Economics

The classical MU [differential marginal utility of money] argument has, in my view, been moderated by the findings of behavioral economics, namely loss-aversion. Taking from the higher-incomes to give it to the lower incomes may be negative utility as the higher incomes are valuing their loss at an exaggerated rate (it’s a loss), while the lower income recipients under value it.

Many on the Left are too quick to grab on to the findings of behavioral economics as a critique of neoclassical economics, but while they often do point away from simplistic free-market views, they do not necessarily point towards left-wing solutions. They are just as likely to point to non-market conservative views.

For example, isn’t it another consequence of the asymmetry of the utility function with respect to the status quo (loss aversion) that social mobility destroys utility? I mean, if the tide is lifting all boats, then you can argue that it’s still better for everyone (the libertarian view), but if your utility function is heavily rank-based (a standard left-wing view) and you accept loss-aversion from the behavioral literature, then social mobility is suspect from an utility point-of-view.

This sounds shockingly old-school conservative when we discuss our own societies (“why should the children of the poor compete with my kids for a place in a good university? they have lower expectations, after all, State U is a step up for them. My kids, on the other hand, would be crushed if they had to go to their safety school”), but is quite acceptable when discussing international inequalities (“it doesn’t morally matter that people in Mexico have much less material wealth, their society has lower expectations”).

That is from Luis Pedro Coelho.

Thanks to Ramez Naam!

by on May 23, 2015 at 10:03 am in Books, Economics | Permalink

Thanks to Ramez Naam for excellent guest blogging this week! Ramez’s homepage is here and his Amazon page here.

The recent terror attack in Karachi won’t help any, but still the news is looking up, from The FT:

The IMF has acknowledged that Pakistan averted a balance of payments crisis in 2013 and managed to stabilise its foreign reserves. This week Standard & Poor’s, the credit rating agency, raised the outlook for its B minus rating from stable to positive, while Moody’s last month raised its outlook to stable from negative — albeit for a Caa1 rating, which puts it one notch above Greece.

With liquid foreign reserves having grown almost fourfold in the past year to $12.5bn, a figure equivalent to about three months of imports, Mr Wathra has less cause for concern about the stability of the rupee than some of his predecessors.

The recent plunge in the price of crude has seen the cost of oil imports fall to $9.7bn in the nine months to March, down from just over $11.2bn a year earlier, according to central bank figures.

Falling oil prices have also helped lower the fiscal deficit to an expected 5 per cent of gross domestic product in the year to June, down from above 8 per cent just over two years ago. And the country’s GDP is forecast to grow by about 4 per cent this year, following a similar rise last year.

You may recall my earlier post on Pakistan being an undervalued economy, more here too.  It still is.

That is the new Anders Aslund book, and it is instructive throughout.  Here are a few things I learned:

1. 80 percent of Ukrainian youth receive higher education of some kind.

2. Ukraine has the world’s highest rate of pension expenditures as a share of gdp, at about 18 percent, circa 2010.  Most of that is old age pensions, and that is for a population with a relatively short lifespan, 68.5 years, 122th in the world according to UNDP.

3. At the time of publication, Ukraine’s public expenditures stood at 53 percent of gdp.

4. “Ukraine is running out of money…”  OK, that one I already knew.

5. “No economy has fared as poorly in peacetime as Ukraine did from 1989 to 1999.  For a decade, Ukrainian GDP plummeted by a total of 61 percent, according to official statistics.”  Some of this, however, was offset by the growth of black markets.

6. Crimea is no longer included in Ukraine’s formal measure of gdp, although Donbas is still included.

This very good Justin Wolfers piece outlines some possible explanations, for instance:

For those not keeping track, it boils down to two camps: economists who blame first-quarter weakness on idiosyncratic factors versus those blaming mismeasurement.

The weather would be one — but not the only — possible idiosyncratic factor.

I wonder, however, if a third class of explanation perhaps should be in play.  It is well-known that economies undergo relatively strong “seasonal cycles,” most notable a major contraction in the first quarter, following the boom of the holiday season.  Might this seasonal contraction interact with the real economy in a different way than before the Great Recession?  Perhaps negative economic momentum, even when expected, chills other drivers of economic activity more than it used to.  This could arise from complementarities, increasingly important thick market externalities, signal extraction problems combined with greater fearfulness, or perhaps it is revealing information about the fragility of risk premia.  Other mechanisms may be operating as well — can you think of any?

In other words, those first-quarter slumps are real, not idiosyncratic, and also not mismeasurements, but still they are (all other things being equal) likely temporary.

This is just a hypothesis, do you have any ideas about how to test it?

