Showing posts from 2008


The Ponzi pub crawl (via FT Alphaville and Dan Hon's blog )

Economic worldviews

To maintain an insight into the economic news and a reliable interpretation of it, you can do one of two things: Pick someone (or a few related people) that you trust and read everything they write. Your choice may be Paul Krugman, Mark Thoma and Brad DeLong if you're broadly left-wing; or Greg Mankiw and Arnold Kling if you're rightish. Or shall I replace 'left' and 'right' with 'Neo-Keynesian' and 'Monetarist-Austrian'. This has the advantage of providing a (fairly) consistent viewpoint and lots of additional evidence to confirm that it's true. Read both, try to reconcile the differing viewpoints on the same issues and figure out which one is correct - or even if the truth is somewhere in between or outside of both. Needless to say, the second is more challenging and perhaps leads to more accurate views - but of course there is a much higher cognitive load. And you still have to do some kind of filtering - for example do you also read all t

Powers and strategies for central banks

Robert Peston is looking back at the powers that the Bank of England should  have had to help forestall the asset price bubble of the last few years. It's an interesting angle, because it also sheds some light on the question of what powers the Bank should have now. He correctly points out that interest rates are too blunt a lever. When a central bank wants to be able to achieve multiple objectives - to do more than just target the inflation rate - it needs multiple tools. Interest rates are a two-sided tool - they can be raised in peak times to moderate activity, and cut in a recession to revive it. It's instructive to ask of any proposed solution: "does it work in reverse?" to see whether it meets this standard of having symmetrical power. The solution Peston discusses is adjusting the capital requirements of banks. In an asset boom, capital reserve requirements would be increased to reduce banks' ability or inclination to lend against assets. This would contro

Theories of one versus many

One of the causes of the fallacy referred to in my last post is that people forget there's a difference between one and many. It may be true that it's better for me to go home at 7.30 than 5.30, because the tube is quieter. It does not follow that it's better for  everyone  to go home at 7.30. And similarly, just because I can defer my consumption from this year to next year by saving, does not mean everyone  can. This is because I am embedded in a large system where my actions can be counterbalanced by others, and this enables us both to specialise. Specialisation normally refers to production but can apply to consumption too - you specialise in consuming an egg today, and I specialise in consuming one tomorrow; therefore one chicken can feed us both. Interestingly, this leads to the insight that some choices are asymmetrical in time. If everyone prefers to consume now instead of tomorrow, today's production will increase, though maybe not enough for everyone. Those wh

Borrowing from the future

" The crisis is caused by excessive debt " " You can't borrow your way to prosperity " (video) " We need a recession to clean up the rot " " We have borrowed prosperity from our grandchildren - transferring consumption through time" Economic illiteracy , all of it. We can only consume today what we can produce today. Was your iPod made in a factory built in 2016? Monetary transfers (i.e. debt) cannot create new goods or services. You cannot transfer consumption from the future. But it is a common fallacy to think you can. There are three kernels of truth in this viewpoint, and some of them give us a clue to the real answer: Individuals can transfer consumption from the future to the present by borrowing money from other individuals. But there is an entry on the other side of this ledger - the lender is transferring their own consumption from present to future. The net effect on the whole system is nil. Countries can do the same - if America

Bailouts for writers but not for cars

More on bailouts: Paul Greenberg in the New York Times says we should bail out writers. Of course, he doesn't analyse the economics properly - but what should we expect - he's a writer. No doubt it would be useful to reduce the oversupply in the writing market; but should we also then be paying bloggers not to post? Is this how farm subsidies got started? And Richard Posner follows up an earlier article about the US automotive bailout arguing that the three big US car companies are fundamentally insolvent but it is better to support them another couple of years and then  let them go bust. I sympathised initially with this view but the comments on that posting - mostly taking the opposing view - are actually quite persuasive. If the companies are going to go bust anyway, maybe now is the time to get the bad news out of the way; rather than wait till a fragile confidence is taking hold and then shatter it again. Posner's argument is (I think rightly) psychological; but so i

