gloomy forecast from a UK analyst

September 9th, 2010

[E]ven if we do avoid full recession, slow growth in the developed world is quite likely because of the effects of financial deleveraging and the fiscal tightening. This would plausibly push up the unemployment rate.

With core inflation low in several countries, this increases the probability of outright deflation, which as Japan attests, could turn into a self-reinforcing downward spiral with lower demand, further falls in equity markets and even greater demand falls.

Sushil Wadhwani, “Japanese lessons on ill-timed fiscal tightening”, Financial Times, 9 September 2010.

Sushil Wadhwani has a PhD in economics (LSE) and is a former member of the UK Monetary Policy Committee. He now runs Wadhwani Asset Management.

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science and religion

September 8th, 2010

Cambridge University philosopher Tim Crane notes that more people today turn to religion than to science. The widespread popularity of religion, he feels, is due not to ignorance or irrationality, but rather to “the kind of intellectual, emotional and practical appeal that religion has for people, which is a very different appeal from the kind of appeal that science has”.

Taken as hypotheses, religious claims do very badly: they are ad hoc, they are arbitrary, they rarely make predictions and when they do they almost never come true. Yet the striking fact is that it does not worry Christians when this happens. In the gospels Jesus predicts the end of the world and the coming of the kingdom of God. It does not worry believers that Jesus was wrong (even if it causes theologians to reinterpret what is meant by ‘the kingdom of God’). If Jesus was framing something like a scientific hypothesis, then it should worry them. Critics of religion might say that this just shows the manifest irrationality of religion. But what it suggests to me is that that something else is going on, other than hypothesis formation. ….

Tim Crane, “Mystery and Evidence”, NY Times Opinionator, 5 September 2010.

Claims in economics often do as badly as religious claims, for much the same reason: “they are ad hoc, they are arbitrary, they rarely make predictions and when they do they almost never come true”. Moreover, like religious claims, they can never be disproved. See my posts on “economics as faith“.

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history and economics

September 7th, 2010

Historian and journalist Gideon Rachman argues that “the entire attempt to treat economics as a ’science … defined by its ability to forecast the future’ is misconceived.” (His quote is from economist Joseph Stiglitz, who is searching for “a new paradigm” to replace the one that failed to forecast the current crisis.)

With the exception of a few deluded Marxists, historians know that their work cannot be used to predict the future. History can suggest lessons and parallels and provide wisdom – but what it cannot do is provide a sociological equivalent of the laws of physics. Yet this seems to be the aspiration of many economists, who notoriously suffer from “physics envy”. ….

[T]oday’s historians are far humbler about what they can hope to achieve than modern economists. Historians know that no big question is ever definitively settled. They know that every big and interesting topic will be revisited, revised and examined from new angles. Each generation will reinterpret the past and deliver its own verdict.

This way of looking at the world is less obviously useful to practical men, seeking to make decisions. But maybe it is time for an alternative to the brash certainties, peddled by those pseudo-scientists, otherwise known as economists.

Gideon Rachman, “Sweep economists off their throne”, Financial Times, 7 September 2010.

My own opinion differs from that of Mr Rachman. I agree that good economics requires knowledge of history, but good history – at least, good economic or financial history – cannot be written without knowledge of economics. History and economics are complements rather than substitutes. Study of economics might prevent historians from making outlandish statements about the causes of a particular war or financial crisis. Study of history might make economists more humble, free them from “P-envy” and allow them to accept graciously the fact that they cannot predict the future.

Economics is a science, but it is a science like evolutionary biology, not a science like physics. Evolutionary biologists cannot predict the future. Nor, for that matter, can meteorologists, at least not with any degree of accuracy. Yet no one argues that evolutionary biology and meteorology are not sciences.

Addendum:

Further to my post this morning, I am reminded of this quote from the famous obituary that Keynes wrote in 1924, on the death of Alfred Marshall:

The study of economics does not seem to require any specialised gifts of an unusually high order. Is it not, intellectually regarded, a very easy subject compared with the higher branches of philosophy and pure science? Yet good, or even competent, economists are the rarest of birds. An easy subject at which very few excel! The paradox finds its explanation perhaps, in that the master-economist must possess a rare combination of gifts. He must be mathematician, historian, statesman, philosopher- in some degree. He must understand symbols and speak in words. He must contemplate the particular in terms of the general, and touch abstract and concrete in the same flight of thought. He must study the present in the light of the past purposes of the future. No part of man’s nature or his institutions must lie entirely outside his regard. He must be purposeful and disinterested in a simultaneous mood; as aloof and incorruptible as an artist, yet sometimes as near the earth as a politician.

