or pro-abstinence seminars often have the same phenomena with their students...5 minutes before the alpha dog slaps on a condom to have sex with the rebel "slutty" girl while sparking up a Marlboro (and he's 14!).

And a lot of us have similar information echo chambers. If you're a right-wing conservative and you tune in to Fox News, chances are you are only hearing your own ideas back bounce at you. A very similar thing occurs if you're a liberal who relies on DailyKOS for all of your information.

The problem with an echo chamber is that people who discuss their ideas tend to start out a bit moderate with a slight leaning in one direction or another. Since they only encounter arguments from their own side, they tend to get very confident in their beliefs, and grow more extreme. If you're a conservative and turn on Rush Limbaugh thinking that welfare is a bad idea, you'll probably turn off the radio thinking that welfare is the WORST IDEA EVAH and that anyone who supports it is an obvious dummy at best, and pandering for the black vote at worst.

A curious effect might be that the most politically active of us become the most polarized of us, at least if we are more likely to look to sources that share our beliefs. The politically active among us talk about the issues, go to their respective echo chambers, and come away bloodthirsty radicals that want change and want it NOW. What can possibly moderate this?!

Well, it ain't the real estate market, that's for sure. See here:

Americans are increasingly forming like-minded clusters. Conservatives are choosing to live near other conservatives, and liberals near liberals.

A good way to measure this is to look at the country's changing electoral geography. In 1976 Jimmy Carter won the presidency with 50.1% of the popular vote. Though the race was close, some 26.8% of Americans were in “landslide counties” that year, where Mr Carter either won or lost by 20 percentage points or more.

Americans, with higher incomes and more mobility, can increasingly choose where to live, and they can make a lot more choices than they used to be able to. Since people like living around like-mindeds, they create clusters of red and blue zones. And the effect magnifies the echo chambers...especially among those who care most about politics.

Heck, politics even seems to matter when we choose who we marry, though I can't find a link for it at the moment.

Echo chambers. So very cool.

But so very dangerous.

This post borrows heavily from the writings of Cass Sunstein, particularly Infotopia. A very good read. :)

Why Poor Nations are Poor

2008-07-23T17:56:00.001-05:00

Why? What we all agree upon

It's one of the biggest questions of the modern world: why are Western Europe, the United States, Japan, and certain British dominions so wealthy, while the rest of the world is so damn poor?

The answer largely depends on who you ask. If you ask a die-hard libertarian, its because the poor world did not embrace markets, whereas the wealthy Europeans have had a more...sophisticated respect for capitalism. A die-hard liberal might point to oppression and exploitation by the West, while more moderates might suggest that institutions (financial markets, democracy, allowing interest payments, etc) allowed the West to gain incredible amounts of wealth.

But we can all point to one point in history where the West started to take off: the industrial revolution. Starting in England and slowly migrating to other parts of Europe, the Industrial Revolution created incredible wealth, while most of the world has only recently begun industrializing.

So, we have our opinions colored by this industrial revolution. Economy policy prescriptions seem largely based on what we think allowed said industrial revolution occurred, which has largely been a rigorous treatment of markets, political reform, and the establishment of new economic institutions.

But, what exactly defined the Industrial Revolution?

A lot of people suggest that it is the development of new technologies, which allowed factories to be built as production was more advanced. Hence, we tend to think of the Industrial Revolution as being relatively capital-intensive: heck, just listen to the communists rant about capital and the means of production. Hence, we consider the development of industry and manufacture to be an essential part of economic development. Because of this, we tend to look at things like tariffs as being an essential part of early development, because it allows domestic industry to develop.

Gentlemen (and whatever ladies we have), this is poppycosh. It is true that capital stores have been enhanced somewhat since the beginning of the industrial revolution. It is not, however, true that the industrial revolution was primarily about industry, and that nations that developed heavy industry were the ones that ended up being the wealthiest by some inevitable process.

Why we buy capital

Capital reserves are based on two things: the real interest rate and the returns to capital. Much like supply and demand must equal each other, so must the interest rate equal the return to capital. If you are going to spend $1,000,000 on building a giant new factory, and earn $50,000 over the life of the factory (or 5%), you'll only build the factory if the interest rate during the same period of time is equal to or less than 5%. Otherwise, you'd invest your money instead of building a factory.

Real interest rates in England at the time of the Industrial Revolution were already relatively low, relative to those of the rest of Europe and of Asia. Declines in real interest rates are not the primary factor driving the industrial revolution. Therefore, we have to point to returns...