Who and how to rescue

So Jaguar might be "rescued" by the UK government. Robert Peston gives a summary of some of the arguments. Even more quickly, here they are: The company is not able to refinance its loans, but is still fundamentally a good business 15,000 people are employed by Jaguar and up to 60,000 second-order jobs are dependent on it It is one of the remaining UK-based manufacturers with substantial ongoing R&D But: It is owned by Tata, the (profitable) Indian multinational There's a risk of moral hazard - if Tata can get finance for its UK operations like this, why wouldn't other companies do it and use their scarce private funds elsewhere? There is no doubt that Peter Mandelson is aware of these arguments - he makes it pretty clear in the interview with Robert Peston. What other criteria or safeguards might he use to make sure that public money is genuinely providing a public good which would not be financed by the private sector; and that it gets a positive return? Sugge

A hidden theme in four parts

Lots to write about today, but not much time. Here are the topics. See if you can spot the connection: The myth of hollowing-out. Frank Furedi (see Tuesday's post) gave an interesting talk but I still see this as the main flaw in his argument. I have started to work on some more concrete theory to help quantify the contribution the knowledge economy makes to consumer benefit. Government intervention/rescue of businesses. Jaguar in particular - definitely a firm on the "productive" side of Furedi's distinction - is a candidate for some kind of financial assistance. Can government choose the right businesses to rescue or set specific criteria for doing so? What should it get in return? Zero interest rates. At some point it isn't the price of money that stops people borrowing or lending; it's the challenge of paying it back. What else can the state do other than print money? Related topic: what should people do with their fiscal stimulus? More to the point, what

Economic misconceptions

This evening I am going to see a lecture by Frank Furedi, "The Political Significance of the Economic Crisis". It's at the LSE but despite that, there doesn't seem to be a lot of economics in it. Here is Prof. Furedi's article in Spiked in which he outlines the argument that I imagine he'll discuss tonight. A couple of sentences really put me on edge: Without the securitisation and financialisation of the economy, the accumulation of capital and a sense of prosperity could not have been maintained in Britain and the US. Outwardly it appeared that economies such as Britain’s and America’s were doing well during the past decade. By the time of the credit crunch, the financial sector accounted for around 30 per cent of the British economy. On both sides of the Atlantic, industry continued to decline. This is another variant of the myth that our economy is based on some kind of pyramid scheme where everyone thinks they are making something but actually nobody is.

Making perfect sense

Robert Peston again - the government is now: ...excluding from the calculation of the risk premium payable to taxpayers the great surge in the perceived riskiness of banks that took place in September and October. In effect, the Treasury has converted the Credit Guarantee Scheme from an insurance policy, which was designed to provide comfort to markets that banks wouldn't collapse for want of access to funding, into a new and substantial source of finance for banks, to replace the funds that have disappeared with the de facto closure of wholesale markets. Well, kind of. There's a good argument that the banks are much less risky now - not least because they have been recapitalised by the taxpayer. This in turn justifies a lower premium. Indeed, the most present risk to the banks was not that they would fundamentally become insolvent through writeoffs. It was that they would be unable to either refinance their short-term borrowings or call in their long-term loans. Securitisatio

The economics of copyright expiry

I plan to write a lot more about this in the coming weeks. But for now I want to respond to Andrew Gowers ' and Andy Burnham 's debate in the FT. Reading either article in isolation, you might be convinced. On the one hand by Gowers' assertion that extending copyright creates no economic incentive to create new work, and incurs administrative costs out of proportion with the benefit to the owners. On the other, by Burnham's sympathetic picture of retired vegan musicians losing their sole income and seeing their work abused in foie gras advertisements. Maybe I'm betraying my inclination in this argument. But despite broadly agreeing with Gowers on this, I do understand the political logic and compassionate aspect of Burnham's position. Economically it's a tricky issue, and Burnham is actually on the side of economic orthodoxy. Economists tend to consider that property rights are an incentive for people to create, husband and market their assets. They also ass

Reducing the capital needs of European companies

According to Robert Peston , European corporations are going to have to repay about $1 trillion of debt in 2009. $800 billion is owed by financial companies and $200 billion by non-financial, which provides some reassurance - no doubt much of the financial debt is owed to other financial companies and some will net out. But without further huge government guarantees (and we might get them anyway) I think we are going to have to restructure some businesses to operate on less capital. Here is a list of ways in which they may be able to do that: Change in revenue and pricing models. One example is a method called structured pricing , where payment for goods and services is made after the fact based on the value they create. I have developed a model which shows that this can reduce the capital requirements of the economy by around 7-10%; I will be posting a more detailed paper on this within the next few weeks. Of course there are many other examples of how to do this, but it is definitely

How much SHOULD Blagojevich have asked for?

