Monthly Archives: January 2014

A Robot-Friendly Environment?

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I am still reading The Second Machine Age. The section on the improvements in robotics made me think about creating a city that is robot friendly. Imagine a city with “self-driving car lanes” comparable to bike lanes today. My guess is that self-driving cars could be more efficient without humans.

But why not go further? Instead of making robots adapt to the human environment, why not put RFID’s on every object and surface, to make it easier for robots to operate. The place to try this out might be at an expensive resort or a cruise ship. You could be in your room and say to your phone or wristband, “I am ready for lunch.” You listen to a menu, you make your choices, and robots assemble and deliver your meal. If you are at a golf resort and are ready to play, you could summon a self-driving golf cart to take you around the course. Maybe each hole could adapt to your level of skill, with the location of the pin and various sand traps moving while you come toward the tee.

Fischer Black on the ZLB

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On the topic of aggregate demand, he writes,

When people say that they see shifts in aggregate demand, they mean that they see changes in the match between wants and resources. Thus in a more specific sort of model, high aggregate demand can be a good match. If this is what “aggregate demand” means, we could also call it “aggregate supply.”

That is from p. 87 of the 2010 edition of Exploring General Equilibrium. Basically, he sees a cyclical slowdown as a reflection of capital investments that were made with good intention but turned out to be wrong. In my terminology, people bet on certain patterns of specialization and trade, and those turned out not to be sustainable patterns.

On the Great Depression, he writes,

Firms made investments during the 1920s based on their beliefs about what tastes and technology would be, along many dimensions, during the 1930s. These beliefs turned out to be very wrong, so the investments were not worth much and ability to produce what people wanted was low…

But monetary forces played a big role too…many countries experienced sharp deflation, which drove their nominal interest rates down. Normally, very low nominal interest rates mean a big demand for currency [but] some countries stopped supplying currency passively. This meant a serious breakdown in financial markets.

…the deflations forced short-term nominal interest rates to zero in some countries, and would have made these rates negative were it not for the effective floor at zero. This caused disequilibrium in real asset markets. The real interest rate was forced above its natural level. It was a kind of “currency trap.”

Longer-term nominal interest rates did not fall to zero, because they reflected the chance that the nominal short rate would bounce back to positive levels. But they were artificially high, so longer-term real rates were artificially high, even more so than short-term real rates.

Some notes:

1. He does not believe in AD, but he thinks that the ZLB mattered in the Great Depression. He thinks that the artificially high real interest rates accentuated the mismatches between previous investments and prevailing wants. He does not give any examples. But imagine that you are a farmer, and you invested in farm machinery, and now crop prices are falling. Are you going to throw more money at your investment by buying seeds and fertilizer? Will the bank lend you the money to do so? If growing crops is no longer profitable, then the value of your investment in farm machinery is looking bad.

2. He is saying that just because you observe positive long-term interest rates, that does not mean that the ZLB is unimportant.

3. What about the U.S. in the last five years? On the one hand, we have seen low short-term interest rates. On the other hand, we have not had deflation, so the short-term real interest rate has been low rather than high. Has the long-term real interest rate been artificially high because of the ZLB?

4. In explaining unemployment, I would be inclined to focus more on mismatches involving human capital. In the 1930s, men who had been farm laborers and tenant farmers were thrown out of work by tractors, trucking (which made it possible to shift production away from relatively poor farmland close to cities to better farmland farther away), refrigeration, and so on. Also, workers whose human capital was in cigar rolling or lightbulb glass-blowing found themselves obsolete. In hindsight, these guys should have stayed in school instead of dropping out without completing high school. But as it was, there were too many of them relative to the technology of the 1930s, which ultimately called for a work force with at least a high school education.

Today, I would say that, in hindsight, more people should either have acquired computer skills or prepared for life providing elder care or otherwise engaged in personal services.

Fischer Black: Seeing Capital Everywhere

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After Tyler Cowen told me that my macro book needs more on Fischer Black, I ordered the 2010 edition of Exploring General Equilibrium, which includes a posthumous essay. I will probably have a number of posts on the book.

One way I think of Black is that he sees capital everywhere. In an extreme (and Black does not take things this far), think of the economy as nothing but different forms of capital producing utility. Take the concept of human capital really seriously, to the point (again Black does not take things this far) of looking at a human worker as just another machine.

From the point of view of a firm, the human worker-machine has some capabilities. However, in order to make it productive, you have to set it up, tune it, program it, and coordinated it with other machines. It becomes obsolete when the cost of maintaining and using it exceeds the value of what it produces.

When I ate a piece of toast this morning, I was getting utility out of various forms of capital. These included the refrigerator out of which I took the bread and the toaster oven. However, the bread itself resulted from roundabout production. Seeds were planted, grain was harvested, other ingredients were added, loaves were baked, etc. In order to know how to obtain the bread and operate the toaster oven, I had acquired human capital.

In a world where utility is produced almost entirely by capital, most economic decisions are risky. Any decision today represents a bet on how the world will look tomorrow.

Some remarks on this capital-centric point of view.

1. Standard national income accounting assigns a 2/3 weight to labor’s share of output. But perhaps this is highly misleading. The value comes from the capital embodied in the workers, which includes general human capital (skill usable everywhere) and specific human capital (skills usable on a particular job).

