From the Department of Economic Literacy or lack thereof

I was browsing through the news this morning and I came across this lovely item in the Politico by Roger Simon.

THE POINT: Clinton is promising “a national response” to “the crisis of the more than 4 million young people between 16 to 24 who are out of school and out of work.” Barack Obama has announced an “urban poverty” agenda that covers some of the same ground.

The programs are interesting because they show how the conversation in Washington would change with a Democratic president. Some Clinton details from a campaign précis: “She will … launch a $100 million Public/Private Internship Initiative to give at-risk middle- and high-school students job skills and work experience during the summer. … In addition, she will offer 1.5 million disconnected youth a second chance with meaningful job training in growing industries in their own communities, including renewable energy, health care, construction and financial services.”

Thats the meat of it... and the illiteracy part comes in here. Senator Clinton and Senator Obama, who has a similar program both voted for the minimum wage increase. There are numerous studies that talk about the effect (negative) on teen employment prospects because of a minimum wage increase. This one here is my favorite. The totally ironic thing as the study points out, the very people that Senator Clinton hopes to help through her new government program, are the very SAME people the minimum wage bill that she so proudly voted for has hurt the most. The most logical thing would be to remove the distortion and get rid of the minimum wage, but thats not how politicians think. One government mistake, needs another government program to fix it... only in Washington.

A better idea, save $99,999,000 and send all of the senate to Professor Mankiw's ever so popular economics class. :)

The Minimum Wage

I know I am few days late and the Federal Minimum Wage jumped up, but I recently came across this article on the minimum wage at the Federal Reserve Bank of Cleveland's website. Their conclusion should be familiar to anyone who has taken Econ 1A, when you increase the price of a good (Or in this case labor), you will consequently lower the demand. More in depth studies I have read, posit that the welfare gains to the lottery winners (those who keep their jobs) are more than offset by the welfare losses to those who gain into unemployment. Another argument is that by reducing the number of low wage (and hence low skill) jobs we are also making it more difficult for the unskilled to gain entry into the work force. Also, whenever you raise the price of something above its market clearing price you create incentives to form a black market. The cigarette market is a perfect example. Before the anti-smoking forces managed to jack up prices, there was very little black market activity in cigarettes. In places like New York City, there is a huge black market thanks to the Indians which do not have to pay the city tax. Regulation in interfering with the price mechanism has a multitude of unintended consequences, and the minimum wage bill, while making for good political theater, will ultimately end up hurting the people it is intended to help.

Economics of Dating

This post will be filed under Monday-FunDay... though technically any day can be a FunDay, Sunday being my favorite day for FunDay. Today, being Monday will have to make up for the lack of fun yesterday. I was browsing through the Free exchange blog at the Economist website, and I came across an interesting post on how male dating prospects would be enhanced by the addition of the "Crush" application to the Facebook website. Being a single guy, anything that involves the psychology and economics of dating is fascinating to me. The behavioral basis of economic decisions is a very small subset of my professional work, but a larger subset of my personal interest. It is human behavior, and the assumption of rationality that underpins economics, and one of things that I find most fascinating. I am not going to debate rationality today, but suffice it to say, most of the attacks on rational behavior I find very unconvincing because it is often a projection of the author's rationality onto their subject, that causes them to diagnose the subject as irrational. Anyhow, back to dating...

One of the common problems associated with being a male, is that there is a cost associated with getting a date. That cost is often rejection, and opportunity cost associated with rejection, though that may be somewhat offset by the benefit gained from honing a better approach. In my observation, there are three basic choice sets for dating. One, is the sales guy approach, in which dating is a numbers game, ie. ceteris paribus, if I talk to X amount of girls, I will get Y amount of phone numbers, and Z amount of dates. The second approach is a variation of the sales guy approach, we'll call it the Ali approach in honor of my friend. This approach seeks to improve on the odds by deselecting certain girls based on observed characteristics. The trade-off is that more observation time and selecting of females will increase the lower the number of X's needed to get Y amount of numbers and enhance the chance of Z dates. The third approach is to rely on the networked approach. This in my opinion has the highest chance of Z per X but, because of the limited pool of X available, it also produces the least amount of Z dates.