Life working in a nail salon

by on May 21, 2015 at 2:48 pm in Economics | Permalink

Luo Yufeng, who has worked in the salons for four years, reports:

Q. What are your thoughts on the New York manicure industry in general?

A. I think it’s fine. Many of my friends have been doing the work for more than 10 years, and they generally think it’s better than working in restaurants. The difference between a manicurist and her boss is not clear-cut. An ordinary worker can start in a nail salon to learn the techniques, and, after three or five years, she can pay around $30,000 to buy a salon and become a boss herself. I found this highly inspiring. Even when I was cursed or when my customers found fault with me, my heart was still full of hope, because one day I could become a boss, too.

The interview is interesting throughout.  By no means do I think her account is the whole story, but relatively few people will see this interview, on the NYT Sinosphere blog, and nail salons have been a topic of discussion as of late.  A discussion of life in the Vietnamese countryside would be illuminating as well.

Over the last 5 years, the price of new wind power in the US has dropped 58% and the price of new solar power has dropped 78%. That’s the conclusion of investment firm Lazard Capital. The key graph is here (here’s a version with US grid prices marked). Lazard’s full report is here.

Utility-scale solar in the West and Southwest is now at times cheaper than new natural gas plants. Here’s UBS on the most recent record set by solar. (Full UBS solar market flash here.)

We see the latest proposed PPA price for Xcel’s SPS subsidiary by NextEra (NEE) as in NM as setting a new record low for utility-scale solar. [..] The 25-year contracts for the New Mexico projects have levelized costs of $41.55/MWh and $42.08/MWh.

That is 4.155 cents / kwh and 4.21 cents / kwh, respectively. Even after removing the federal solar Investment Tax Credit of 30%, the New Mexico solar deal is priced at 6 cents / kwh. By contrast, new natural gas electricity plants have costs between 6.4 to 9 cents per kwh, according to the EIA.

(Note that the same EIA report from April 2014 expects the lowest price solar power purchases in 2019 to be $91 / MWh, or 9.1 cents / kwh before subsidy. Solar prices are below that today.)

The New Mexico plant is the latest in a string of ever-cheaper solar deals. SEPA’s 2014 solar market snapshot lists other low-cost solar Power Purchase Agreements. (Full report here.)

  • Austin Energy (Texas) signed a PPA for less than $50 per megawatt-hour (MWh) for 150 MW.
  • TVA (Alabama) signed a PPA for $61 per MWh.
  • Salt River Project (Arizona) signed a PPA for roughly $53 per MWh.

Wind prices are also at all-time lows. Here’s Lawrence Berkeley National Laboratory on the declining price of wind power (full report here):

After topping out at nearly $70/MWh in 2009, the average levelized long-term price from wind power sales agreements signed in 2013 fell to around $25/MWh.

After adding in the wind Production Tax Credit, that is still substantially below the price of new coal or natural gas.

Wind and solar compensate for each other’s variability, with solar providing power during the day, and wind primarily at dusk, dawn, and night.

Energy storage is also reaching disruptive prices at utility scale. The Tesla battery is cheap enough to replace natural gas ‘peaker’ plants. And much cheaper energy storage is on the way.

Renewable prices are not static, and generally head only in one direction: Down. Cost reductions are driven primarily by the learning curve. Solar and wind power prices improve reasonably predictably following a power law. Every doubling of cumulative solar production drives module prices down by 20%. Similar phenomena are observed in numerous manufactured goods and industrial activities,  dating back to the Ford Model T. Subsidies are a clumsy policy (I’d prefer a tax on carbon) but they’ve scaled deployment, which in turn has dropped present and future costs.

By the way, the common refrain that solar prices are so low primarily because of Chinese dumping exaggerates the impact of Chinese manufacturing. Solar modules from the US, Japan, and SE Asia are all similar in price to those from China.

Fossil fuel technologies, by contrast to renewables, have a slower learning curve, and also compete with resource depletion curves as deposits are drawn down and new deposits must be found and accessed.  From a 2007 paper by Farmer and Trancik, at the Santa Fe Institute, Dynamics of Technology Development in the Energy Sector :

Fossil fuel energy costs follow a complicated trajectory because they are influenced both by trends relating to resource scarcity and those relating to technology improvement. Technology improvement drives resource costs down, but the finite nature of deposits ultimately drives them up. […] Extrapolations suggest that if these trends continue as they have in the past, the costs of reaching parity between photovoltaics and current electricity prices are on the order of $200 billion

Renewable electricity prices are likely to continue to drop, particularly for solar, which has a faster learning curve and is earlier in its development than wind. The IEA expects utility scale solar prices to average 4 cents per kwh around the world by mid century, and that solar will be the number 1 source of electricity worldwide. (Full report here.)

Bear in mind that the IEA has also underestimated the growth of solar in every projection made over the last decade.

Germany’s Fraunhofer Institute expects solar in southern and central Europe (similar in sunlight to the bulk of the US) to drop below 4 cents per kwh in the next decade, and to reach 2 cents per kwh by mid century. (Their report is here. If you want to understand the trends in solar costs, read this link in particular.)