But why did returns suddenly increase? Is it, as some people suggest, England levied protective tariffs? Perhaps this is A factor, but probably not the primary one. The textile industry (which produced roughly half the gains England experienced in the early Industrial Revolution) was a highly competitive industry within England, since the optimum size of a textile plant was very small. Hence, returns to capital were low, as profits were very low.

Technology? Definitely the case, along with other innovations. Efficiency gains make the production possibilities increase, and also increase the returns to capital. Hence, there's a rush to buy MORE capital after a new technology comes out that makes spinning threads easier.

You might be thinking that I have just disproved my point. Au Contraire. Keep reading

Globalization in the Late Industrial Age
At first, England tried very hard to protect its markets, as well as keep technology within its own borders. This proved impossible, and technology slowly leaked to other nations around the world. Similarly, England steadily lowered its tariffs (in contrast to, say, France, where tariffs were low throughout to the 19th century).

Great Britain also committed itself to a policy of free markets and free® trade, and other European nations were also committed to building essential railroads within its colonies in order to safeguard gains. Hence, by the time the late 1800s rolled around, the world was surprisingly well-integrated. The globalization of the 1870-1914 era is hard to understate. This is largely the result of the two World Wars: if the economy was so well-integrated, why would the nations of the world fight each other? This is another question for another time, but suffice to say that trade compromised a large part of most European economies at the time. Exports and imports accounted for something like half of the French economy in 1914, compared to 54% of the French economy today. And Germany was the biggest trade partner in 1914, just as it is today.

The developing world was also well-integrated, at least for global capital markets. We can see this in the interest rate between nations at this time, which have absolutely nothing to do with income: India's interest rates were actually lower than those of the United States. India had access to all the capital she would ever need, and all the technology that her European peers had. Because of this, Indian railroads (which were subsidized by the Indian government) were actually better constructed than American railroads.

Yet, India did not develop. Nor did Africa, nor did the Ottoman Empire. In contrast, the United States, plagued by monopolies, corruption, and relatively BAD capital markets, did develop. What gives?

Efficiency: Not Just Technology
As previously stated, efficiency gains explain why countries would purchase more capital. What I did not mention is that efficiency gains also explain a large portion of economic growth in and of themselves (75% or more).

Efficiency, however, is not merely new production technology. I could give a group of three year olds access to a nuclear reactor, and they would be unable to produce even a watt of electricity. Technology means nothing if you can't utilize it properly, and that was the difficulty that less developed nations had. For instance, a textile mill in India would have 1 worker per loom. In contrast, a British or American loom would typically have 1 worker service 8 looms at once. Hence, productivity per worker was far higher in the developed world, and wages/income were higher as a result.

Intangible are things we undervalue greatly today. In part, this is the fault of economists, who concentrate largely on maximization and equilibrium rather than the spread of ideas. Yet, these intangibles are largely the reason why the West is developed today, while the rest of the world has not developed.

Hence, the American South, which had very little industrialization at all, would've rated as the world's 4th richest nation in 1860. Nations can make a fine dollar by exporting something that is not considered an industrial staple, as the general increase of wealth increases demand, and the nation can increase its own supply side through alternative means.

What intangibles are important
Of this, I am less than certain. "A Farewell to Alms," which this post is heavily based off of, suggests that labor quality in the undeveloped world was far inferior to that of the developed world. The example used, though, is hardly conclusive, and might be construed as inept management.

Labor quality probably was, however, inferior, just as it remains inferior today. Similarly, the undeveloped world did not have a core of entrepreneurs and experienced managers, unlike the developed world. This is highly important, as importing management is not as easy as it seems (the soft skills of a manager matter greatly). The lack of entrepreneurs might in turn be the result of lower literacy levels and the low social status of merchants in such times, whereas business became the playground of literate Samurai in Japan. (Indeed, literacy levels in India remain relatively low, barely higher than levels in 1700s England).

Prescription
So, if we want to increase wealth in the developing world, what should we do?

First off, stop dumping aid on them. It doesn't actually increase their living standards. If anything, it actually REDUCES living standards, because parts of the world remain in a Malthusian trap. Any increase in resources(particularly medicine) actually reduces living standards.

Rather, we should focus on the intangibles of growth. That means discipline in the workplace. It means a strong respect for entrepreneurship, and higher literacy and experience in managing businesses. It also means more focus on how different societies operate, so that managers can make most effective use of their work face.

What am I not prescribing? I am not talking about democracy. I am not talking about free trade or free flow of capital. I am not suggesting high tariffs. Certainly, to some extent, these things are actually helpful (in fact, the reintroduction of globalization in the 1970s and 1980s probably set the stage for growth in India and China after they had experienced large growth in literacy and bureaucratization from their statist governments. Ironically, their socialist governments might have done an absolutely remarkable job in preparing them for the capitalist world). They are not, however, sufficient conditions.