The different basic approach that one uses actually is very interesting, because it implies a certain appetite for risk, and also puts an implicit value on rejection, and can reveal some other insights into how this person would react in other situations.

Implied Rejection Cost
	Low	Medium	High
Sales Guy	X
Ali		X
Network			X

From this we can see their implied cost of rejection.

The Facebook application, because of its networked capability increase the numbers of X far beyond the number you would meet in a typical weekend. It also reduces the psychological cost of rejection because if the girl does not have you as a crush, there isn't any public rejection. My theory is that the whether rejection is public or private it doesn't really matter, because public rejection is rejection none the less. The addition of Facebook and the internet will do little change the approaches and success rates of the three main approaches. The Network guy will continue to use his network to acquire dates, and will have the highest probability of Z from X. The Sales Guy approach will have the lowest probability, but again, no matter the approach, X is the determinant factor. Your psychological profile will determine which approach you use. If the cost of rejection to you is low, your optimum dating approach is the sales guy approach. If you place a high cost on rejection, then use your network to minimize the cost of rejection. That is your optimum approach, and it is likely you place a relatively lower value on Z. Whereas the Sales Guy puts a higher value on Z. The Sales Guy probably will do best professionally in a people-centric environment because the skills he has developed to do well in dating, (deemphasis of rejection, highly conversational) will serve him well professionally. He is most likely to be a salesperson, or a hospitality type. The Ali approach is often related to a strong analytical skill set. The skills developed here are a keen sense of place, and how one fits into it, along with an analysis of a variety of factors that will ensure the greatest likelihood of success. The Ali-type is a great analyst and adviser. The Network guy is likely to be something of an analyst but not much of one, because he lacks the good communication skills that the analyst has. He is likely to work in IT, or something similar, in which high-value social skills are not that important, whereas expertise is. His job does not require innovation in a broad sense, in other words, he is not good at thinking "outside the box" but very good at managing the space within the box.

Happy Monday!

Barter & Real Estate

There was an article this morning in the, the Phoenix Business Journal, (sub. required) that talked about a housing related "service." The website is called swapyourhouse.com, and it claims to be re-inventing the way we buy and sell real estate. Thats the headline on the website, at least. Actually, it is not a reinvention of any sort.

Being an economist, I found the site interesting for two reasons.

1. The use of Barter
2. Another demonstrated use of the internet

The use of barter is indicative that there is insufficient capital in the system and that the money system has broken down. Similar things occurred in Russia after the ruble crisis of 1998. The currency in use no longer served as a store of value, which led to it no longer being an effective means of exchange. Barter, which is demonstrably less efficient than a monetary transaction only comes into play in modern times when the money system breaks down. My guess is that in places like Zimbabwe, where the money system is broken (because of government action), barter goes on quite frequently. In real estate, the transaction market has become decidedly less liquid, particularly here in Phoenix. In other words, at the current pricing levels, there are not enough buyers in the market. Sticky pricing prevails, and hence the supply of homes, at a given price is above the market clearing rate. The bargaining comes into play because there isn't sufficient capital for these particular buyers and sellers and the transaction market doesn't move fast enough. Its interesting, because its an inefficient way to transact. WHICH, brings me to point #2... the internet.

By now, everyone has read posts about the internet and real estate, and how it changes everything. Sure. Old story, lets move along right? The oft-overlooked thing about the internet is that its greatest power is in lowering the cost of information. The dramatic effect this has had on the consumer market is evident in shopping comparison sites. It has also had an effect on the auto industry, and now it is rolling into real estate. Greater competition, and more information at effectively zero cost has reduced the value of the services that agents provide. This is the biggest effect that this site will have. The swapping is of no consequence, it is the service based pricing, that will effectively undermine the current real estate agent pricing structure. Successful agents in both commercial and single-family will need to identify how they provide value to the seller, beyond throwing things up on the MLS, which is losing its information monopoly to sites like trulia and zillow.

