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Mankiw: Do Equity Analysts Create Prosperity?

April 24th, 2010 3 comments

In my peregrinations I just came across an old 2006 post by Greg Mankiw. He describes the situation of:

…a Harvard PhD in economics who left an academic job for a better-paying one in private equity. Based on the article, he seemed a bit wistful about leaving an academic job behind. At a higher tax rate on his new higher income, might he have stayed with the perks of the ivory tower? Perhaps. But, based on market prices, his talents are more productively applied in private equity, where he is filling the important role of allocating the economy’s capital stock. If he gave up that job because of a higher tax rate, the loss to the overall economy would be measured by the deadweight loss.

But Mankiw is making an assumption here: that the market pricing for equity analysts (versus professors) reflects and effects an optimum allocation of (human) assets — that if that professor becomes an equity analyst, it will increase overall prosperity.

Based on recent events (and reams of research and theory), it seems clear that this assumption is false.

1. The financial sector is far larger than is necessary to effectively lubricate and nourish the real economy — the part that produces valuable goods and services (such as … university educations).

2. It is many times larger than is necessary to set prices efficiently. Fama and French showed long ago that it requires very few players for a market to be efficient. (The same is probably true of types of securities; stocks, bonds, options, futures and shorts probably do all or perhaps far more than is needed to achieve efficient pricing.)

The size of that sector both reveals, and in a self-perpetuating cycle causes, a massive misallocation of resources by the invisible hand.

And that’s before we even consider the systemic risks of a top-heavy financial system.

Moving another smart person into that sector arguably decreases prosperity.

Another Reaganomics Inflection Point

April 22nd, 2010 No comments

Does Unemployment Insurance Make People Lazy?

April 22nd, 2010 3 comments

Short answer: Yes.

Slightly longer answer: Not very many people, and not much lazier.

Rob Valletta and Katherine Kuang of the Federal Reserve Bank of San Francisco just released a new study of unemployment insurance and unemployment. This graphic stands out:

People who quit their jobs or are just entering the job market aren’t eligible for unemployment compensation. People who lose their jobs are. This is just the kind of great natural experiment that lets us judge, by comparison, the effects of past policies.

The money quote:

The differential increase of 1.6 weeks for job losers is the presumed impact of extended UI benefits on unemployment duration. It is straightforward to translate this increase in unemployment duration into an effect on the unemployment rate, based on their proportional relationship and adjusted for the share of job losers in overall unemployment, which was about 67% in December 2009. The implied increase in the unemployment rate is quite small, slightly less than 0.4 percentage point, indicating that without UI extensions, the measured unemployment rate would have been 9.6% in December 2009 rather than the observed 10.0%.

Job losers (eligible for UIC)  take an extra week and a half to get jobs.

So the “obvious” is true: if you pay people not to work, they will work less, in aggregate. Some people will opt for “funemployment” insurance and take the summer off. But that simplistic truism hides the truly important reality: the effect is very small — even when you throw five UI extensions into the mix.

Simplistic arithmetic based on this study suggests that any given moment, because of UIC there are about 600,000 people not working, who would be working without it. (.004 times the U.S. work force of 150 million.) That sounds like a lot, and it’s certainly enough to inflame many people’s hot-wired “cheater resentment” genes.

But the reality is, there will always be gamers, cheaters, and free-riders, in any system. (Just look east, to Wall Street.) In the case of unemployment I say get over it. They’re a tiny percentage, and in the big picture the effects are trivial.

Maybe my resentment genes are pathologically inoperative, but these numbers do a hell of a lot more to light up my compassion genes — compassion for the 14.4 million hard workers who are protected from potential economic catastrophe, a catastropohe that was none of their own doing. (I won’t even start on how the whole economy is better off as a result.)

If 600,000 people get a few weeks of extra leisure along the way — the kind of extended leisure time that I, lucky soul, have been blessed with throughout my life — I say more power to ’em.