Rod Blagojevich has been caught exploiting something given to him by the Illinois legislature – his right to appoint the state’s next senator. But isn’t he just doing what economics orthodoxy says he should – making sure the position goes to whoever can create most value from it? Ronald Coase demonstrated that the seat will go to the person who values it most in any case – the only question is who has the property rights and therefore who will get paid for it? Now, Coase does exclude transaction costs from his analysis and there is certainly the potential for Blagojevich to incur a very high cost for this transaction. But in principle, selling the seat is not (economically) a sin. The doubtful aspect of what he has done is to appropriate the benefits of selling the seat to himself, instead of letting them be distributed to the media and electorate of Illinois via the campaigning process. But what I want to know is: how smart was Blagojevich? How much is a Senate seat worth and was he g

500 years of ancestry determines your wealth

An amazing piece of research is published today in VoxEU. Louis Putterman and David N. Weil have discovered that the proportion of a country's ancestry which lived in Europe in 1500 explains 44% of the variation in per-capita GDP in 2000. This is a huge influence and should have a big impact in understanding how countries - and people - achieve economic success. The VoxEU article speaks for itself really, so have a look. Possible areas to follow up: How is the migration distributed through time - for example if most emigration to the US happened in the 1800s, the dominant effect may not be 500 years old but only 150. Today's ethnic classifications express only roughly the ancestry of individuals. How many ancestors do you have who were alive in 1500? The answer is: around a million (assuming 25-year generations and minimal inbreeding!). I don't think the survey purports to account for the fact that these people must have almost certainly come from more than one country. As

Tim Harford on perceptions and economic behaviour

Interesting article this weekend from Tim Harford in the FT. He says that economic behaviour is not mainly determined by media-influenced perceptions. These perceptions - which contrary to popular belief, are not only controlled by Robert Peston, but occasionally other journalists too - may impact consumer confidence but this doesn't drag the real economy down. He quotes Neal Gandhi (who I met yesterday at Entrepreneur's World ) as saying of Peston  “because of his influential position, his predictions come true almost exclusively because he has predicted them”. While I agree with Tim that this is going too far, there is still a big question about what influences economic behaviour. The economist's contention (and this is at the heart of Tim's book The Logic of Life ) is that rational incentives control behaviour more than intangible psychological factors. But Tim does not mention one major factor. Incentives depend on how we believe the world will behave in the future

DeLong's answer

Brad DeLong has solved the financial crisis (co-opting the help of Keynes, Bernanke, Trichet, Brown, King, Geithner and Summers). I must admit the conclusion he came to was not the one I expected. Note particularly that: he disagrees with me on crowding-out - he thinks there is still net business investment to be crowded regardless, he believes that business investment will not be a substantial source of demand in the near term That's a bit disappointing, if he is right. I was hoping for a more positive outcome but I suppose that's why it's called a depression.

Wage reductions in a downturn

Robert Peston raises the old chestnut about wage reductions. According to neoclassical theory, wages should reduce in a downturn as workers realise there is less demand for their services and cut the price accordingly. In the case of Corus and JCB, two British manufacturers, this is exactly what is happening - the unions have proposed a 10% wage cut in order to prevent plants from closing altogether. However, adjustment rarely happens this way and there are some competing explanations for this - game theory and anchoring being the top two. Here is an article from the Economist giving some of the alternative viewpoints. But I would add two things: Despite what Robert Peston says, the MPC was probably right not to assume this would happen. It would never have taken place if the union and workers were not immersed in the conversation about the savage recession we are expecting. Wage stickiness has a positive economic effect - both to combat deflation and also to maintain gross demand. I

Freakonomics: Coolness inequality declines

Over the last forty years, the American General Coolness Survey has asked subjects the following question: "Taken all together, how do you think you shape up these days? Would you say that you are: very cool, pretty cool, or not too cool?" In a new paper published today I demonstrate some dramatic results: coolness inequality has diminished hugely in the four decades covered by the survey. Simultaneously, overall coolness has increased substantially. In 1968, 5% of people reported themselves to be "very cool". A further 10% were "pretty cool" and 60% "not too cool" (a substantial proportion of respondents did not answer this question). By the 1970s, coolness had increased but so had inequality. 40% were very cool, 28% pretty cool and 30% not too cool. In the late 80s and early 90s, however, overall coolness fell and society became more equal - with a majority reporting themselves "not too cool" again. By the time of the 2008 survey, coo

Economist's View: Crowding-Out and Crowding-In

Just a quick note to point you to a much more detailed analysis of the crowding-out question . As usual on Economist's View, the posting itself is good and the diversity and depth of thought in the comments are perhaps even better. I can't think of another blog anywhere in the world where that's true.