DIFFERING VIEWPOINTS #1: Fannie Mae and Freddie Mac

2008-07-20T11:42:00.004-05:00

Unless you've been living under a rock, you probably know that Freddie Mac and Fannie Mae are probably going to join the long list of companies that have had government bailouts. You know, along with the S&Ls, the airline industry, etc. etc...

The problem, many believe, is that private companies should not have government bailouts....ever. Firstly, it's immoral: private corporations shouldn't be getting money from the government. The logic behind this is obvious. People who invest in corporations are naturally taking an obvious risky option, and the people who own major corporations are (presumably) the wealthy. Why pay off a bunch of rich people because they screwed up?

The second argument is a more practical argument. When Freddie and Fannie do well, the stockholders reap all the profits. When Freddie and Fannie do bad, the taxpayer is left holding the bag. Socialized costs and private benefits, it is argued, tend to lead to excesses. If I lose little of my own money, and but get all the rewards if I win, I'm going to be taking a lot of risky actions.

So, bailouts are bad.

The second bit is the logic one of my friends uses in his argument, in one of the companion pieces to this post. You can see the whole thing here

However, I disagree with both of the above points...at least to some degree.

In the first: Increasingly,, regular people are owners of equity. It's not just Warren Buffet who gets hurt when the Dow Jones tumbles 2,000 points. It's also your neighbors and the California teachers. This doesn't necessarily mean that it's right to bail out companies in order to buoy stock prices. After all, we could still help those people out through other means (liberals would argue, perhaps, by increasing social security benefits). But it's something to consider...at least if only to recognize that, when the financial market gets hit, everyone else hurts too.

In the second, as Krugman points out, Freddie and Fannie weren't the ones innovating in high-risk securities. That's those "other" companies, like Bear Stearns, Countrywide, etc etc. You know...those other guys that are getting bought out.
That's because Freddie and Fannie were highly regulated in addition to having an assurance of a government bailout. So, they only were investing in relatively safe loans. It looked like a bad bet when everyone was making money in the 90s and the early millennium...doesn't seem too stupid now.

However, even Freddie and Fannie are getting hurt...but that's because the whole system is hurting:

In Los Angeles, Miami and other places, anyone who borrowed to buy a house at the peak of the market probably has negative equity at this point, even if he or she originally put 20 percent down. The result is a rising rate of delinquency even on loans that meet Fannie-Freddie guidelines.

That, in addition to the fact that Freddie and Fannie were pressured to start making near-subprime loans after the private sector started failing, meant that they weren't in all too great a shape. And that's because everyone else screwed up, not Freddie and Fannie. It's a great example of how everyone is connected.

But, there are SOME inherent problems with the two giant mortgage companies. The companies generally have too little capital on hand. Part of the point of having them be semi-private companies is that they could raise capital buy selling stock, hence being somewhat independent of the government.

Still, though, the government bailout isn't showing how Freddie and Fannie have failed. It's showing how regulation in the financial industry has failed.

Union of the Mediterranean

2008-07-14T11:20:00.002-05:00

While the focus of this article is on France bringing Syria out of diplomatic isolation and back to reengagement with the West.

What I'm surprised by....

Why didn't Libya attend the meeting? A nation can't possibly reintegrate into the world if it refuses to talk to its neighbors about issues as simple as students visas and pollution management.

Should we all be learning second languages?

2008-07-13T15:15:00.002-05:00

Senator Obama seems to think so, apparently

My question to those who say we should be learning foreign languages, since everyone else is taking the trouble to learn ours...

Okay, which ones?

German? We still trade plenty with Germany, and even import weapons
Spanish? Got a lot of immigrants coming in from all over Latin America
Japan? That's where we get our high tech stuff right?
Vietnamese and Korean? I mean...we get video games from there...right?
Thai?
Mandarin?

English has been chosen as a global language. Really, us learning foreign languages simply isn't as essential as foreigners learning English. Even if we wanted to be global wine/book/whatever connoisseurs, we couldn't possibly succeed: There are too many languages to learn!

The Anarchist Misconception

2008-07-12T23:22:00.001-05:00

There are a LOT of young anarchists. A LOT. Like, if you wander around an internet forum or a college campus with the big red “A,” you’re almost guaranteed to have some random weirdo walk up to you and deliver a sweaty high five right into your palm…and if you’re lucky, he might even offer you a joint!

These people are generally classified under one of two belief systems:

1. For any given society, they are better off without a government than with a government

2. By changing cultural norms, they can eliminate most of the needs for governments

They promise that things will be better with no government, and point to all the terrible things that governments have done since the beginning of human history. They have supported slavery, extorted massive amounts of wealth from citizens, protected negligent and polluting companies, started pointless wars, etc etc.