Where Did the Deficits Come From? From “Conservatives” of Course

April 19th, 2010 1 comment

Should the Financial Sector Shrink?

April 16th, 2010 No comments

The financial services industry seems to be x times larger than it needs to be to effectively service and lubricate the real economy that produces useful goods and services. (Arnold Kling is one of many that agree with me.)

This suggests that the market is misallocating resources (both capital and human). It is also failing to price in the very real negative externalities of that oversized sector (i.e. global financial collapse).

But: the financial services industry does, quite literally, create lots of *money* — not only via leverage, but via the profits from fees and commissions. (It accounted for 40% of corporate profits just before the crash.)

If that sector shrank significantly,* would real gross prosperity decline or increase? Short term? Long term?

* How would this happen? As Pigovians say quite aptly, “if you want less of something, tax it.”

Pubs and Economic Opportunity: Not

April 15th, 2010 9 comments

I’ve blogged about this before, but I need to pass on another piece of proof, courtesy of Matthew Yglesias.

Adopting one of the free-marketers’ favorite mantras: a good economic system allocates resources to create the greatest prosperity for all. (It’s a sum function.)

That includes human resources: people’s talents are directed where they’re most effective in creating prosperity.

That includes meritocracy: people’s skills have more effect on their success than the circumstances of their birth.

In a meritocracy, people’s incomes are more loosely linked to their parents’ incomes. People succeed because they perform well, not because they were born well.

Free marketers would have you believe that the free market allocates those resources most effectively, because it provides the greatest opportunity for merit to prosper.

Nice theory, but it’s contradicted by the facts on the ground. It’s much easier for meritorious children to climb above their parents on the economic ladder if they live in a country with generous social services and more robust redistribution.

In the U.S., 50% of a boy’s chance of climbing the ladder is the result of his father’s income. In Denmark, it’s only 15%.

Which system allocates human resources most efficiently?

Tea Partiers: Old, White, Rich, Educated Men

April 15th, 2010 1 comment

That’s not the whole tea party, of course. But tea partiers skew strongly on each of these dimensions, according to a new NYT/CBS poll.

I just think it’s worth pointing out that that group has benefited more than any other from the government policies that were put in place before their births and while they were children.

But I do have to give them some credit. 52% of tea partiers believe their taxes this year are fair, compared to 62% of all adults.

I find it especially interesting that tea partiers are just as conflicted about taxes and debt as other Americans. They’d have just as much trouble writing a real budget as our legislators do.

Do Experts Know Better?

April 14th, 2010 9 comments

My friend Steve likes to proclaim the value of casual intuition — based on one’s day-to-day observations over the course of life — and downplay the value of expertise, analysis, and data in making good judgments. Among other things, he defends Sarah Palin and other less-thinkerly politicians on these grounds.

He also points to Robert McNamara — the king of data analysis — as having failed utterly in his judgments on Vietnam. This putting aside the facts that 1. Steve’s casual intuition would have led him to exactly the same policies (if not worse), and 2. McNamara’s data was not the driving force behind the big decisions and judgments on Vietnam. They were at best excuses, self-justifications, rationalizations, or simple thumb-twiddling. McNamara actually manufactured a system that delivered systematically false data.

Also: systematic, in-depth knowledge — rooted in research, analysis, and frequently, data — is obviously not sufficient to guarantee good judgment. But it is arguably necessary. Or at least, it (greatly?) improves the odds of making good judgments. If the Bush administration, for instance, had had some basic knowledge of the difference between a Shiite and a Sunni…

One of the key books on this field is Philip Tetlock’s Expert Political Judgment. He argues — based on analysis of 82,000 predictions by 284 experts — that political experts perform only slightly better than random dart throws. It’s a pretty damning condemnation of experts.

