Archive for September, 2009

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John Kay on bogus quantification

Wednesday, September 23rd, 2009

John Kay has a delightful column today, commenting on the UNDP’s annual Human Development Report. The 2009 report will be released shortly – on 5 October – so treat Kay’s column as an advance warning.

The annual report of the United Nations Human Development Programme is an entirely admirable endeavour. The agency focuses on three broad dimensions of development – health, education and material standard of living – and reports on progress towards these goals among UN members. ….

Take life expectancy at birth, subtract 25 years, then divide by 60. This score has a one-third weight in the final total. Educational development is measured as a combination of attainment – adult literacy – and opportunity – enrolment. Material standard of living is measured by gross domestic product per head at purchasing power parity. But differences in GDP are much larger than differences in life expectancy, so you prevent this measure from swamping the whole calculation by using the logarithm of GDP rather than the level. Finally, you give equal weight to each of the three components and come up with your ratings. Iceland, ironically, comes top, and Sierra Leone bottom.

If you must undertake an exercise of this kind, then what the UNDP does is sensible enough. ….

Such measures do not, however, add anything to [our] knowledge …. If anything, they reduce it. Just as the statement “Iceland has an HDI score of 0.99” tells us less, not more, than the sentence “Icelandic people are, by global standards, rich, healthy and well educated”.

John Kay, “Do not discount what you cannot measure”, Financial Times, 23 September 2009.

In last year’s Report, Iceland did indeed rank first, with an HDI (Human Development Index) of 0.968 and Sierra Leone at the bottom, with an HDI of 0.336. Norway also had an HDI of 0.968, so appeared to be tied with Iceland for top place, but a note to the table explains “The HDI rank is determined using HDI values to the sixth decimal point”. What will the 2009 Report show? And does it matter?

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Alex Rosenberg on the efficient-market hypothesis (EMH)

Wednesday, September 23rd, 2009

The efficient markets thesis is that the market makes complete use of all relevant information, and the “proof” is roughly that in a perfectly competitive market among perfectly rational agents prices invariably and instantaneously reflects all agents’ real beliefs and real desires. Any one who knows anything that can make him or her money acts on it—buys or sells—and that signal is picked up by every one else, who also acts on it, thus preventing any one from making excess profits—rents—long-term.

The first thing a philosopher notes about this notion is that since most people have false beliefs, especially about the future, an efficient market doesn’t internalize knowledge, but only beliefs. If they are mostly false, then the market isn’t efficient at internalizing (correct) information, it’s efficient at internalizing mostly false beliefs. If false beliefs are normally distributed around the truth, then they’ll cancel out and the proof of a probabilistic version of the efficient markets theorem will go through—market prices reflect the truth most of the time. Too bad false beliefs don’t always take on this tractable distribution. Even worse, when enough people notice the skewed distribution of false beliefs, they can make rents, as the markets crash. This is what [Chicago economist John Cochrane seems to think can’t happen. How many times will it have to happen for the Chicago School to give up the efficient markets hypothesis?

“Alex Rosenberg on Cochrane and Economics”, Leiter Reports, 20 September 2009.

Philosopher Alex Rosenberg is commenting on Chicago economist John Cochrane’s response to Paul Krugman’s New York Times essay on the failures of macroeconomics.

Alexander Rosenberg is author of Economics: Mathematical Politics or Science of Diminshing Returns? (University of Chicago Press, 1992), which won the 1993 Lakatos Award in Philosophy of Science from the London School of Economics. The book is a follow-up to his PhD thesis on the same subject, published as Microeconomic Laws: A Philosophical Analysis (University of Pittsburgh Press, 1976). Rosenberg also writes extensively on the philosophy of biology, most recently Darwinian Reductionism or How to Stop Worrying and Love Molecular Biology (University of Chicago Press, 2006).

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schooling and economic growth

Tuesday, September 22nd, 2009

If England led the rest of the world in the Industrial Revolution, it was despite, not because of, her formal education system.

Joel Mokyr, The Lever of Riches (Oxford University Press, 1990), p. 240.