J.M. Keynes, “Alfred Marshall, 1842-1924″, The Economic Journal, Vol. 34, No. 135. (September 1924), pp. 321-322.

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age pensions in the Ukraine

September 5th, 2010

Ukraine recently increased its nearly universal, minimum pensions by 250%, to a level above the legal minimum wage, without any means or retirement testing. This eliminated pension-aged poverty, but allowed many elderly workers to stop working. The vast majority (88 percent) of pensioners currently receive a minimum pension, a reflection of low wages of the Soviet era. Economist Alexander Danzer, who teaches at Royal Holloway Colege (University of London), uses this “natural experiment” to measure the disincentive effects of pensions on work. PensionReforms discusses his findings, and provides a link to the full paper.

“As old-age pensions are neither means-tested nor conditioned on retirement, the rise in benefit levels will induce a pure income effect, which enables an individual to afford more leisure.” This implies that the pensions are not taxed as income, so would not place a worker in a higher tax bracket. The author finds measured “strong disincentive effects on the labor supply decision of elderly people”. More precisely, the threefold increase in the minimum pension leads to an increase of 37-47 percent in male retirees at age 60, and a 30-39 percent increase in female retirees at age 55. The author chooses to emphasise this finding, warning: “The policy goal to combat poverty via pension increases might become ineffective and fiscally extremely costly, when the pension aged withdraw their manpower from the labor market.”

PensionReforms notes that it is important to keep in mind that few workers in the Ukraine were retiring at the statutory age (55 for women and 60 for men) prior to pension reform, so the denominators of these 30-47 percent figures are not very large. The effect of the pension increase on the size of the labour force is much smaller, simply because the denominator is somewhat larger. In the words of the author “The overall effect of the pension increase can be expected to amount to roughly 413,000 persons or 2.4 percent of the pre-reform labor force.” Moreover, this reduction in the labour force was predominantly the result of the retirement of women and service sector workers with little education, so the effects on the economy would be even smaller. PensionReforms thinks that this seems to be a price worth paying to eliminate poverty in old age. That price would be lower still if the pension age were increased to, say, 65 years from the current 55/60 years.

“Retirement Responses to a Generous Pension Reform”, Pension Reforms, 30 August 2010.

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universal age pensions and Taiwan

September 4th, 2010

Two Taiwanese academics cite my work, but leave me scratching my head:

Rather than relying on the Bismarck model for basic old-age income security, we need to adopt the Beveridge principle of a uniform single rate. The National Pension protection should be extended to all people, forming the first tier of protection (Willmore, 2006; 2007). The low income living allowance for the elderly should be abolished and replaced with a pure means test. On the one hand, a means test will ensure that scarce resources are not misallocated to individuals and families with adequate resources of their own. On the other, it also will ensure that the truly needy receive sufficient support to prevent them from falling into poverty. All citizens are entitled to a basic level of old age income security, and the State needs to be the guarantor of this civil right.

Chih-lung Huang and Carl Shrsyung Chang, “Rethinking Old Age Income Security for All in Taiwan”, paper sponsored by the National Science Council (NSC 98-2410-H-214-019-MY2), 2010, p. 22.

The authors are concerned that the pension system in Taiwan fails to prevent poverty in old age. The current first tier pension (”low-income Old Age Allowance”) is means-tested. They want to abolish this, and replace it with ….. another means-tested age benefit, to be called “Supplementary old-age income”.

I don’t understand how this would change the system. In any case, what I advocate is movement to universal flat pensions, not movement to a “pure” means test. Professors Huang and Chang cite my publications, but not my ideas. Three British academics, in contrast, convey my message concisely and precisely:

Larry Willmore, of the International Institute for Applied Systems Analysis (IIASA) in Austria, argues against means-testing pensions; rather, he supports giving smaller pensions to all the elderly instead of larger pensions to the poorest, on both political and practical grounds. First, such programs are politically attractive because they provide a guarantee of a basic income for all voters’ old age, and for that of their parents and friends. Starting with a modest universal pension, the pressure from voters is to increase the size of the pension, as has happened in New Zealand and Mauritius. “Means tests promise fiscal savings, but tightly targeted benefits lack political appeal, so a means-tested benefit runs the risk of becoming smaller and smaller relative to wages and per capita GDP,” Willmore warns. The second argument for avoiding means tests is that they send the wrong signals to workers. They discourage low-income workers from saving for their old age and from continuing to work, even on a part-time basis, beyond normal retirement age.