Governments, in their view, are mostly bad things that people use to oppress others. We’d be better off without them.

Unfortunately, I find this to be an argument that really doesn’t appreciate how much government has changed since the industrial revolution (and, indeed, just the past 50 years!)

Liberal democracies generally do not assault their citizens, or even citizens of foreign nations. Indeed, they are highly dedicated to international institutions, foreign aid, and providing healthcare and education to their citizens. Obviously, this might piss off a libertarian (who sees government as slowly encroaching on all areas of life), but it should demonstrate to most other people that government is NOT intent on screwing people over anymore.

It might be incompetent.
It might be mean sometimes.
It might overstep boundaries occasionally (see waterboarding).

But the government is NOT evil. At least not by intent.

The typical retort is that government, even if it isn’t bad NOW, will probably revert back to a horde of evil, barbaric Roman conquistadors. It is, after all, the way of government!

However, this really ignores how much history has changed. Back before the industrial age, the only way to make a quick buck was to steal it in some fashion. In this era, looting is not profitable, nor is it easy to do in an era where guns are so prevalent and liberal democracies don’t permit doing bad things to foreign countries anymore.

So, I really don’t see the return of “evil government.”

But, they say, doesn’t that mean that people are already good, and that government is superfluous? After all, good people don’t need government, and bad people wouldn’t be capable of making good government…

Perhaps. But we’ve turned a new leaf in how we rule ourselves, and a lot of anarchists don’t seem to accept that. That’s the main problem I have with them.

They're all a bunch of whiners!

2008-07-10T19:44:00.002-05:00

Or, at least we are according to Phil Graham.

Now, I don't know too much about Senator Graham, so I am going to have to guess a bit. I'm guessing that, since he's the economic adviser to John McCain, he's REALLY keen on the market, and really keen on trying to show the recent economic performance as pretty strong (since a Republican is in office after implementing sizable tax cuts, which is the bedrock of the McCain energy campaign).

So, much like the extremists on Iraq or global warming or anything else, he HAS to argue that his policies work...pretty much no matter what. Never mind that all market economies have recessions: failure is unacceptable.

So, what does an extremist do when almost everyone disagrees with him? In revolutionary France, he would behead everyone. In America, he calls us whiners instead.

Extremists, extremists...

Militants now heading to Pakistan

2008-07-10T10:51:00.002-05:00

Apparently, Iraq is no longer the "hot spot" for ticked off Sunnis that want to kill Westerners

The number of foreign fighters entering Iraq has dropped to fewer than 40 a month from as many as 110 a month a year ago, a military spokesman in Baghdad said Wednesday. “The sanctuary situation in Pakistan’s tribal areas and North-West Frontier Province is more, rather than less, troublesome than before,” Gen. David D. McKiernan, the new NATO commander in Afghanistan, said in a telephone interview. “The porous border has allowed insurgent militant groups a greater freedom of movement across that border, as well as a greater freedom to resupply, to allow leadership to sustain stronger sanctuaries, and to provide fighters across that border.”

Looks like the "America is now winning in Iraq" story is a bit too good to be true. What seems to be the turning point, at least according to this article, is Pakistan's negotiations with tribal leaders (which began in March). Pakistan, unable to actually dislodge the militants and having to deal with possible rebellions in other provinces, backed out of the area and tried to convince tribal leaders to take on Al Qaeda themselves. This isn't necessarily a bad plan: the United States is using it with great success in Iraq right now.

Unfortunately, it isn't going over so well in Pakistan. Al Qaeda and Taliban have instead of dug in even more, and have solidified their operational relationship. Al Qaeda is training Taliban and financing cross border attacks, which are proving fierce (though they cannot hold any ground and withdraw quickly).

Options by the US are, of course, limited at the present time. Going into Pakistan is unlikely to happen (even if Senator Obama wants to pretend to a cowboy to get votes, any attack in Pakistan may be political suicide and bring down the Musharraf government). CIA planes in the area are small in number, and increasing special operations is currently an option dying a slow, bureaucratic death.

However, militants going to Pakistan is a far better situation than militants going to Iraq. In Iraq, the insurgents can blend in with the population in densely populated areas, and strike American/Iraqi forces at will. In contrast, the terrorists in Pakistan are holed up in the tribal area. We know EXACTLY where they are, and, if we need to, we can pound them into salt much like we did in Afghanistan (though it'll be more difficult without the equivalent of a Northern Alliance to help out). In addition, the Pakistani government is far more stable than the Iraqi government. Until relatively recently, the latter didn't even have a functioning army. So, the chance of Iraq tumbling was far higher than Pakistan toppling.