More on Subprime

And this is what passes for analysis from Nouriel Roubini:

"This fairy tale spinned by free market supply side voodoo fundamentalism zealots will blame the otherwise appropriate current Congressional action on predatory lending for being one of the main causes of the credit crunch that will lead to a painful recession (as the WSJ editorial page recently claimed) while forgetting that predatory lending practices developed by free unregulated markets created the toxic waste that is subprime and near-prime mortgages.. This voodoo religion cabal will also incorrectly blame regulators"

I am not sure if this whole sentence qualifies as "analysis." I recognize that we as the blogging community are not all that filtered, but as an economist, we do like approach things from an objective manner. Roubini clearly does not, and lets his emotions color his analysis, which is very unfortunate. It may fire up his fans, but hardly leads to intelligent debate.


Dave Altig, over at macroblog covers this ground from a less excited perspective yesterday. The risk is two fold From a housing perspective, how long does the reduction in credit to the riskier borrowers last? And what effect does that have on housing demand? Secondly, does the default risk as Altig points out spread to commercial mortgages?


The answer remains... we shall see.


As a side note, apartments will likely benefit from the lack of liquidity in the subprime market. This will be very regional, but could spell good news for places like North Scottsdale, and other prime Class A buildings / Locations, who lost a lot of renters to conversions and for-sale housing.

More Thoughts on Subprime

Alex Tabarrok at Marginal Revolution hits the nail on the head on what really distresses the whole bubble blogger / subprime bear contingent. It comes through in their language (McMansions, Housing ATM, 'binge' borrowers, reckless, etc etc, ) (ed: we get the point) . It really is about expanded access to credit, that the poor and unwashed, might (gasp) actually be able to buy a house. As the Instapundit would say.... read the whole thing

Light Posting

I got caught up in a few things at work and also for school. As such, I'll cross post my essay here. This essay was written for my favorite class so far in my MBA. Why??? Well, duh, its econ! And as my professor said, loving economics is a good thing.

Without further ado...

Essay 2

If one considers two countries that have different levels of technological infrastructure (e.g., expenditures on private and/or public research and development, large amounts of spending on advanced university research centers for "high technology", extensive patent laws that are enforced aggressively within the country, etc.), which country might be more at risk relative to long-run economic growth? Explain using the module. Can public policies be developed to try to alter this situation, and if so, what measurements might help us summarize the extent and impact of such public policies on economic growth?

The two countries that are the subject of this essay will be called Techie and Laboria. Techie is characterized by high levels of technological infrastructure, with quality universities, government subsidized R&D, strong protections for intellectual property, an efficient and well protected patent systems, and a strong respect for the rule of law, as it is aggressively enforced. Laboria is quite the opposite, it has weak institutions, bribery is commonly known, intellectual property protection if it exists is weak, and the few universities that do exist are oriented toward educating the elite and are considered prestigious because graduates are strong candidates for entry into the civil service.

Risks to Growth

Techie will likely be the least at risk relative to long-run economic growth. Its institutions and technological infrastructure make it more likely that it will see continued Total Factor Productivity (TFP) growth. High levels of research spending make it more likely that breakthroughs will occur and strong intellectual property laws that are vigorously enforced provide an incentive for private-sector agents to continue to pursue research. A strong university system makes it likely that Techie will be strong in basic research, which seems to provide the foundation for future technological change, which leads to higher TFP through better machines and workers. Due to its excellent university system, strong institutions, and strong legal apparatus, superior products and companies will have access to the marketplace. The best products will have the chance to succeed, and the energy of entrepreneurs and business people, will be focused on satisfying market needs rather than responding to the dictates of government or working to influence those dictates to benefit themselves.

For precisely the opposite reason, Laboria faces a far greater risk of stagnation. Weak institutions, and a cosseted elite rule a country with little respect for the rule of law, but rather on the rule of whom you know. Little or no research means that Laboria does not innovate but rather copies. The lack of an intellectual property framework reduces the incentive to innovate, because it is easier to simply copy others, especially since the marketplace is directed towards ruling coterie’s benefit. The closed nature of Laboria’s economy allows the elites who hold special licenses to import certain goods to gain monopoly profits. Overall, the lack of genuine market system, strong rules for enforcing contracts, and a closed economy, as much as a lack of technological research capability inhibit the growth of Laboria.