Cass Sunstein on informational cascades

This article is from October, but germane to my discussion of fiscal salesmanship. Cass Sunstein: Wall Street's Lemmings : Why policymakers need to understand psychology as much as economics to solve the financial crisis. A couple of comments below the article point out that psychology is not the only  cause of the financial crisis, but Sunstein is not claiming that. Undoubtedly it makes a big contribution and turning it around (he uses the example of Roosevelt, maybe the best fiscal salesman ever) is within the powers of politicians - Barack Obama of course being the one most capable of it, for many reasons.

Selling the incentives

I’ve been thinking more about fiscal salesmanship – the concept that people will not just spend their fiscal stimulus – it has to be structured or presented in a certain way. I asked myself, as an entrepreneur, what would I do if I wanted to change the behaviour of a large group of people? I would do some marketing. People don’t just respond to pure incentives. Of course incentives do make some difference; when a consumer decides what to spend in the shops today, one of the factors will be that most products are 2% cheaper. But it’s only one of many influences, and people simply don’t have enough processing power to automatically incorporate all available incentives in their decision-making process. Indeed, financial incentives can usually be overridden or even inverted by the right kind of sales or marketing effort. BMW salespeople don’t cut their prices because of the signal it might send about their quality. Ryanair makes people think it is the cheapest airline by the clever ploy of

The psychology of contagion

Another interesting blog from Robert Peston...London Scottish, a small bank, has had its deposits fully guaranteed because of the risk of contagion if it were allowed to fail. It is too small to matter systemically in itself, but it is felt that the message it would send is too dangerous and would result in lots of other small banks having funds withdrawn to the point where many of them would collapse too. It's a barely avoidable decision, the way Peston tells it. But there's a big question here. Where does it stop? First, all major (too-large-to-fail) bank deposits were implicitly guaranteed. Now, all small banks are guaranteed. You might think bank deposits are privileged. But what about deposits in credit unions or Christmas hamper schemes? They are quite like banks. Now what if I have put money into some other kind of scheme - say a cash ISA. If that's not guaranteed, will people take all their money out of those? What about other types of investment fund? Life insuran

Investors are human too

I read Paul Krugman's latest NYTimes column (via Economist's View ) and it got me wondering. Why does crowding out not happen? In other words, why does an increase in long-term public debt not result in a reduction in long-term business investment? There's a school of thought which argues that there is money which would otherwise go into productive private investment, but instead is diverted into lending to government (which is likely to lead to less productive spending). Due to less money being available, this pushes up the price of borrowing for businesses and means some otherwise-viable investments will not happen. Krugman gives part of the answer - that a (successful) stimulus encourages economic growth which in turn makes business investment more, not less, likely. But there's another reason. This is that business investment is not  happening anyway. There is not a large pool of money going into long-term business investment now. Why? Because investors weight shor

Turning up the synergy

I love the following description from Forbes via Mish , in "19,000 WaMu Employees will be Synergised Out of a Job": Up to 19,000 employees of Washington Mutual face being laid off this weekend as JPMorgan Chase turns up the synergy on its recent acquisition. Mish proceeds to demolish this newly invented weasel word for firing people. Remember the good old days when we only had downsizing? Also in the news, Jose Manuel Barroso puts his foot in it with an interview surely calculated to do maximum possible damage to the cause he is notionally espousing. What was he thinking?