And, finally: We can actually create a pluralist government in Iraq. It's more vital to our long-term interests, especially since it means fewer dead American soldiers (which means more energy for future missions).

Still a good move for us, all in all.

The Size of the Late Han Dynasty Harem

2008-07-09T21:09:00.004-05:00

6,000 women.

Unfortunately, when imperial rulers pay too much attention to the pleasures of the forbidden garden, they tend to ignore the needs of their empire, and let bureaucrats take over. Not always a healthy career move (often resulting in serious power struggles).

That from War in Human Civilization by Azar Gat. I highly recommend it, and probably will be writing on it more extensively. Warning, though: the author writes more extensively on the impact of the horse than the impact of harems.

What I read in the Tribune today:

2008-07-09T21:09:00.001-05:00

A Dad discovers religion and wants his daughters to attend his church. The mother, on the other hand, wants the children to attend the traditional Catholic Church on Sundays.

The big surprise:

The father is a Satanist!

That definitely gave me a "WTF!" moment

Integration in Asia, and how it applies to the US

2008-07-08T22:25:00.003-05:00

Number of Asian Free Trade Agreements in 2001: 7

Number of Asian Free Trade Agreements in 2008: 100+

Asia is increasingly integrating itself, much like North America and Europe already have. The problem is that Asian integration is a lot more haphazard and a lot less comprehensive: these agreements only apply to specific sectors. It's hardly the type of wide-scale trade freedom that exists in American trade deals (or at least that's what the people on C-SPAN tell me! God I love it when the House takes off...they never do anything important anyways). Hence, I suppose, the need for so many deals.

However, without widescale integration, I would imagine it would be tough to get true consensus on a lot of critical economic issues. For instance, if we can't even agree on whether or not Japanese beef should be allowed in Vietnam, how in the world can they agree on management of capital flows? And then what's to prevent another financial crisis from starting?

Haphazard integration like this needs to stop. The world needs wide-scale integration in order to deal with serious trasnational issues, like pollution, refugees, and arms control.

Unfortunately, there is massive resistance to this within the United States even today. Instead of creating large institutions designed to help countries work together better, the Bush Administration has pursued foreign policy unilaterally, and our trade policy largely consists of creating bilateral trade agreements and jawboning China about currency appreciation.

Haphazard policy: not just for nations with a history of protectionism

Having a Good Marketing Campaign Reaps Good Dividends

2008-07-08T22:03:00.002-05:00

Percentage of laptop-buying college students that wanted a Mac in 2003: 8%

That same percentage in 2007: 42%

I like my Mac computer. I really don't think this Mac computer is much different from an XP-driven laptop, nor do I think this particular Mac is much more advanced the old Macs that I used to use...

Though this desktop looks a LOT more high-tech, and the IPod has had several years to build brand value for Apple (and ITunes has had a lot of time to extract monopoly advantage by encouraging people to buy Mac software!).

I gotta chalk this up to the value of a successful marketing campaign. Seize an under-utilized market (the MP3 player), build up good feelings about the brand (awesome product, fighting evil Microsoft!), get a reputation as a secure system (in an era of extreme anxiety post-9/11), and price yourself higher than your competitors (we're the luxury brand!), and get some normal-looking fanboys...

You got yourself a juggernaut!

Why do some people reach their creative potential in business while other equally talented peers don’t?

2008-07-06T16:06:00.000-05:00

Answer:

After three decades of painstaking research, the Stanford psychologist Carol Dweck believes that the answer to the puzzle lies in how people think about intelligence and talent. Those who believe they were born with all the smarts and gifts they’re ever going to have approach life with what she calls a “fixed mind-set.” Those who believe that their own abilities can expand over time, however, live with a “growth mind-set.”
Guess which ones prove to be most innovative over time.

Talent? Overrated. Open mind, hard work ethic, and a desire to grow? That’s where you want to be.

Illegal Immigration and Big Business

2008-07-06T16:05:00.000-05:00

http://www.nytimes.com/2008/07/06/us/06employer.html?pagewanted=1&_r=1&th&emc=th&adxnnlx=1215360712-6kaHS%20Bb8i5lywEjCeBCig

Three years ago, the United States had a massive immigration reform debate on a bill (sponsored by Presidential Candidate John McCain) that ultimately failed. Since then, there have been a large number of local and state laws made to try to discourage illegal immigration,, and a lot of pressure on the federal government to enforce laws already on the book.

One of the big grievances? Employers who give illegal immigrants work. They’re made out to be the bad guys in this story, as they provide iillegal immigrants with their livelihood by giving them low-wage jobs out of single-minded greediness.