Analysts at wealth management firm Alliance Bernstein put this drop in prices into a long term context in their infamous “Welcome to the Terrordome” graph, which shows the cost of solar energy plunging from more than 10 times the cost of coal and natural gas to near parity. The full report outlines their reason for invoking terror. The key quote:

At the point where solar is displacing a material share of incremental oil and gas supply, global energy deflation will become inevitable: technology (with a falling cost structure) would be driving prices in the energy space.

They estimate that solar must grow by an order of magnitude, a point they see as a decade away. For oil, it may in fact be further away. Solar and wind are used to create electricity, and today, do not substantially compete with oil. For coal and natural gas, the point may be sooner.

Unless solar, wind, and energy storage innovations suddenly and unexpectedly falter, the technology-based falling cost structure of renewable electricity will eventually outprice fossil fuel electricity across most of the world. The question appears to be less “if” and more “when”.

Since I’ve been in China, a number of you have written me and asked me how “conditions on the ground” are looking for a Chinese hard or soft landing.  But in fact visual inspection of the country does not answer this question in any simple way.

I recall being in Madrid in 2011 with Yana and seeing everything slow and all the people looking depressed; it was obvious that the country was in a deep recession.  But a comparable inference cannot be made from looking around China.

There is a visual feature of China which is incontestable, namely the country has a lot more buildings and structures than it is currently using.  If you take the train through the countryside, or out West, this is especially noticeable.  But does it have to be bad or fatal news?  Well, no.

At the very least it is possible that migration from the countryside will fill and validate those structures and other apparent over-extensions of capital investment.  Under both the optimistic and pessimistic views, China today evidences some extreme in-the-moment overcapacity.  That is what you would expect from a rapidly growing economy — “build for the glorious future!”, but it is also what you would expect from a rapidly malinvesting economy.

(By the way, those who have never visited often think that China is “crowded.”  But relative to facilities, the country is quite undercrowded; for instance it is easy enough to dispense with dinner reservations most of the time.)

How long will this excess capacity last?  How much time will the Chinese future need to “catch up” to this infrastructure?  Will that validation come too late?  We all may have opinions (or not), but the visuals themselves do not tell any specific tale.

So to a China pessimist and a China optimist, the world looks more or less the same.  For now.

The Robot Employment Act?

by on May 20, 2015 at 10:26 am in Books, Economics | Permalink

In light of LA’s vote to increase the minimum age to $15 an hour by 2020 here is one of my favorite pictures and caption from Modern Principles of Economics.

From Cowen-Tabarrok, Modern Principles of Economics

Should the Minimum Wage be called the “Robot Employment Act?”

Cowen-Tabarrok, Modern Principles of Economics, 3rd ed

 

1. You cannot build and sustain a polity on the idea of redistributing wealth to take advantage of differences in the marginal utility of money across varying wealth classes.

2. The ideas you can sustain a polity around often contradict the notion of socially arbitraging MU differences to try to boost total utility.

3. The MU argument, in isolation, is therefore rarely compelling.  Furthermore its “naive” invocation is often a sign of underlying weakness in the policy case someone is trying to make.  The proposed policy may simply be too at odds with otherwise useful social values.

4. This is related to why parties from “the traditional Left” so often lose elections, including in a relatively statist Europe.

5. That all said, sometimes we should in fact take advantage of MU differences in marginal increments of wealth and use them to drive policy.

6. Figuring out how to deal with this tension — ignoring MU differences, or pursuing them — is a central task of political philosophy.

7. The selective invocation of the differential MU argument — or the case against it — will make it difficult to improve your arguments over time; arguably it is a sign of intellectual superficiality.

I say downwards:

With bargain gasoline prices putting more money in the pockets of Americans, owners of hybrids and electric vehicles are defecting to sport utility vehicles and other conventional models powered only by gasoline, according to Edmunds.com, an auto research firm.

There are limits, it appears, to how far consumers will go to own a car that became a rolling statement of environmental concern. In 2012, with gas prices soaring, an owner could expect a hybrid to pay back its higher upfront costs in as little as five years. Now, that oft-calculated payback period can extend to 10 years or more.

“We’d all like to save the environment, but maybe not when it costs hundreds of dollars per year,” said Jessica Caldwell, director of industry analysis for Edmunds.com.

It is a bigger shift than I would have thought:

In all, 55 percent of hybrid and electric vehicle owners are defecting to a gasoline-only model at trade-in time — the lowest level of hybrid loyalty since Edmunds.com began tracking such transactions in 2011. More than one in five are switching to a conventional sport utility vehicle, nearly double the rate of three years ago.