Joseph Hanlon, Armando Barrientos and David Hulme, Just Give Money to the Poor (Kumarian Press, Sterling, VA, USA, 2010), p. 107.

In Taiwan, the message seems to have been lost in translation.

To add to my confusion, the US Social Security Administration publication, Social Security Programs Throughout the World states: “The social  insurance system involves a flat-rate benefit for citizens under the national pension program and earnings-related benefits under the labor insurance program.” The national pension is financed in part from a flat-rate payroll tax, and provides a minimum benefit of NT$3,000 per month and a maximum benefit equal to 0.65% of the minimum wage multiplied by the number of years of contributions plus NT$3,000 or 1.3% of monthly insured amount multiplied by the number of years of contributions, whichever is greater. Benefits are indexed to the consumer price index (CPI). “Citizens age 65 and older who have been residents of Taiwan for more than 6 months a year for the last 3 years” are eligible for benefits. Contributions seem not to be required for eligibility, nor is there any mention of a means test, but those with a contribution history are eligible for a larger pension.

I learned more from a few pages of the SSA than I did from the 32-page paper of Professors Huang and Chang. But is the information correct? Does Taiwan have a universal minimum pension, or does it have a minimum pension tested against all income, and possibly against assets as well?

The minimum pension, in any event, seems much too low to lift anyone out of poverty. The minimum pension in 2008 was NT$3,000 a month, only 17% of the minimum monthly wage of NT$17,280.

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corruption and civil servants

September 2nd, 2010

Work that I did some time ago for the UN is only now beginning to attract readers (or at least downloads!), even a couple of citations. Here is the abstract, and a link to the full paper:

Using cross-country data for 51 countries, including 23 in Africa, the author controls for differences in per capita income and measures the effect of structural variables on a number of outcomes, including the quality, integrity and prestige of public service. He finds merit-based recruitment and promotion to have a positive, independent effect on the quality and the integrity, but not the prestige, of public sector bureaucracies. Better remuneration of high officials increases the quality, integrity and – for non-African countries – the prestige of public sector employment. New Public Management, measured indirectly as the extent to which high officials intersperse private and public sector careers, has no apparent effect on quality or integrity, but it is associated with low prestige of public service, making it difficult to recruit and retain talented professionals. This was prepared as a background paper for the World Public Sector Report 2005 (United Nations, New York, Sales No. E.05.II.H.5).

Larry Willmore, “Public Sector Performance, Prestige and Promotion”, May 2005.

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timid US fiscal policy

September 1st, 2010

Today there is another superb column from Martin Wolf. Here are just a few snippets (really) from an essay that should be read in its entirety.

[A]s Larry Summers, Mr Obama’s chief economic adviser, had said: “When markets overshoot, policymakers must overshoot too”. Unfortunately, the administration failed to follow his excellent advice. This has allowed opponents to claim that policy has been ineffective when it has merely been inadequate. ….

The recession in US output (and so demand) has been relatively small, but the decline in employment has been exceptionally large, as a result of an extraordinary surge in US productivity. ….

Since the US was the epicentre of the financial crisis, the relatively small decline in output is remarkable. Moreover, since fiscal and monetary stimuli bear directly on demand and output, not jobs, this is a policy success.  ….

Debate is emerging on how much of the surge in unemployment is structural. My answer, from European experience, is that one way to ensure it becomes structural is to let it linger. ….

So what is going to happen? I assume that, after the midterm elections, resurgent Republicans will offer new tax cuts and ignore the fiscal deficits. They will pretend that this has nothing to do with any reviled stimulus, though it is much the same thing – increasing fiscal deficits, thereby offsetting private frugality. That would put the administration on the spot. It would have to choose between vetoing the tax cuts and accepting them, so allowing the Republicans to get the credit for their “yacht and mansion-led” recovery. Any recovery is better than none. But it could have been much better than this. Those who were cautious when they should have been bold will pay a big price.

Martin Wolf, “Obama was too cautious in fearful times”, Financial Times, 1 September 2010.

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the booming bond market

August 31st, 2010

Consider the situation from the point of view of those who look after these large pools of savings. These funds must be parked somewhere and, given the current state of mind of their beneficial owners, safety is prized more highly than the level of return. The corporate sector, its balance sheets stuffed with cash, has little requirement to borrow and the financial sector, once a deviser of all sorts of clever instruments that delivered triple C yields with triple A ratings, is no longer quite so creative.