But it ain’t that simple…

A human resources manager who worked for the company a decade ago hired a number of workers without conducting an extra check of their documents with the Social Security Administration, the executive said. Now she has received notices from the agency of mismatches in the identity documents of 20 workers who were hired 10 years ago, out of 90 workers on the assembly floor today.
Because of the antidiscrimination rules, the executive cannot check to be certain that the 20 workers, mainly Hispanic women, are illegal. Moreover, they have advanced through training, she said, and excel at their jobs, which require the repetitive assembly of tiny parts by hand, often under microscopes

The legal infrastructure in place isn’t that conducive to making sure that your workers are legal. Apparently, a large number of companies can hire illegal immigrants purely by accident, and won’t be able to check up to see if documentation checks out because it is illegal to question an immigrant;’s legal status after already being hired.

Conundrum? Yes indeed.

"Clean Coal"

2008-06-25T19:11:00.002-05:00

Here you can see John McCain supporting clean coal technology in order to wean us off our foreign oil addiction and satisfy our clean energy needs over the next century:
http://youtube.com/watch?v=-oNp93aBXLE

Other major politicians, including President Bush, Barrack Obama, and Hillary Clinton, have supported clean coal as well.

The idea is pretty simple: coal is a very dirty substance, but it is also very cheap to use. And we have a LOT of it, especially in the United States. If we can find someway to reduce the pollution coal generates, we have ourselves an energy resource that will take care of us for centuries without damaging the environment.

Problem: Clean Coal prolly ain't so clean.

First, thinking that we can eliminate all the negative environmental consequences just by focusing on the "burning" part is ill-founded. Coal mining itself is considered to be highly damaging to the environment. It leaves massive scars on the earth where the mining took place, and can lead to dangerous run-offs in local ground water. Yikes! Even burning coal in some super ultra-clean fashion will not eliminate THOSE effects, and damaging the ground like that might not be such a great idea in the long-run (we might want to live in Wyoming one day, after all).

Also, even with all of our advanced technologies we have these days (including advanced scrubbing technology and burning low sulfur coal), most urban areas are STILL in violation of the Clean Air standards. I don't know what kind of technologies we can produce in the next 5 years that we hacen't already developed in the last 30 that is going to magically make coal a super-awesome source of energy.

Finally, the biggest issue facing coal plants now is carbon dioxide emissions, which are a leading cause of climate change in the world. There are currently no means for dealing with the carbon emissions from coal plants, and the most likely method (turning CO2 into liquid and shoving it back into the ground) could cost a LOT a money to implement. If it even works, that is: we're still in the experimental stage on that.

That's not to say clean coal has absolutely no role to play in our electricity policy. It's just that it is unlikely to become a bedrock for any policy that addresses environmental concerns. Many areas of the nation will still use coal energy, such as cities that require intensive amounts or areas of the country that are resource-poor in renewables.

And hence, I don't see what the fuss regarding clean coal is all about.

Economic Outlook for the US: 2008

2008-06-20T16:37:00.000-05:00

Well, first quarter growth, while weak, was a little bit better than expected. The economy grew at a .9% pace, as opposed to the .6% pace of previous months. If the 2001 economic slowdown is any indication, the US should avoid a recession. Even the Fed has apparently decided to stop its aggressive interest rate cuts, opting for a “wait and see” approach to see how the economy handles the various stimulants that have been injected into it over the past half a year.

Unfortunately, we are FAR from out of the woods. GDP growth was largely carried by inventory build-up by businesses, rather than actual consumption growth. In fact, personal consumption grew barely, and mostly on non-durable goods (which people would buy up if they were confident their incomes were growing). So, demand isn’t holding up that well. And we shouldn’t expect it to, either, as incomes lag, people start saving more, and gas prices continue rising.

What happens when demand starts falling? That means that US companies, two-thirds of which are considered are junk debt now, are going to be struggling to pay bills. That means a lot of fold-ups, and a lot less business investment (especially since bigger companies are going to prefer to buy these cash-strapped smaller companies and their assets, as opposed to new investment). Lower returns for them also means problems for the banks that are relying on those payments. And that means more trouble in the financial sector, which is in turn going to keep a clamp on lending for the foreseeable future.

Is the Back of a Cocktail Napkin the Best Place to Solve the World's Problems?

2008-06-20T16:34:00.004-05:00

Well, some people seem to think so:

The back of the Napkin: Solving Problems and Selling Ideas with Pictures

Guesstimation: Solving the World’s Problems on the Back of a Cocktail Napkin

I admit, there’s something very intriguing about simple explanations that can be summed up on something that’s about six square inches. Unfortunately, the back of a cocktail napkin can be a bit too simplistic and unrefined sometimes (see Laffer Curve)

Are You a 2?

