Monthly Archives: October 2015

Getting Capital Out of the Buggy-Whip Industry

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A commenter writes,

My favorite pet story is the economy is awash in “buggy whip profits”. Many businesses that currently generate free cash flow will be either outsourced or computerized in the future, but it is clear that investment in such firms is not profitable.

This is consistent with the productivity dispersion recently discussed on MRU and also with the large share buybacks made by mature firms.

Because our financial system cannot intermediate these funds towards the really innovative firms, the result is high asset prices and low interest rates.

My thoughts:

1. I love the phrase “buggy whip profits.”

2. There are those who say that the corporate raiding of the 1980s helped move capital out of lazily-managed firms and into better uses.

3. There are those who say that Michael Milken’s junk bonds helped move capital into forward-looking industries, such as the early cell phone networks.

4. As economists, we really do not know much about how financial intermediation works. As you know, I think of households as wanting to hold short-term, riskless assets and firms as wanting to issue long-term, risky liabilities, with intermediaries doing the opposite. But how can we tell if and when there is variation in the ability of the financial system to “intermediate these funds toward really innovative firms”?

Angus Deaton vs. The Representative Agent

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His Nobel citation says,

The insights provided by Deaton’s work on consumption and income have had a lasting influence on
modern macroeconomic research. Previous researchers in macroeconomics, from Keynes onwards, had
relied only on aggregate data. Even if their purpose is to understand relationships at a macro level, today’s
researchers usually start at the individual level and then, with great caution, add together individual
behaviors to compute numbers for the entire economy.

Women Gather, Men Hunt

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Catherine Rampell writes,

But it’s still a bit strange that women are more likely to spend money on ever-rising tuition when they’re not seeing the same financial upside as men.

She goes on to write,

The three fields in which women outnumbered men in the highest numbers are more traditionally utilitarian: health professions (125,000 more women than men), education (61,000) and psychology (60,000).

I am sorry, but psychology is not a utilitarian major. It is a self-indulgent major. There are approximately zero jobs seeking anyone with an undergraduate degree in psychology. Meanwhile, the number of jobs for people with advanced degrees in psychology is very small relative to the number of undergraduate psychology majors, so admission to graduate programs is quite selective.

As for education and allied health professions, I would note that these are occupations that are highly regulated. That is, people with less formal education could do many of these jobs, but they are not allowed to compete for them. They are also fields that strongly resist the concept of merit pay.

Rampell adds,

There are, at least for the time being, lots of decent, middle-class jobs predominantly held by men that don’t require higher education (such as construction and other trades); comparably paying jobs disparately held by less educated women are few and far between.

Females riding garbage trucks are like Black Swans–they may exist but I have never seen one.

A very crude version of evolutionary psychology is that women gather and men hunt. That is, women look for safe and reliable income while men seek income in ways that are more dangerous and can involve extremes of success and failure. I do not think that one should carry this idea too far, but Rampell’s column can be placed in that framework.

Housing Finance Policy and African-Americans

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From The Atlantic:

“Becoming a homeowner was not a fruitful asset accumulation strategy for low- and moderate-income black families in the 2000 decade, in either the short- or medium-term,” write Sandra J. Newman and C. Scott Holupka, authors of a new study from Johns Hopkins University.

…Black families who bought in 2005 lost almost $20,000 of net worth by 2007, according to the paper. By 2011 those losses were more like $30,000. White homeowners didn’t have quite the same problem. Those who purchased in 2007 saw their net worth grow by $18,000 in two years, and then those gains eroded, leaving them with an increase of $13,000 by 2011. All told, the black families lost, on average, 43 percent of their wealth.

…in general black families would have been better off if they hadn’t bought homes at all.

And yet, the advocates of mortgage subsidies and other misguided government housing policies are as active as ever lobbying for more.

Why did the sample of comparable white home owners not do as poorly?

Presumably, the value of their homes declined less. One possibility is that “affordable housing goals” for lenders temporarily increased the prices of homes in black neighborhoods and also created pockets of foreclosures concentrated in those neighborhoods. There are other possibilities, of course.

Thoughts on Inflation

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Scott Sumner writes,

Take a look at the fiscal situation in Europe and Japan, and then the inflation rates in Europe and Japan, if you are still skeptical that monetary policy drives inflation.

My comments:

1. This sounds like a good retort to a view that government deficits determine inflation, because deficits are high in those countries. However, it might also be a retort to the view that money growth determines inflation.

2. I think that you want to hear that “X determines inflation.” The most common view of X is that it is money growth. And when I say that it is not money growth, you want to jump to the conclusion that I must mean that X is the budget deficit. But my troubling answer is that “there is no X.”

3. Prices have meaning in an economy because people expect to wake up tomorrow to find prices very similar to what they find today. Money has value today because people expect money to still have value tomorrow. Thus, I say that money and prices are a consensual hallucination.

4. When have seen money and prices break out of a stable pattern? During hyperinflations, we see governments unable to borrow at reasonable interest rates but still determined to run deficits. Then they print so much money that prices lose their meaning.

5. In general, then there is a regime with very low and stable inflation, and there is another regime with very high and variable inflation, and a necessary condition for the latter is high budget deficits. However it takes more than high budget deficits to get to the high-inflation regime. It takes a deficits that reach a point where the credit markets attach a punitively-high risk premium to the government’s debt.

6. The biggest puzzle for this point of view is an intermediate-inflation case, such as the U.S. in the 1970s. I am left with hand-waving, like saying that wage-price controls created a backlash, where people tried to charge as much as they could, while they could, before they got hit with wage-price controls again. Or the rise in the price of oil created an “inflation psychology.” However, I take a Fischer Black view of monetary policy in that period, which is that money is passively supplied to meet the need for transactions. Remember that the 1970s was also a period in which “money” as we knew it was radically changed by money market funds and the erosion of interest ceilings on deposits.