That one-and-done syndrome coincides with tumbling sales of electric and hybrid vehicles. Through April, sales of electrified models slid to 2.7 percent of the market, down from 3.4 percent over the same period last year, Edmunds.com said. At the same time, sport utility vehicles grabbed 34.4 percent of sales, up from 31.6 percent.

From Lawrence Ulrich, you can read more here.

I’m familiar with studies showing estimated economic gains from TPP in the neighborhood of $1.9 trillion (pdf).  Given the past performance of trade models, I am willing to believe that might be an overestimate.  So let’s cut those gains roughly in half to say a trillion.  (That said, if I understand the Peterson document correctly, they are not even trying to incorporate gains from reallocation on the production side, as might result from comparative advantage or dynamic specialization; in this sense $1 trillion may be a considerable underestimate of the upside.)

That is still a sizable sum of economic gain.

What would convince me to oppose TPP if is somebody did a study showing the following: when you use a better trade model, use better data, and/or add in the neglected costs of TPP (which are real), those gains go away and indeed become negative.

Then I would change my mind, or at least weigh those economic costs against possibly favorable geopolitical benefits from the deal.

What does not convince me is when people simply list various costs and outrages associated with TPP.  Furthermore if one of those problems with TPP is addressed, or partially addressed, often these commentators circle around to another possible problem.  In fact that response pattern is a sign the critics don’t themselves have a very good comprehensive estimate of global costs and benefits.  By the way, it also fails to convince me when the critics attack those who support TPP for being craven, superficial, lackeys, and so on.

I say let’s just have a two-way button and ask everyone to press it: do you believe that TPP would lead to a net gain in economic welfare or not?

If those costs and outrages associated with TPP are so bad, it ought to be possible to do a study which makes the trillion in benefits go away.  Has anyone done such a study?  Would such a study survive the commentary from the NBER annual macro conference?

I am not suggesting that economic welfare should be the only criterion for evaluating a policy.  But making everyone press this two-way button — and in the process citing their favorite comprehensive policy study of TPP – would do wonders to bring clarity to the debate.  Commentators still would have the liberty of accepting the reality of the economic gains while disfavoring the policy, as indeed I do with forced kidney extraction and transplant.

In the meantime, the more desultory lists I see of possible negative consequences of TPP, the more likely I am to think it is a good idea after all.

A large study in the New England Journal of Medicine verifies that financial rewards for quitting smoking are effective. Participants were randomly offered one of a variety of incentive schemes that paid participants who successfully quit smoking (verified with saliva and urine tests). Participants were free to decline the offer.

The most interesting variation of the study was to compare a carrot model which paid up to $800 for success with a carrot-stick model in which participants lost $150 if they failed to stop smoking but gained $800 if they succeeded (i.e. $650 of reward plus refund of $150). In theory, the carrot-stick model should work better because it harnesses loss-aversion. And statistical analysis suggested that for those who would accept either the carrot or the carrot-stick model, the carrot-stick model did work better. The problem is that far fewer people who were offered the carrot-stick model chose it compared to those offered the carrot model. Overall, therefore, the carrot model was far more successful.

Smokers are costly so even a pure carrot model of $800 paid by employers would more than pay for itself:

…Finally, the finding that individual rewards of $800, as compared with usual care, nearly tripled the rate of smoking cessation among CVS Caremark employees and their friends and family confirms and extends the generalizability of our finding from a previous trial involving General Electric employees. In addition to the public health effects of such smoking reductions, these findings are important for employers. Because employing a smoker is estimated to cost $5,816 more each year than employing a nonsmoker, even an $800 payment borne entirely by employers and paid only to those who quit would be highly cost-saving.

Why China is hard to figure out

by on May 18, 2015 at 12:31 am in Economics, History | Permalink

It’s not just the differences of language, history, and culture.  It’s not just the (sometimes) questionable economic data, or the paucity of good Chinese academic research until very recent times.

Today’s China is sui generis.  The country has grown so quickly that every decade or so there is a very new China.  And so we cannot easily look to the past as a guide.  In economic terms, China seven years ago is equally removed from China today as the United States about thirty-five years ago is removed from the United States today, putting recent cyclical factors aside.

You could say that China’s recent past is relatively thin in terms of information.   For a more extreme example, how well would we understand an economy which went from zero to fully grown in the span of a week?  When do the diagnostics get to be run and how well would we understand its resiliency?  Arguably we also would not understand the resiliency of an economy which never grew and never changed in our sample…which raises the question of which rate of economic growth makes recent history “thickest” in terms of information and instructiveness?

Economics aside, China’s political system also has changed much more than ours, and it is less predictable than ours.

So for any question about contemporary China, it is n = 1, if that.

Has it been so bad?  For us?  For them?  How many of us had even noticed?

Here are some information (pdf), and here (pdf), I thank Matthew Vogel for reminding me of this.

Here is my previous post on ISDS and TPP.  Here is a good CRS brief on previous trade agreements with Vietnam.