But as Bryan Caplan has pointed out, there are two fatal flaws in Tetlock’s argument:

1. He only examines questions that are highly controversial among experts. (If 50% believe each way, 50% will inevitably be wrong.) Tetlock explicitly ignores the “dumb” questions that seem to the experts to have obvious answers, but which everyday folks might consider controversial.

2. He doesn’t compare the the experts to the average person on the street. The only such comparison in the book is between experts and Berkeley undergrads — who are darned high on the elite/expert spectrum, in absolute terms. And even in that comparison, the experts win in a landslide. The undergrads aren’t even as good as chimps or dartboards.

This suggests that if you looked at those “obvious” questions — which are often not at all obvious to non-experts — and compared casual to expert opinion, you’d see experts being right far more of the time. As they say in the biz, “more research needed.”

Tetlock does reveal another fact, however, that serves to seriously undermine one’s confidence in the intuitionally inspired beliefs of Sarah and similar: among the experts, “foxes” — those who in Nicholas Kristof’s words are “are more cautious, more centrist, more likely to adjust their views, more pragmatic, more prone to self-doubt, more inclined to see complexity and nuance” — resoundingly beat out the “hedgehogs” — those who “have a focused worldview, an ideological leaning, strong convictions.”

Is this also true of everyday folks? Based on my many years of decidedly non-systematic observation, I would suggest that it is.

Update: Chris’ comment,

This worked well enough back when virtually all information of note was controlled by experts.  Now they’re forced to compete with everyone, which has the nasty side effect of forcing people to become steadily more extreme and loud just to be heard.

Reminds me of another takeaway from Tetlock’s research. Again quoting Kristoff because he summarizes it well:

the only consistent predictor [of accuracy] was fame — and it was an inverse relationship. The more famous experts did worse than unknown ones. That had to do with a fault in the media. Talent bookers for television shows and reporters tended to call up experts who provided strong, coherent points of view, who saw things in blacks and whites.

In other words, the loudest, most simplistic, and most dogmatic “experts” — the extreme hedgehogs — 1. are the least accurate, and 2. get the biggest megaphone.

Change Your Goddam Voice Mail Message! (Pass It On)

April 10th, 2010 2 comments

Starting today, your outgoing voice mail message should start (and quite possibly end) with:

Hi this is [insert your name here]. Press [star or pound] to leave a message.

I probably don’t have to explain why. But I will.

1. Everybody hates waiting through your message, and they really hate waiting through the instructions on how to leave a message.

2. You  never know whether pound or star will bypass all that crap. Each voicemail system’s different. If you press the wrong one, you’re really pissed off because … you know. So you wait through the goddam message and instructions.

It takes a good twenty seconds to go through that crap, every single time.

It’s not just annoying. A back-of-the-envelope calc (based on utterly reliable data randomly sourced from the interwebs) tells me that all those 20-second annoyances are worth about 1.2 trillion dollars a year (if our time is worth $20/hour).

Yeah: if everybody changed their messages, we’d increase our country’s annual GDP by 10%. (Or enjoy the equivalent in more free time.)

Pass it on.

Stockman: Was It Reagan’s Fault?

April 5th, 2010 5 comments

I finally got around to reading (large chunks of) David Stockman’s book on the rise of Reaganomics. Having done so, I realize I could have learned everything I needed from the back cover:

There’s only one thing I disagree with here: “…it had not been his fault. He had been misled by a crew of overzealous — and ultimately incompetent — advisers.”

By my lights, if a president has one responsibility above all others, it is to choose good advisors, and to know when to ignore them. If he fails in that, it is very much his “fault.” Reagan’s poor judgment has echoed, amplified, for decades, and those incompetent advisers and their cronies and successors are still with us in force.

If there’s one thing Reagan should get full credit for, it’s his belief that the Soviet Union could change — despite the almost unanimous opinion of all his advisors. (Including our current SecDef.)

And if he gets credit for that, he should receive full blame for the other thing. Which is paradoxically just what Stockman says in his last paragraph, above.