2008-06-20T16:34:00.001-05:00

Jimmy John’s is an interesting restaurant. I’m not such a big fan of their sandwiches, but the place is very “alive.” Everywhere you look, you can see posters, quotes, interesting historic pictures, etc etc.

At the UIC-area location, a poster of famous quotes from Dave Berry lays on the right-side wall. One of them I find particularly humorous and truthful. It goes something like “Regardless of race, religion, age, or sex, we are all unified by the same confidence that we are above average drivers.”

People, and I guess Americans in particular, are very over-confident in there ability (especially their driving abilities). Unfortunately, these unrealistically high expectations typically lead to a lot of disappointment as we realize our limits. Thankfully, we don’t all realize those limits in public, and, thankfully, most of us are “good enough” drivers.

I like to think I keep a realistic view of my abilities. So, at the beginning of this semester, when our finance teacher handed out a survey, I marked myself down as a “2” on a scale of 1-5 when asked about my driving ability.

I wonder how many other people answered that way?

At the end of the semester, the finance teacher went over the survey results. Of all the guys, half said they were 5s. Another half said they were 4s.

And then the teacher picked up his head up, looked calmly at the class, and slowly said “and some boy said he was a 2.”

Interesting, ey?

Taking "Clubs" a Little Far?

2008-05-26T09:58:00.004-05:00

Across America's top universities, career-minded undergraduates, feeling pinched by increasing competition for a limited number of jobs and internships, are forming new clubs to give themselves a head-start in their chosen professions.

Sounds innocent, right? Just take a look at this article.

These students are obviously smart, and obviously committed. The question is...how committed?

Some interesting tidbits from Businessweek on the matter:

-40% of the members are freshmen

-At least one member describes themselves as "followers of Warren Buffett"

-It can be difficult to juggle classwork and a club that amounts to a full-time job

Understanding a company takes a lot more than just understanding financial metrics. Unfortunately, I can't comment on how this group operates and whether its students are getting a full, diverse education. What I can say is that concentrating on nothing but financing is a sure-fire way to kill a company.

Now, if these students never aspire to become Chief Executive Officers, they are obviously doing alright. If they do have higher dreams, though...they may just be following the wrong path.

Diversity in Education

2008-05-25T12:32:00.002-05:00

From the Chicago Tribune this morning:

College recruiters trying to reach the most promising applicants can purchase customized mailing lists based on where students live, their grades and test scores, even their ethnicity and religion.

One category, however, has been off-limits since the early 1980s: family income...But now, as some of the nation's most elite colleges are trying to bring more economic diversity to their overwhelmingly affluent student bodies, admissions officers who want to lure low-income students to campus are pushing to get that data

My gut reaction to this was something along the lines of:

"Goddam incompetent government. They are deliberately targeting people who can't pay?! I wonder how much money this is going to cost..."

I was a libertarian for the last few years. So the institutions are mostly private. Sue me, I like to blame government for everything.

Despite my and possibly your knee-jerk opposition to hand-outs (even if they aren't always government hand-outs), there's sound reason to make sure your student body has a good number of low-income students...or, rather, diverse in general.

Any college education worth its salt teaches students how to problem-solve and think for themselves. One of the major issues humans have, though, is the proliferation of heuristics and blind-spots we have. The mind operates a bit like an old accountant that runs the same equations over and over again. There might be new, better ways to do things out there, but he is loathe to adopt new techniques: He likes to do things the traditional way.

Heuristics are the rules of thumb that we use to problem-solve. For instance, when someone asks me if something enhances social welfare, the first thing I do is consider supply and demand, and it makes it proxy a perfectly competitive market better, then it improves social welfare. Some guys think that any woman with a tattoo on the lower back is a bit "easier" than the average woman. Same basic principle.

What diversity at an institution does is present different viewpoints and new sets of information. The danger of just having a bunch of white, rich, suburban children in the same institution is that they all tend to face similar problems. Oh, sure, they might have differing political views. I doubt, though, that they will understand the jealousy a young african-american woman may experience when she looks at the extravagant hair of a Caucasian woman. I highly doubt many of those students will understand the obsession that small Japanese retail shops have with new products.

Without a different viewpoint and a different set of cultural experiences to draw upon, a student's understanding of different market-places is impaired. More to the point, a student may miss out on different methods of problem-solving that other cultures may posses.

Hence, diversity is a benefit to any institution.

By the way, the University of Illinois at Chicago is considered the 5th most ethnically diverse campus in the country.

Grey's Anatomy

2008-05-24T15:01:00.004-05:00

In case you needed MORE reasons to watch: It has lesbians now.