2. Standard national income accounting says that consumption is over 2/3 of output. However, very little output is immediately consumed. When I buy a loaf of bread, I do not consume it immediately. Instead, the bread is an input to consumption that takes place over subsequent days. Although Black does not take things this far, you can think of the bread as capital that, when used, depreciates rapidly and proportionately. This is in contrast to the toaster oven, which depreciates slowly and not exactly proportionately to its use.

3. The value of capital changes as events unfold. A desktop computer from 1987 is not worth much today. Houses in Las Vegas were not worth as much in 2009 as they were in 2005. The ability to shoe a horse is not worth much today. Arguably, a plain vanilla college degree was not worth as much in 2013 as it was in 2006.

4. Black points out that because of adverse selection and moral hazard, human capital investments are harder to diversify than physical capital investments. That is, I cannot sell shares in my future earnings without creating adverse-selection and moral-hazard problems, so I have to retain a large interest in my own human capital.

5. One of Black’s central points is that as events play out, some investments earn good returns and some investments earn bad returns. You will not always see equal amounts of good luck and bad luck. A lot of good luck is a boom. A lot of bad luck is a bust.

6. Black says several times that worker compensation consists of training as well as pay and benefits. When a lot investments do not pan out as hoped/expected, compensation for some humans has to fall. Black points out that if the compensation still includes a lot of training, then the firm may not be able to afford much in terms of wages and benefits. It made me think of unpaid internships as a market response to these circumstances. Of course, dropping out of the labor force is another natural response.

7. In thinking about the current situation, ask yourself which sorts of investments are no longer panning out. At the margin, does it no longer pay to take on a manual worker and train that worker? Health insurance costs are rising, and machines are getting smarter and more dexterous. At the margin, does it no longer pay to hire an American worker with a plain vanilla college education? A web site and a call center in India may be more efficient than an American sales force. Maybe financial institutions have had to cancel a lot of plans to hire plain vanilla college graduates to work in what was once thought to be an ever-expanding lending-securitization industry. Maybe when you factor in health care costs and the time it takes for a worker to get up to speed, the present value of investing in a new college-grad worker is no longer positive.

Laurence Kotlikoff on the U.S. Budget

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In a podcast with Russ Roberts, he says,

I think we are probably in worse fiscal shape and any developed country. The reason, Russ, is we’ve been piling up debts for over 6 decades; and when I say ‘we’ I’m referring to Republican and Democratic administrations and Congresses. And we’ve been hiding them. We’ve been keeping them off the books and using economic labels, words, to pretend that they are not real liabilities of the government…we have all these obligations to something like 30-40 million current retirees and close to 80 million baby boomers who are about to start collecting Social Security benefits if they haven’t already. All those obligations are not reported as part of the government’s debt, so we are missing those off-the-book obligations.

But the real economic emergency is inequality. Or austerity. Or something.

Models as Traps

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Tyler Cowen writes,

Enter DSGE models. There are plenty of good arguments against them. Still, they provide a useful discipline and they pinpoint rather ruthlessly what it is they we still do not understand. We can and should devalue them in a variety of ways, and for a variety of reasons, but still we should not dismiss them.

Models are simplifications. Sometimes they seem useful. For example, the AS-AD model often seems useful for explaining economic fluctuations. The production function often seems useful for explaining the distribution of income.

The DSGE model was never adopted for its usefulness in that sense. It was adopted in order to satisfy a methodological principle. That may be why I am tempted to dismiss it.

Any model can be described as valuable if you say that it shows us what we do not understand. To me, that is a low bar.

I think that a model is a trap if factors outside of the model constantly have to be invoked, to the point where they overwhelm the factors that are in the model.

Take the neoclassical production function. Recently, it has occurred to me that this may be a trap. Economists seem to need to add all sorts of types of capital to the model: human capital, social capital, network capital, brand-name capital, etc. It is hard enough dealing with heterogeneity in physical capital–how many forklifts equal one blast furnace? But when physical capital does such a poor job of explaining differences in performance across firms, across economies, and over time, at what point do you say that the neoclassical production function is a trap?

Radical Federalism Watch

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The Washington Times reports,

Venture capitalist Tim Draper of Silicon Valley has filed paperwork for a November ballot measure that would divide California into six states, calling the Golden State as presently constituted “too big and bloated.

I am mulling the idea for my next book (after the macro book). I am thinking of how to implement a radical form of federalism, so that the U.S. could be broken into states the size of Singapore or Norway.

My Case for Radical Federalism

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In this essay, I document the negative relationship between the population of a country and its economic freedom.

Overall, 43 percent of the small nations are in the highest group for economic freedom. Only 20 percent of the middle-sized nations are in that group. And just 17 percent of large nations have high levels of economic freedom.

After you read that essay, you might want to look at this version, where I use a controversial measure of national average IQ as an additional variable to predict economic freedom.

Think about what it might mean to have responsibility for something like Medicare or unemployment insurance devolved to the state level. Would someone who is born in Missouri and moves to Maryland be considered a citizen of Missouri who then is a guest worker in Maryland? When would that person become a citizen of Maryland? etc.

Gold-medal Misanthropy

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Jay P. Greene writes,

I hate the Olympics. I hate everything about them… their show-casing of murderous authoritarian regimes, their graft and corruption, their promotion of obscure sports that generate little genuine interest, their hypocritical claim of being non-commercial and non-political, their subordination of athletic excellence to soap-opera story-telling… everything.

Are there libertarians out there who love the Olympics? It occurs to me that anti-Olympics misanthropy might be correlated with anti-state misanthropy. It is true enough in my case.