Policy Guidelines-Techie

Techie should take further steps to open its economy to foreign trade, as it will benefit from a wider pool of investment capital and foreign technical know-how. It should continue to invest heavily in education and research. Education investment is dependent on its level of development. Techie should invest where it will gain the greatest returns. Techie should continue to insure that playing field is level for all competitors and that price signals are accurately given in the economy. Private property rights, both physical and technical should continue to be enforced. In other words, Techie should strengthen the public policy steps it is already pursuing to maintain increases in TFP.

Policy Guidelines-Laboria

High investment in universities or shipping students off to foreign countries is a standard practice in less well off countries. It is in fact, the wrong step to take. The best thing that Laboria can do, is the hardest, and that is begin to open its economy and loose the “animal spirits” of free enterprise.

Property Rights

The first step in this process is codifying and establishing property rights, and working to ensure the legal system protects them. Hernando De Soto identifies undefined property rights held by the poor as a huge source of untapped assets, which can power economic growth by establishing a basis for credit to be granted. I would also argue that a stable monetary framework is an essential part of stable property rights. Through inflationary monetary policies governments undermine the property (savings) of its citizens.

Trade

After property rights on a physical level, trade needs to be opened up to bring in foreign expertise and technology. As the economy opens up, workers will need to be educated and labor laws relaxed.

Human Capital

Education should initially focus on literacy for the general population and primary education.

Transparency and Government

The size and role of government should be reduced to reduce the scope for bribe taking and rent seeking. This is a long process in a country, and one of the best ways to reduce corruption is by promoting transparency in government, and by limiting its role. As the income of the country starts to grow through the basic steps of reducing the diversionary role of government, the middle class will grow and in the process create the basis cultural and societal framework that is conducive to a strong civil society that will promote greater advances in growth.

Innovation and Intellectual Property

At this point as the returns from playing catch up begin to diminish, it will be necessary to build on physical property rights by implementing increasingly stronger intellectual property protection. Coincident with the development of an innovation oriented growth policy; competitive universities and research institutions should be developed. The development into serviceable products of basic research should be left to the private sector as they will be market driven and have a better idea of how basic research should be translated into an actual product. The key point here is that the incentives for innovation should be created through the introduction of a serviceable and enforceable patent system. Though, the optimal balance must be found between intellectual property protection and the diffusion of innovation, so that organizations don’t hide behind intellectual property laws to protect their monopolies and therefore retard innovation that is essential to continued growth.

Markets and Regulatory Policy

I am hesitant here to strengthen the hand of government because it is often used to deaden the “invisible hand” rather than strengthen it. In this case, there is a role for government in ensuring a clean civil service, open entry into markets, and protecting the populace. In doing all this, the government should work to make sure that the tax base is broad and as non-distortionary as possible. It is here in the tax code that in rich countries, especially the United States that there has been numerous avenues opened for rent seeking. The tax code should be as neutral as possible in concerning the actions of economic agents. The specific role of government should focus on consumer welfare and regulatory agencies should be held to a strict standard of cost-benefit analysis when implementing new regulations.

Conclusions

The challenges that Laboria and Techie face are very different, and the consequent policy prescriptions are slightly different. Techie’s policy should focus on continuance of its existing policy and adapt government regulation to technological change. Laboria faces the much greater task of reorienting its entire framework towards a growth-oriented policy. The best thing Laboria can do is to begin to level the playing field and allow the market to work. As this process opens up, Laboria will grow faster than Techie because it will be playing catch up, and we will begin to see economic convergence between the two. As that happens, the policy of Laboria needs to change its emphasis towards Techie’s initial emphasis on promoting innovation. Good policy will promote strong growth in TFP.

The K.I.S.S. principle and the stickiness of ideas

K.I.S.S. - Keep It Simple Stupid

Long an acronym in corporate circles, the so-called KISS principle means exactly what it says. It is something uneducated execs say to their techies (or Economists) all the time, keep it simple, meaning relate it to something I can understand. I run into this challenge all the time in my day job. I am busy explaining why this metric I developed is the best thing since sliced bread, and I get a blank stare from my boss (not an economist). I get frustrated and remember back to my grad school days of tutoring and nurturing young minds in the basics of economics, and inevitably drift back to my first econ class in college (micro 1A). In that class, we learned the basics of utility (or as later professor termed, it "happiness") through the idea of binge drinking (something most college students understand rather well).