Scotland had universal literacy and a much more educated population, yet lagged behind England in in the 19th century. The same was true of Sweden.

Economic historian Joel Mokyr teaches at Northwestern University. The “lever of riches”, according to him, is technical change, which most emphatically is not the same thing as schooling.

Recycled from the thought du jour 2003 archive.

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the elusive search for causes of growth

Tuesday, September 22nd, 2009

The success of the East Asian Gang of Four—and now China—has exerted an irresistible lure to researchers of growth. Academic economists who were used to studying whether a politically difficult tax reform might make Americans better off by an amount equivalent to 0.1 percent of US GDP rushed into a field of inquiry that promises to explain how to increase your income seventeen times over. Theoretical breakthroughs in the late 1980s by Paul Romer (now at Stanford) and by Nobel laureate Robert Lucas helped inspire a remarkable effort by economists to find in the empirical data which factors reliably lead to growth. Yet hundreds of research articles later, we wound up at a surprising end point: we don’t know. [my emphasis]

In 2003, Arnold Harberger, a free-market economist from the University of Chicago, observed that “there aren’t too many policies that we can say with certainty…affect growth.” A year later, a group of famous economists (including some on the liberal end of the spectrum like Paul Krugman and Joseph Stiglitz) produced something called the Barcelona Development Agenda that announced: “There is no single set of policies that can be guaranteed to ignite sustained growth.” And in 2007, the dean of growth research, Nobel laureate Robert Solow, said: “In real life it is very hard to move the permanent growth rate; and when it happens…the source can be a bit mysterious even after the fact.”

William Easterly, “The Anarchy of Success”, New York Review of Books 56:15 (8 October 2009).

NYU economist Bill Easterly is reviewing  The Drunkard’s Walk: How Randomness Rules Our Lives by Leonard Mlodinow (Pantheon, 2008; Penguin, 2009) and Bad Samaritans: The Myth of Free Trade and the Secret History of Capitalism (Random House, 2007; Bloomsbury, 2008) by Ha-Joon Chang. Mlodinow’s book offers a clue why so many writers continue to claim to have a prescription for economic growth: “Humans are suckers for finding patterns where none really exist, like seeing the shapes of lions and giraffes in the clouds.” Chang’s book is an example of this type of outlandish claim, namely “the success of such countries as the East Asian Gang of Four can be replicated by other countries”.

Bill Easterly blogs at Aid Watch.

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the World Bank on ‘social pensions’

Monday, September 21st, 2009

Even acknowledging the “limited coverage of mandatory pension systems” (our emphasis) is, in PensionReforms’ view, a step in the right direction.  If citizens ignore the law, governments are relatively powerless to do anything about it when it comes to retirement saving.  This failure forces policy attention in the direction of things that governments can do, like “social pensions”, the subject of this latest report. ….

[A] striking feature of Closing the Coverage Gap was its conclusion that “…based on first principles… universal programs are likely to be sub-optimal.”  Those “first principles” are fiscal affordability, the ‘income effect’, the ‘substitution effect’ and their effects on labour supply.  However, the book then didn’t look closely at the range of countries with a truly universal system to see whether practice  and experience conformed to theory.   ….

New Zealand [for example] … has had a universal pension for most of the last 70 years.  It also has one of the lowest reported poverty rates amongst the elderly in the world.  In Closing the Coverage Gap, New Zealand received some mentions but no close examination.  PensionReforms thinks that as the only richer country with a universal pension, the World Bank might be able to test some of its theoretical criticisms of a universal, adequate Tier 1 pension against a real life experience.

That is from a review – at PensionReforms.com – of the World Bank’s June 2009 publication, Closing the Coverage Gap: The Role of Social Pensions and Other Retirement Income Transfers, made up of 14 chapters written by 20 authors and edited by three of them (Robert Holzmann, David A. Robalino, and Noriyuki Takayama). The full report can be downloaded here without charge, or purchased here.

