Monthly Archives: January 2015

Apparently, Gregory Clark is Not Most Economists

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Gillian B. White writes,

According to the Fed study, about 60 percent of black children whose parents had income that fell into the top 50 percent of the distribution saw their own income fall into the bottom half during adulthood. This type of downward slide was common for only 36 percent of white children.

…Still, most economists lack a clear, definitive explanation for why, after reaching the middle class, many black American families quickly lose that status as their children fall behind.

Pointer from Mark Thoma.

Obviously, she did not read my review of Gregory Clark’s latest book.

Clark suggests that this may reflect that the underlying mean for these ethnic groups may differ, and the higher propensity of middle-income blacks and Hispanics to have their children’s income fall to the bottom third might be due to regression toward a lower mean.

Suppose that you have two populations of men with different height-producing genetic characteristics. The mean height in group A is 5 feet, 9 inches, and the mean height in group B is 5 feet, 7 inches. There is substantial variation within each group.

Now, out of the current generation of men, you select men from each group who happen to be 5 feet, 8 inches. Track the height of their sons. It seems reasonable to predict that, starting with men who are 5 feet 8 inches, the sons of men from group A are likely to be taller than the sons of men from group B. This does not result from social prejudice against men from group B. It is the result of laws of probability.

Arrow’s Impossible-to-Understand Theorem

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Tyler Cowen writes,

Can one economist in forty properly define the “independence of irrelevant alternatives” axiom behind the Arrow Impossibility Theorem

That one I think I understand. What I do not understand is the “nondictatorship” axiom. Does it mean that ex ante no one is given the privilege of selecting for the group? Or does it mean ex post that no one’s preferences are perfectly satisfied? My impression, which may be wrong, is that it is the latter, in which case I think that nondictatorship is a misleading term for it. [UPDATE: commenters point out that I am wrong, and that it is an ex ante assumption]

As an undergraduate, I spent a lot of time trying to understand the Arrow Impossibility Theorem. I was much more fluent with it then than I am now, and yet I never thought that I had it. I think that every attempt to explain it in simple terms is wrong.

I agree with Tyler that much of modern finance is not well understood. The Portfolio Separation Theorem is very important, and yet few can explain it. My attempt is here.

One of my long-standing complaints is that nobody is sure whether aggregate demand slopes up or down. In undergraduate macro, it slopes down. In graduate macro, with inflation on the vertical axis, it slopes up (although in graduate macro nobody draws it–they just write down equations.)

Fiscally Responsible Italy

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Lawrence Kotlikoff writes,

As for Italy, its fiscal gap of negative 2.3 percent is the lowest of any of the 24 included countries. Indeed, Italy can spend almost €180 billion more and still be able to meet all its expenditure obligations. The source of Italy’s long-term fiscal solvency is its two major pension reforms that have dramatically reduced its pension obligations. In addition, Italy has strong control of its health care spending.

Pointer from Greg Mankiw.

This is why accrual accounting would be an improvement. Under the present system, politicians have an incentive to run up their debts in the form of obligations in pensions systems. By not using this trick, Italy managed to be fiscally responsible.

The Tea Party, McBoehner, and ObamaCare

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Tyler Cowen has referred a couple of times to a book by Philip Klein on Republican politics and health care reform. I am not a political analyst, but here is my impression:

1. The most important Republican divide is between the Tea Party and McBoehner. The Tea Party wants policies to change, and McBoehner want most of all to be Senate Majority Leader and House Speaker, respectively.

2. The Tea Party wants to overturn Obama’s policies on immigration and health care. McBoehner wants to loosen environmental regulations and tweak Dodd-Frank, because that is what their friends in business are telling them are priority issues.

3. I think that a conservative consensus on health care reform is there to be formed, but McBoehner are not the ones to form it. I think that the Tea Party is likely to be shafted both on immigration and on health care reform. That might make them a bit ornery during primary season in 2016.

The FARMS Indicator

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Alex Tabarrok writes,

Eligibility for free and reduced-price lunches, however, depends on eligibility rules and not just income levels let alone poverty rates.

He is criticizing the sensationalist statistics that “half of public school children are in poverty,” when eligibility for free and reduced meals is not quite the same thing.

Still, I think that the percentage of FARMS students is a very useful indicator. For example, a couple of times I have downloaded data on standardized test scores for various Maryland school districts. The scores and the FARMS percentages line up very closely. In contrast, there is almost zero correlation between school spending and test scores. As far as spending goes, the null hypothesis holds.

The interesting question, then, is whether the FARMS proportion is rising because of changes in eligibility rules or because of changes in the demographics of the public school population. I suspect is is the latter, and I suspect that it is a leading indicator of worse outcomes, such as performance on stand in terms of standardized tests and high school graduation rates (provided that schools do not reduce the requirements for graduation).

Scope and Banking

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A reader recommended this post by Jeff Carter.