In pitching an idea, I have learned to stay away from the exciting technical aspects involved with data collection, etc (ed. Yeah... like watching paint dry exciting) and paint with a broad brush the idea and its outcomes. Big surprise... this works much better.

I think in the same vein, whether it be business, economics, real estate, or whatever, the ability to convey precise information in a concise manner is all important. This readily explains the appeal of socialist economics, and protectionism. Environmentalists are also notorious for this tactic. (watch Al Gore's movie, or the "Save the Whales" campaign, acid rain, the anti-ddt campaign). Socialism as an idea is so appealing because it is utopian and easy to understand. Socialism also takes advantage of an innate trait of humanity to be slightly risk-averse. The answer is why worry, it will be taken care of. The stark reality of socialism is a painted writ-large across Eastern Europe, Russia, China, etc. That message, and view countered the simplistic idea of security, equality and prosperity for all.

Environmentalists are often wrong, but they have been so successful in propagating their message because they have been experts at finding the right way to deliver their message. For instance, DDT, the bane of malarial mosquitoes was banned because Rachel Carson, wrote a book called "Silent Spring." It was a title, and a subject everyone could relate to. They took this simple message, and caused a stir, and got ddt banned. The ultimate consequence is being born by millions of dead Africans over the last 30 years, and not to mention that her ideas were wrong on a scientific level. The usefulness of DDT was hard to explain in the face of silent spring. The environmentalists were able to portray a complicated idea in a simple manner and create stickiness.

Stickiness becomes important, because it take a proposition, and is able to communicate that proposition on a simple level that the intended audience is able to relate to. Talking about deadweight losses due to tariffs or trade barriers is hard when it is compared to the image of a 50-year old steel worker, head in his hands, talking about his mill won't be able to operate anymore because his plant was outsourced. The unemployed steel worker was sticky. The idea that free trade isn't always a good thing becomes sticky. I am not sure what the solution is, but economists, especially free-traders need to do a better job of winning the idea war against the easy path of statism. Don Boudreaux over at Cafe Hayek, does a great job again of arguing for the free market and in this respect uses the unfortunate example of Walter Reed Hospital in this post.

When it comes to business, you should be able to state your reason for business as a KISS principle. Why are you in business? Why do we (as a company) need to do your project?

Remember, kisses are sticky (consequence of nature), and your ideas should be too. So next time, when you are pitching a project, talking economics at the proverbial cocktail party, explaining to your client why this building is so great, think of kisses, and then talk.

Principal-Agent Issues

Just was thinking about it... and its one of my favorite subjects to ponder. Particularly after reading this post James Hamilton over at econbrowser. It seems the good folks over in San Diego are a poster child for a principal-agent issue. The government attempts to cover this gap, by enforcing a fiduciary responsibility. Is there another way besides regulation to solve this issue?

I am not too sure... any thoughts would be welcome in the comments.

The Gas Tax-Pigovian?

In this post from the Only Republican in San Francisco, and as many in the blogging world know, Greg Mankiw has been advocating a pigovian tax on gasoline. My collaborator over at The Economics of Sports, is a strong advocate of this type of tax. There is of course, the reaction.

I think the pigovian tax is state coercion dressed up in a warm fuzzy, environmentally sensitive dress. Mankiw lays out his arguments. To sum Mankiw lays out seven reasons to support a $1.00 increase in the gas tax.

1. The Environment
2. Congestion
3. Regulatory Relief
4. The Budget
5. Tax Incidence
6. Economic Growth
7. National Security

Let us look at these one by one. The first argument is that by raising the tax on gasoline, consumption will be reduced and will spur the development of alternatives (supposedly "greener"). The central premise of this argument is that carbon and the byproducts of petroleum consumption are a significant. I don't think anyone who would argue against the ideas that burning petrol is a relatively dirty business. I believe the case for CO2 as a big global warming driver is much weaker due to the relatively low radiative forcing value for C02 compared to other gases such as H20 and methane.