The obvious strategy is to lend the money, however unenthusiastically, to the government. Investors need not lend money to all governments. A small country such as Greece, which combines a high level of debt with a sorry record of obfuscation, can be quite easily deleted from the list of suitable investment targets.

But when one comes to the major government bond markets – Treasuries, JGBs, Bunds, even gilts – it is unclear that investors have quite the same freedom. They have to put the money somewhere. All these bond markets – fiscal concerns notwithstanding – have been remarkably strong.

Jonathan Allum, “The lessons to be learnt from Japanese bonds”, Financial Times, 31 August 2010.

Jonathan Allum  is Chief Japan strategist at KBC Asset Management in London.

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age, education and employment

August 29th, 2010

Why would any company hire a computer programmer with the wrong skills for a salary of $150,000, when it can hire a fresh graduate—with no skills—for around $60,000?  Even if it spends a month training the younger worker, the company is still far ahead. The young understand new technologies better than the old do, and are like a clean slate: they will rapidly learn the latest coding methods and techniques, and they don’t carry any “technology baggage”.  As well, the older worker likely has a family and needs to leave by 6 pm, whereas the young can pull all-nighters.

At least, that’s how the thinking goes in the tech industry. ….

For tech startups, it usually boils down to cost: most can’t even afford to pay $60K salaries, so they look for motivated, young software developers who will accept minimum wage in return for equity ownership and the opportunity to build their careers. Companies like Zoho can afford to pay market salaries, but find huge advantage in hiring young workers. In 2006, Zoho’s CEO, Sridhar Vembu, initiated an experiment  to hire 17-year-olds directly out of high school. He found that within two years, the work performance of these recruits was indistinguishable from that of their college-educated peers. Some ended up becoming superstar software developers.

Vivek Wadhwa, “Silicon Valley’s Dark Secret: It’s All About Age”, Tech Crunch, 28 August 2010

Apparently Bill Gates is not the only college dropout to have done well in the software industry.

Vivek Wadhwa is a Visiting Scholar at the School of Information at UC-Berkeley, Senior Research Associate at Harvard Law School and Director of Research at the Center for Entrepreneurship and Research Commercialization at Duke University. He actually appreciates older workers, who “tend to be more pragmatic and loyal, and to know the importance of being team players. And ego and arrogance usually fade with age. During my tech days, I hired several programmers who were over 50. They were the steadiest performers and stayed with me through the most difficult times.”

HT: The Browser.

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health care and efficiency

August 29th, 2010

Greg Mankiw has already linked to Princeton economist Uwe Reinhardt’s thoughtful discussion of the economist’s concept of efficiency, so this post may not be necessary. I would add that Professor Reinhardt writes clearly, without jargon. You do not need a degree in economics to understand his message. And do not miss his assignment for students. Here is a brief excerpt from that assignment:

Different people can differ honorably on the ethical precepts that should be imposed upon the distribution of health care in a nation. To illustrate, in an article published in the Journal of the American Medical Association (JAMA) of November 5, 1997, I had raised in passing the following question:

“As a matter of national policy, and to the extent that a health system can make it possible, should the child of a poor American family have the same chance of avoiding preventable illness or of being cured from a given illness as does the child of a rich American family?”

Of the several readers who responded to that question, only one, Richard A. Epstein, LLB, Distinguished Professor of Law of the University of Chicago, answered it forthrightly. He wrote:

“The correct answer is no. … His proposal for equal medical treatment perversely requires more care to children of poor parents than to children of rich ones, precisely because the rich families can more easily avoid injury or illness and can better pick up any slack in health care delivery. Worse, programmatic success depends not just on offering carrots but wielding sticks in overriding parental judgments on children’s food, lifestyle and education.” (JAMA, vol. 279, No. 10, March 11, 1998.; p. 745.)

I do not share Professor Epstein’s view on children in society. Indeed, I had answered my own question in this commentary in the affirmative, on the assumption that we in America aspire to an “equal opportunity” society. Good health is part of that opportunity. But I respect Professor Epstein immensely for having had the courtesy and courage to answer my question so forthrightly.

Uwe E. Reinhardt, HOMEWORK ASSIGNMENT NO. 4, ECON 100/FALL 2005.

Reinhardt’s blog post is “When Value Judgments Masquerade as Science”, Economix, 27 August 2010, where there is a link to this assignment.

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