The times, they are a changin'

Why Competition can sometimes be BAD for Social Welfare

2008-05-22T23:19:00.005-05:00

Linky

We find that: (a) the main sources of knowledge are competitors; suppliers; and plants that belong to the same business group ; (b) these three flows together account for about 50% of TFP growth; (c) the main "free" information flow spillover is from competitors; and (d) multinational presence contributes to this spillover.

Sometimes, innovation can be very expensive and costly. New processes sometimes take a lot of trial and error to get right: for instance, the "just-in-time shipping" Boeing uses right now is quite troublesome, and their new airliner has had its release date set back significantly. Several times.

So, if I am a business, I'm not going to innovate unless I am damn sure I can lower costs significantly. Enough so that I can get a competitive advantage. But, my competitors are going to gain from my hard work! Because of this effect, it is quite possible that we are missing out on some major innovations.

What innovations are we likely missing out on? The most expensive kinds that are most likely to reap the big rewards: if Starbucks suddenly spends $1 billion on developing some new production process, it may IMMEDIATELY get stolen by local coffee shops as employees shift around. So, the risk of such innovations is too high: Starbucks is going to stick to cheaper innovations instead.

There are other ways competition can be bad, too. For instance, reducing my price makes consumers richer, since the overall price level will be lower. However, this means that it will increase the demand of my competitors. After all, if two goods are substitutes, it means I am going to consume BOTH of them to some extent...if Nestle lowers the price of their chocolate, I am going to use some of the savings to finance my addiction to dark chocolate M&Ms. That's a losing proposition for Nestle.

Of course, this doesn't mean competition is BAD. It just means that, sometimes, it doesn't work perfectly.

Medicine in India

2008-05-21T22:50:00.003-05:00

From the Economist:

" 'In the absence of competition, differential pricing is a hoax; scoffs Yusuf Hamied, chairman of Cipla, an Indian generics firm. In his view, only generic-makers like his firm provide genuine competition to Big Pharma..."

More correctly, differential pricing (IE, price discrimination) is not even possible with competition. If I am competing with someone, he's going to be charging a lower price than I am.

Progressive Taxes and Price Discrimination

2008-05-21T00:09:00.003-05:00

If you look at the facts, the two are a LOT alike.

First, some background:

Progressive taxation essentially means taxing people a higher percentage of their income as their income increases. If you make $50,000 in the United States, you are probably paying something closer to 10% of your income in federal income taxes, as opposed to 20% if you are making $200,000 annually. Theoretically, this allows the government to raise funds more easily and reduces inequality.

Price Discrimination means charging different people different prices for a product. A lot of people thinks this means that businesses are being mean to minorities or women: not so. Amazon bundling books on their website is price discrimination, as is a movie selling a cheaper ticket to a student or a senior citizen. Businesses do this whenever possible, because it is profit-maximizing.

How are these two similar in any way?

Well, businesses price discriminate primarily because, for any given product, there are heavy users and casual users. Consider Cubs games. There are those, like some of the Brothers in my fraternity, that REALLY love the Cubs and try to watch every home game. On other hand, I watch a Cubs only every once in a while. So, we have different demand curves. If possible, you want to charge the people that have higher demand curves a higher price, since they are willing to pay it.

Governments are capable of doing the same thing. Government is a bit like a service or a product offered by businesses. What it offers is safety and enhancement of welfare. That doesn't mean that government should be maximizing profit (that'd be a bit immoral, no?), but it does mean people have different demands for government services. For government, though, the demand curve is based less on the "need" for the service and more on the ability to pay: Rich people have more money, and thus can afford more government...their demand curve is therefore higher.

So, if a government wants to effectively raise income, it should be charging rich people more. And that...is progressive taxation.

Now, that's not to say that progressive taxation is always the way to go. Income taxes typically are expensive to operate. They require good census data and a big agency to enforce the laws (the IRS is by no means "small" or "uncostly"). So, income taxes should only be used if you need to raise a LOT of money.
But if you are going to use an income tax, you might as well do it right: go progressive

The Dangers of Marketing Yourself Low

2008-05-20T23:41:00.003-05:00

Most people ignore the true power of marketing and how you sell dreams and lifestyles. To a lot of people, it's just "lowest price wins."

During the Great Depression, Pepsi lowered its price to 5 cents a bottle and called itself the discount drink.

When the economy recovered, people were embarrassed to sell Pepsi and switched to Coke, because only poor people would drink Pepsi.

This would basically continue until Pepsi poached Coke's marketing man and marketed itself as the drink for the "Pepsi Generation"

Just a reminder: price ain't everything