Leigh Caldwell in Observer/Courvoisier The Future 500

The Observer today published its selection of 500 UK rising stars for 2009 . I'm very happy to have been selected in the Business category, along with 70 other businesspeople including Amanda Zuydervelt of Stylebible, Carl Jewitt of Ernst & Young, Jay Bregman of eCourier, Luke Ashworth of Netbasic, Sokratis Papafloratis of Trusted Places, Tom Critchlow of Distilled, Simon Campbell of ViaPost, Richard Alvin of Clearsight, Duncan Cheatle of the Supper Club, Carol Brown of Thomson Bethune, Elizabeth Harrin of Spire Healthcare/A Girl's Guide to Project Management, Edward Mellett of WikiJob and Darren Fell of Crunch. Some interesting people from the other categories are: Art and Design : Alex Fleetwood of Hide and Seek, theatre director Annette Mees, Renato Benedetti of McDowell+Benedetti, sports artist Keith Fearon Drinks : Richard Bigg of Cantaloupe Fashion and Retail : Tamsin Lejeune of the Ethical Fashion Forum Food : Liz Jarman of Sainsbury's Media : Stefan Lewandowski

Best quality in the comments!

If you have time, try reading not only this post from Mark Thoma at Economist's View , but all the comments below it. It's rare for a blog to have so many comments and of such consistent high quality. They genuinely add a major contribution to the discussion, and hardly any of them are sniping at each other.

Crisis to end on March 7th 2009

Just in case you think I've gone mad, this is Myron Scholes ' prediction, not mine. He made it at a speech to Chicago Graduate School of Business in June, which I forgot to write up at the time. He was referring to the credit crisis rather than the economic downturn, but even then it was pretty clear that recession was on the way. So let's keep an eye on the calendar and if he's right, he's due our congratulations. Unfortunately he slightly spoiled the effect later in the presentation by referring to the prediction as March 9th 2009. So we need to allow error bars of a few days in measuring the end. Oh for the days when such a prediction from an esteemed (though a little less than before LTCM went under) Nobel prize winner would be self-fulfilling. Now, maybe if Warren Buffett said the same thing, it would be...

Extreme times require extreme blog postings

Like this one  (from CalculatedRisk) inspired by this one  (from Nouriel Roubini, but that's not too surprising). Or how about Mish's Global Economic Analysis  and ECRI Leading Indicators Fall to Lowest Level Ever from Big Picture? On the other hand, Paul Krugman and Greg Mankiw separately quote more sanguine texts from Keynes. And there's lots of good stuff on Economist's View , Freakonomics and Econbrowser . Incidentally, Austan Goolsbee will be a member of both the new Economic Recovery Advisory Board and the Council of Economic Advisers. Seems to be a good choice but I have been hearing growing calls for more people from the private sector. Academic economists have lots of value - and probably should take the leadership positions - but maybe it would do no harm to have some commercial experience on board too. Maybe there are few businesspeople out there who are capable of dealing with the concepts and abstractions involved. Maybe Intellectual Business will make

Steve Waldman on transparency

Thanks to Dani Rodrik for pointing out this thoughtful and original analysis on transparency by Steve Waldman. Intellectual Business  is making some proposals on the subject which go further than Steve is willing to, but he has given an excellent and quirky example of how to analyse the potential gains or losses from transparency.

Fiscal salesmanship

Greg Mankiw links to John Taylor's article in the Wall Street Journal looking for alliterative proposals (or predictions) for the expected US fiscal rescue package. Shame the S has already gone, as I wanted to propose self-fulfilling: successful or squandered . Taylor's article takes the Milton Friedman viewpoint that a temporary stimulus does not work, because people base their spending on expectations of permanent income and will just put a temporary rebate in their savings account. Robert Lucas goes even further and says that even a permanent change does not work because people adjust their spending in accordance with their expectations of future government borrowing. Both of these are respectable (indeed Nobel prize-winning) economists. But consensus generally allows that a Keynesian stimulus did work in the 1930s and does still work, sometimes, or to some extent. Certainly policymakers still indulge in them from time to time. So why is this, one of the most important ques

Preventing a global slump

Martin Wolf posted a few weeks ago his five steps to preventing a global slump . I wrote the following response which I am just getting around to posting. Roubini’s paper from 8th February makes an intriguing point. In his list of reasons why the Fed cannot save us this time, the final one is that the entire system is in “a crisis of financial globalisation and securitisation” and so a recession cannot be prevented within the current framework. The implication is that quantitative policy actions will not solve the problem, but systemic reform or qualitative changes are required. While the actions proposed by Sachs and Wolf seem reasonable and well thought out, it is unclear that they will be convincing to market participants. This argument is borne out when we look at the situation from the angle of behaviour and incentives instead of just the figures. Decision-making behaviour is in theory guided by what people believe the future will hold, not what happened in the past. Of course if