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Mankiw on unequal provision of health care

Sunday, September 20th, 2009

Harvard economist Greg Mankiw, in today’s New York Times, offers an interesting thought experiment. “Imagine that someone invented a … Dorian Gray pill …. Every day that you take the Dorian Gray, you will not die, get sick, or even age. Absolutely guaranteed. The catch? A year’s supply costs $150,000.”

So here is the hard question: How should we, as a society, decide who gets the benefits of this medical breakthrough? Are we going to be health care egalitarians and try to prohibit Bill Gates from using his wealth to outlive Joe Sixpack? Or are we going to learn to live (and die) with vast differences in health outcomes? Is there a middle way? ….

The push for universal coverage is based on the appealing premise that everyone should have access to the best health care possible whenever they need it. That soft-hearted aspiration, however, runs into the hardheaded reality that state-of-the-art health care is increasingly expensive. At some point, someone in the system has to say there are some things we will not pay for. The big question is, who? The government? Insurance companies? Or consumers themselves? And should the answer necessarily be the same for everyone?

N. Gregory Mankiw, “Economic View: Why Health Care Will Never Be Equal”, New York Times, 20 September 2009.

Greg Mankiw is correct: health care will never be the same for everyone. But he is wrong to assert that universal coverage means provision of “the best health care possible”. Private insurers and governments alike refuse to pay for some procedures either because they are not cost-effective or because they are cosmetic. Even in countries with universal health coverage, citizens have the option of paying privately for any health care they desire. Ten percent of UK residents, for example, have private health insurance that allows them to go to private clinics rather than the National Health Service. Canada is a glaring exception to this rule, but for most Canadians the US border and private payment is a short drive away.

What universal coverage means is that basic health care is provided to all residents, regardless of income. Each society has to decide what is meant by “basic care”, which determines in turn the amount of public money spent on health care.

A good analogy is schooling. Governments typically provide universal schooling, at least through high school. Parents who want their children to consume a better – or different – type of schooling are free to pay fees in an independent school of their choice. Bill Gates is not forced to send his children to public school. Similarly, no one would force Bill Gates to limit his consumption of health care to that provided by Medicare from age 65 or by a similar universal system for all ages.

The case for universal health care, like the case for universal schooling, is that differences in outcomes can be mitigated–not eliminated, which is an impossible goal.

HT to Greg Mankiw.

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health care systems of the USA

Saturday, September 19th, 2009

Health care in the US is complex because the country has three four systems, each catering to a different segment of society. Abigail Zuger, MD, explains.

[W]hat Americans often consider a single unique system of health care is an illusion: we exist in a sea of not-so-unique alternatives. Like the citizens of Gemany and Japan, workers in the United States share insurance premiums with an employer. Like Canadians, our older, destitute and disabled citizens see private providers with the government paying. Like the British, military veterans and Native Americans receive care in government facilities with the government paying the tab. And like the poor around the world, our uninsured pay cash, finagle charity care, or stay home.

Abigail Zuger, “One Injury, 10 Countries: A Journey in Health Care”, New York Times, 15 September 2009.

Dr Zuger is reviewing Washington Post journalist T.R. Reid’s new book, The Healing of America: A Global Quest for Better, Cheaper, and Fairer Health Care.

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American populism

Friday, September 18th, 2009

[T]he teabaggers … are primarily working-class, largely rural and elderly white people. ….

Barack Obama is the apotheosis of all they fear. He is a child of what used to be called miscegenation–a mixed marriage. His father was a Muslim, his mother was sort of a hippy. She raised him in Hawaii, which is just barely American and in Indonesia (which is very suspicious). He is a liberal (even if a prohibitively moderate one). Worse, he’s a completely urban sort. There is nothing resembling a log cabin in his background. We’ve had elite Presidents–the Roosevelts, the Bushes–but we have never really had an urban one. (New York Governor Al Smith, Tammany Hall’s finest, was trounced in 1928–the last pure urban candidate.) This sort of populist paranoia is disgraceful, but as American as apple pie. The appropriately-named Know-Nothing Party of the 1840s was anti-immigrant. The Republican Party has pursued an implicitly racist “southern strategy” since the late 1960s.