7. In the 1960s, monetarists wanted to set targets for money growth. Today, there are no money-growth targeters left. That is a tacit admission that there is no reliable relationship between money and other nominal variables.

What Else Would be True?

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Chris Dillow writes,

we should remember the Big Facts. For example, one the Big Facts in finance is that active equity fund managers rarely beat the market for very long, at least after fees. This, as much as Campbell Harvey’s statistical work reminds us to be wary of the hundreds of papers claiming to find factors that beat the market.

Pointer from Mark Thoma

This is a good example of asking, “What else would be true?” When you are inclined to believe that a study shows X, consider all of the implications of X. In the example above, Dillow is suggesting that if one finds that there is some factor that allows one to earn above-market returns, how do we reconcile that with the fact that we do not observe active fund managers earning above-market returns?

Recall that I raised a similar question about the purported finding that in the United States worker earnings have gone nowhere as productivity increased. This should greatly increase the demand for labor. It should greatly increase international competitiveness, turning us into an export powerhouse. Since I do not see either of those taking place, and since many economists have pointed to flaws in the construction of the comparison of earnings and productivity, I think this makes the purported finding highly suspect.

In contrast, consider the view that assortative mating has increased and plays an important role in inequality. I have not seen anyone say, “IF that were true, then we would expect to observe Y, and Y has not happened.”

I think that this is the way to evaluate interpretive frameworks in economics. Consider many possible implications of an interpretive framework. Relative to those implications, do we observe anomalies? When you have several anomalies, you may choose to overlook them or to explain them away, but you should at least treat the anomalies as caution flags. If instead you keep finding other phenomena that are consistent with the interpretive framework, then that should make you more comfortable with using that framework.

Income Causes Conscientiousness?

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The WaPo reports,

Not only did the extra income appear to lower the instance of behavioral and emotional disorders among the children, but, perhaps even more important, it also boosted two key personality traits that tend to go hand in hand with long-term positive life outcomes.

The first is conscientiousness. People who lack it tend to lie, break rules and have trouble paying attention. The second is agreeableness, which leads to a comfort around people and aptness for teamwork. And both are strongly correlated with various forms of later life success and happiness.

Look, I hope this is true. Just keep in mind that any study that found that instead money made no difference would never be written up and published.

The Puzzle of Low Real Interest Rates and Low Investment

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Antonio Fatas writes,

What the world is missing is investment demand. The real tragedy is that investment in physical capital has been weak at the time when financial conditions have been so favorable. Why is that? Jason Furman (and early the IMF) argues that the best explanation is that this the outcome of a a low growth environment that does not create the necessary demand to foster investment. And this starts sounding like a story of confidence and possibly self-fulfilling crises and multiple equibria. But that is another difficult topic in economics so we will leave that for a future post.

Pointer from Mark Thoma.

The puzzle in macroeconomic data is that the real interest rate is low and investment is low. There are a number of stories, none of them fully convincing.

In the Keynesian category, we have:

1. Low “animal spirits.” As far as I know, no one has actually propounded this.

2. Accelerator model. That is, when other forms of spending are high, investment is high. So when spending by households goes down, investment goes down. I put Furman (and most Keynesians) in this camp.

In the non-Keynesian category, we have:

3. Real interest rates are actually high, because prices are falling. This is perhaps more plausible if you think about sectoral price movements. If the price indexes go up because of college tuition and health insurance, then prices elsewhere may be falling.

4. Real interest rates are actually high for risky investment. Interest rates on government debt and on high-grade private bonds are a misleading indicator of the marginal cost of capital.

5. Crowding-out can occur at low interest rates. That is, if financial intermediaries are gorging on government debt, they may not seek out private-sector borrowers.

These explnations are not mutually exclusive.

Free Trade and Trade Treaties

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Noah Smith writes,

As for the Trans-Pacific Partnership — the most important trade deal in years — support from the economics profession has been muted. However, some of that might be because of the intellectual-property protections in the treaty, which many consider a trade restriction rather than a liberalization.

Pointer from Mark Thoma.

On the other hand, Greg Mankiw writes,

I would guess that TPP would also poll well among economists. FYI, here is CEA chair Jason Furman singing the praises of TPP, and here is an open letter from a sizeable group of past CEA chairs.

Apart from mood affiliation, economists should not feel compelled to support every trade agreement. In fact, there is no reason to presume that a trade agreement actually promotes free trade. One country can do its part to promote free trade without having to negotiate an agreement with anyone. Just eliminate trade barriers, regardless of what other countries do.

It is likely that every trade agreement includes at least some measures that are protectionist. Maybe you can say something good about an agreement “on net, relative to the status quo.” But in a better world, there would be no trade treaties–just free trade.

UPDATE: Jeff Frankel gives the upbeat view of the TPP.

Garett Jones is Endorsed

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‘Pseudoerasums’ writes,

Your “moral circle” is wider with intelligence and patience than without.

…To paraphrase Garett Jones…smart, patient people are more Coasian; they find a way to cooperate and build good institutions.

It is a very long essay, and all throughout I was thinking of Garett Jones, so it was nice to see him turn up at the end. Pointer from Tyler Cowen.

The substantive point is that you can expect good institutions when you have a population that is high in intelligence and patience. Although the author of the essay does not go this far, I would suggest a causal pyramid with population intelligence and patience at the bottom, institutions the layer on top of that, and economic outcomes and other indicators of human development on top of that.

See also the appendix to my recipe for good government piece.