But as Professor Mankiw should know, the cost must be less than the benefit. And it is actually pretty unlikely that a $1.00 increase in the gas tax will do much to reduce consumption. We have already had an increase of well over a $1.00 in the price consumer's pay at the pump, with very reduction in consumption. Is there a magic tipping point at $3 a gallon? $3.50... who knows, but based on the empirical evidence, we know gasoline is a highly inelastic product, and a $1.00 increase in the tax will likely do very little to change that fact. Secondly, by increasing the price of gasoline via a tax, the government is also reducing the price incentives that would be communicated by the market, reflecting actual issues of scarcity and cost. For instance, so even if gas is an elastic good, the price indicator loses some its value when it is distorted by a tax. It is the same reason, many economists oppose taxes in general, because it distorts the workings of the market. Why gasoline would be any different.... remains a mystery to me.

Congestion: The congestion argument is really the same argument as the consumption argument. People will drive less, therefore congestion will decrease. For the same reason a higher gas tax won't reduce consumption, it is highly unlikely that it will do much for congestion. I believe that this has a lot to do with the relative cost of gasoline related to income and that people's homes and jobs are a fixed variable in the short-run, and therefore congestion will not change. In anti-car cities such as Portland, which purposely build less roads and in fact narrow roads to make congestion worse (basically raising the cost of driving), has done little to help with congestion. Raising the cost yet again, is highly unlikely to change American housing preferences and do little to reduce congestion.

Regulatory Relief: Professor Mankiw is treading on weak ground here. He is arguing that a large increase in the gas tax would eliminate CAFE standards, which distort consumer choice. He is right, CAFE standards do, and should be rightfully eliminated on their own merit. If the good Professor believes government would do something so sensible, he has more faith in it that I do. Regulations and agencies never really die. If a gas tax went through it would no doubt be accompanied by an increase in CAFE standards on the basis of an environmental and anti-consumption argument.

Budget: The classic line, we need to raise taxes to close the future budget deficits. Really? Why stop with the gas tax? Why not raise income taxes? Impose a VAT... etc etc etc... the answer to the budget issue is to cut spending, and grow the economy, not raise taxes.

Tax Incidence: Professor Mankiw rests his argument again, that higher prices in the US will reduce consumption. Maybe... maybe not. For one, consumption needs to fall, and unfortunately for the good Professor, oil operates in a global market. IF US consumption did fall, what makes anyone think that other nations will not take advantage of the lower prices to increase consumption. Still, the end result is that the consumers are paying higher prices... hard to see how a net increase of 80 cents as opposed to a dollar... is a great deal.

Economic Growth: Yes, consumption taxes are preferable to income taxes. Agreed. BUT and here is the big but, this rests on the argument that congress will offset a gas tax increase with a decrease in the income tax... which, based on past history is highly unlikely. Increasing the costs of transportation throughout the system, likely will lead to lower economic growth and a general increase in prices... the net result.. is a negative for the economy.

National Security: This is the one argument that conservatives latch on to. We need to stop sending our oil money to Hugo Chavez and the terror supporting Saudis... right?? Raising the tax will do that? Really? Lets accept that the price of oil begins to fall, due to a decrease in consumption (which we already known is pretty darn unlikely)... which fields go first? Well, as we know from Econ 1A producers like to produce where the marginal revenue is equal to the marginal cost... so the highest marginal cost fields will be shut first. Want to guess where those are located? BIG HINT: It isn't in Saudi Arabia or Iran... so, in other words, the higher cost of gasoline, coupled with lower overall oil prices as suggested by Professor Mankiw, will only make the national security situation worse by increasing our reliance on Saudi and other middle eastern oil producers... oops.

The net of all this: The gas tax is a bad idea. An increase in government power via a regressive tax, will do nothing to enhance our national security, nor will it likely help the environment, or encourage alternative energy sources. The gas tax, dressed in pigou clothing is not the free market panacea that its supporters would have you believe. It is a statist solution, that induces government coercion to change private behavior.