Joe Klein, “Yes, It’s Racism…but it’s Complicated”, Swampland, 16 September 2009.

I found Klein’s post helpful as I try to comprehend the strong reaction to Obama by large numbers of people in the US heartland. Is it a fair assessment?

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Paul Volcker on macroeconomics and regulatory reform

Friday, September 18th, 2009

The September 2009 issue of “The Region”, published by the Federal Reserve Bank of Minneapolis, has an interview with Paul Volcker, a Democrat who was appointed by President Jimmy Carter to chair the Fed in 1979, and reappointed by Ronald Reagon in 1983. He served in that capacity until 1987, when Reagan replaced him with Alan Greenspan. Today Volcker chairs President Obama’s Economic Recovery Advisory Board.

In the interview he was asked whether he thought that macroeconomics had changed since the early 1970s, when he first became active in policymaking. Volcker responded with laughter: “It’s interesting you ask that question because I recently commented to some of my economist friends that I’m not aware of any large contribution that economic science has made to central banking in the last 50 years or so.” This remark is very much in the spirit of Paul Krugman’s recent writings on the shortcomings of modern macroeconomics.

As for regulatory reform, Volcker shares to a great extent the views expressed by Martin Wolf and John Kay in last Wednesday’s Financial Times (16 September 2009):

I wouldn’t regulate so strictly the nonbanks. If they get big enough, then they’re going to need capital requirements and leverage requirements. But I don’t think that’s going to be many firms. I’d like to create the impression, to the extent you can, that there’s no automatic bailout of those institutions. ….

[In contrast] we should deal with commercial banks as basically service organizations: They are dealing with customers, they’re dealing with clients, they’re providing some very basic services the country needs. And in recognition of the importance of those basic functions, virtually every country provides certain protections and support. ….

But, and this is partly substantive and partly symbolic, I don’t think a bank should own a hedge fund or own a private equity fund because that puts them in a different business.

“Paul A. Volcker in conversation with Gary H. Stern”, The Region, September 2009.

It is worth recalling that Columbia University economist Joseph Stiglitz last year said “Paul Volcker, the previous Fed Chairman known for keeping inflation under control, was fired because the Reagan administration didn’t believe he was an adequate de-regulator. Our country has thus suffered from the consequences of choosing as regulator-in-chief of the economy someone [Alan Greenspan] who didn’t believe in regulation.”

Paul Volcker was interviewed for The Region on 15 July 2009.

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David Laidler on macroeconomics

Thursday, September 17th, 2009

Western Ontario economist David Laidler has written an essay on macroeconomics and the 2008 financial crisis that is very critical of Chicago economist Robert Lucas and sympathetic to Keynes. Laidler does not refer directly to Paul Krugman, except for a passing reference on the possibility of a liquidity trap, but I read the essay as generally supportive of  Krugman. Here is a key quote, from page 13, that is a direct response to Lucas’ claim that general equilibrium models represent an important advance over disequilibrium (non-market clearing) dynamics:

[N]o theoretical system based on the assumption of continuously clearing markets – and this is true even of those mislabeled “new Keynesians” … – can deal with some of the critical monetary and financial features of any real world economy. It is not just that such macroeconomic models cannot address the policy issues that the recent convulsions in financial markets have created, though they can’t, but rather that it is difficult for anyone brought up under their influence even to conceive of such events occurring in the first place. That is why a crisis in macroeconomics is an integral part of the current economic situation.

David Laidler, “Lucas, Keynes, and the Crisis”, University of Western Ontario, Department of Economics, Research Report 2009-2, July 2009.

What Laidler is saying is macroeconomic models that assume full employment are useless – no, worse than useless, because they lead to bad policy advice. The essay is interesting in no small measure because its author is not known as a Keynesian – new or otherwise. He is in fact a leading monetarist scholar who received his PhD from the University of Chicago the very same year (1964) as Lucas. Laidler is best known for his book The Demand for Money, which has been published in four editions (1969, 1977, 1985, 1993) and translated into five languages, most recently Chinese.

HT to Justin Wolfers at Freakonomics for the pointer.

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