The days of the one stop shop that Sandy Weil envisioned when he built Citigroup ($C) are gone.

I have always believed that there are diseconomies of scope. Companies with many lines of business are difficult to manage effectively, in my view.

In the case of banking, I thought that the “financial supermarket” fad of the 1980s was silly. Consumers are fine having separate vendors for credit cards, checking accounts, and stock portfolios.

I have to say, though, that it is not just banks that defy my prejudice against multiple business lines. Amazon has branched into all sorts of unexpected businesses, such as renting Web servers. Google is another example of a company that is not strictly bounded in what it businesses it will try.

Some possibilities:

1. I am correct, and whenever you see a company with many lines of business, whether it’s a bank or a tech firm, it represents the CEO’s ego gain and the shareholders’ wealth loss.

2. I am somewhat correct, but the diseconomies of scope are actually quite small. Six lines of business can be managed almost as effectively under one organization as under six totally separate entities.

3. I have it wrong. There actually are tremendous fixed costs to developing a good decision-making structure, and CEO talent is scarce. These super-managers, or management super-cultures, can handle a sixth line of business more effectively than other managers can handle a first.

Medicare Spending by Age Group

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Timothy Taylor writes,

on a per capita basis, Medicare costs are rising faster for those at later ages. In 2000, for example, Medicare typically spent about 2.4 times as much for a 90 year-old as for a 65 year-old. By 2011, it was spending about 2.8 times as much

There is much more at the link. He cites a Kaiser Family Foundation analysis.

Something to bear in mind is that the mix of ages within Medicare can change. If you get an increase in “young old” in a given year, then average spending could decline, even though on a lifetime basis Medicare spending is not falling, and may even be rising.

Annual Physicals vs. Evidence

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Ezekiel Emanuel writes,

Those who preach the gospel of the routine physical have to produce the data to show why these physician visits are beneficial. If they cannot, join me and make a new resolution: My medical routine won’t include an annual exam.

He cites controlled experiments showing that the Null Hypothesis is true for the routine physical exam.

Not surprising, really. Ask Robin Hanson.

Pointer from Jason Collins.

Robin Hanson, Manorialist

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Robin Hanson writes,

I’d predict that if there were many for-profit cities most people would be okay with them, as they’d be reluctant to move to worse-run non-profit cities.

This reminds me of Spencer Heath, whose descendant wrote,

Spencer Heath once reasoned that if a new town were developed under unified ownership and its land parceled among the occupants by means of long-term land leasing rather than subdivided in fee, we would have an entrepreneurial community in principle very much like a hotel carried out-of-doors and writ large. In light of both the size and the complexity of many contemporary hotels, Heath’s suggestion that hotels might be viewed as prototypes of cities of the future is far more credible today than when he wrote sixty years ago. The MGM Grand in Las Vegas promotes itself as a self-contained city, and it does approach a truly generalized community. It includes shopping malls, professional offices, convention facilities, restaurants and cafes, chapels, theaters and art galleries, medical services, a security force, a monorail station, and the list goes on. It is significantly larger — counting room guests, service staff and visitors — than was the city of Boston at the time the United States gained its independence from England.

He terms this manorialism. What Hanson proposes is a way of getting from here to there–of having cities sell their land and the right to enact rules to a private buyer.

Hanson writes as if the current owners of a city are those who currently own its property. That does not take into account the teachers’ union, which acts as if it owns the county where I live. Given the political power that the union exercises, it could hold hostage any sale of the sort that Hanson contemplates.

Babies and Marriage: One Pattern, Two Explanations

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The WSJ reports

For every 1,000 unmarried U.S. women ages 15 to 44 in 2013, there were 44.3 births, down 2% from 2012 and 7% from 2010, CDC data show.

In contrast to unmarried women, birth rates for married women increased 1% in 2013 from 2012 to 86.9 births. In fact, they’re up 3% since 2010, after declining 5% between 2007 and 2010. (The absolute number of births among married women in 2013, 2.34 million, remained slightly below 2010’s 2.37 million.)

That piece, and this one, view this as a change in behavior, as if a constant group of married women decided to have more children, and a constant group of unmarried women decided to have less.

However, there is another possible explanation. Suppose that the two constant groups are “planners,” meaning women who only have children once they are married, and “non-planners,” meaning women who are willing to have children while unmarried. Also, suppose that among planners the rate of child-bearing is highest between years 3 through 10 of marriage. What happens if the marriage rate declines among planners because of a weak economy? Because they are unmarried and will not have children, you will see an increase in unmarried women not having children. Because the proportion of new marriages (where couples are not ready to have children) drops, you will see a bit of an uptick in married women having children. No fundamental change in behavior, just a decline in marriage rates among planners due to the recession.

I am not claiming that this is the explanation. But I need to see better quantitative analysis to rule it out.