Innovation Matters

Innovation Matters a podcast of the United Nations Economic Cooperation and Integration Group interviews me on matters related to innovation.

If productivity growth had continued on the WWII-1973 track we would today be living in the world of 2097 rather than the world of 2024.

The education sector in the United States is underdoing a revolution. Since the pandemic we have had millions of children start homeschooling, private education with vouchers and charters are exploding. I hope with AI we can give every student a personal tutor, one who never gets tired, never gets grumpy.

In my view we should be subsidizing degrees with the greatest externalities and yet we are subsidizing degrees with the lowest wages and smallest externalities and we expect innovation out of that…no way, it’s not going to happen.

The US is a welfare-warfare state. We spend a tiny amount on innovation.

There can be multiple equilibria. If you focus on redistribution you can get low growth and then it makes sense to focus on redistribution because that is the only way to get more. But if you focus on innovation you can get high growth and then people are much less concerned with redistribution. Both equilibria can be stable. Which do we want?

Late Admissions

NYTimes: Glenn C. Loury’s new book, “Late Admissions,” is unlike any economist’s memoir I have ever read. Most don’t mention picking up streetwalkers. Or smoking crack in a faculty office at Harvard’s Kennedy School — or in an airplane at 30,000 feet. Or stealing a car. Or having sex on a beach in Israel with a mistress and attracting the attention of the Israel Defense Forces. Or later being arrested and charged with assaulting her. Or cuckolding a best friend….“Late Admissions” passes the Orwell Test. “An autobiography is only to be trusted when it reveals something disgraceful.”

Of course, even given all this, Loury has had a successful career as an economist and as a public intellectual.

Here’s a less salacious Conversations with Tyler and here is EconTalk both with Loury.

*Unit X*

The subtitle of this new and excellent book is How the Pentagon and Silicon Valley are Transforming the Art of War.  It is written not by journalists but two insiders to the process, namely Raj M. Shah and Christopher Kirchoff.  Here you can read about Eric Schmidt, Brendan McCord, Anduril, Palantir, and much more.

I am not yet finished with the book, in the meantime here is one short excerpt, one that sets the stage for much of what follows:

It turned out that before Silicon Valley tech could be used on the battlefield, we had to go to war to buy it.  We had to hack the Pentagon itself — its archaic acquisition procedures, which prevent moving money at Silicon Valley speed.  In Silicon Valley, deals are done in days.  The eighteen- to twenty-four month process for finalizing contracts used by most of the Pentagon was a nonstarter.  No startup CEO trying to book revenue can wait for the earth to circle the sun twice.  We needed a new way.

And this bit:

Ukraine avoided power interruptions in part because its over-engineered power grid boasts twice the capacity that the country needs — ironically, the system was originally designed by the Soviets to withstand a NATO attack.

The authors understand both the worlds of tech and bureaucracy very well, kudos to them.  Due out in July.

How Does Flexible Incentive Pay Affect Wage Rigidity?

Perhaps not as much as you might think:

We introduce dynamic incentive contracts into a model of inflation and unemployment dynamics. Our main result is that wage cyclicality from incentives neither affects the slope of the Phillips curve for prices nor dampens unemployment dynamics. The impulse response of unemployment in economies with flexible, procyclical incentive pay is first-order equivalent to that of economies with rigid wages. Likewise, the slope of the Phillips curve is the same in both economies. This equivalence is due to effort fluctuations, which render effective marginal costs rigid even if wages are flexible. Our calibrated model suggests that 46% of the wage cyclicality in the data arises from incentives, with the remainder attributable to bargaining and outside options. A standard model without incentives calibrated to weakly procyclical wages matches the impulse response of unemployment in our incentive pay model calibrated to strongly procyclical wages.

That is from a new and interesting paper by Meghana Gaur, John Grigsby, Jonathon Hazell, and Abdoulaye Ndiaye.  My take is that effort is often relatively fixed with personality and temperament, and thus more net flexibility results than this paper indicates.  Nonetheless this is an interesting result worthy of some pondering.

Sunday assorted links

1. The most notable person from each geographic area?

2. French post office releases scratch-and-sniff baguette stamp.

3. Skepticism about the new and higher estimates of the costs of climate change.  And here are some critical comments from Matt Kahn, most about lack of adjustment in individual behavior, as it is modeled.

4. Did humans settle the Chesapeake earlier than we had thought?  “To complicate matters, Lowery — who has been affiliated with the Smithsonian but does much of his work independently — presented the results of his study of Parsons Island in a 260-page manuscript posted online rather than in a traditional peer-reviewed journal.”

5. “On a recent trip to Sephora, 11-year-old Lincoln Rivera asked his mom for a $125 atomizer of Yves Saint Laurent eau de parfum.

He also covets scents from Jean Paul Gaultier, which he learned about from the animated movie “Megamind,” and Paco Rabanne (some of its cologne bottles are shaped like robots).

“I feel fine about how I smell,” said Lincoln, a fifth grader in Westchester County, N.Y., whose olfactory experimentation has so far been limited to deodorant. “But I could smell even better.”  Here is the NYT link.

6. Group chats rule the world.

7. Robin Hanson responds on prediction markets.

8. A 1930 take on what makes for a good party.

Why prediction markets are not popular

By Nick Whitaker and J. Zachary Mazlish, this is the best piece on this question so far.  Excerpt, noting I will not double indent:

“Rather than regulation, our explanation for the absence of widespread prediction markets is a straightforward demand-side story: there is little natural demand for prediction market contracts, as we observe in practice. We think that you can classify people who trade on markets into three groups,  each is largely uninterested in prediction markets.

  • Savers: who enter markets to build wealth. Prediction markets are not a natural savings device. They don’t attract money from pensions, 401(k)s, bank deposits, or brokerage accounts.
  • Gamblers: who enter markets for thrills. Prediction markets are not a natural gambling device, due to various factors including their long time horizons and often esoteric topics. They rarely attract sports bettors, day traders, or r/WallStreetBets users.
  • Sharps: who enter markets to profit from superior analysis. Without savers or gamblers, sharps who might enter the market to profit off superior analysis are not interested in participating. They also largely don’t need prediction markets to hedge their other positions.”

[TC again] The core argument is explained further at the link.  For instance:

“There is one important reason that prediction markets are not used by savers, and probably never will be. Prediction markets, unlike most asset markets, are zero-sum – in fact they are negative-sum, once you factor in platform fees. And if your money is in a prediction market, it can’t be invested in equities, or be earning interest in the bank, either. Every winner of a prediction market necessitates an equal and opposite loser. Securities investors with diversified portfolios can expect positive returns in the long term, because they are giving up their money for others to use to create output and wealth, in exchange for a share of what they create. That’s why responsible people have their pensions in stocks and bonds, rather than a diversified portfolio of sportsbooks. Positive-sum savings vehicles are far, far superior to zero-sum ones, for the simple reason that they will grow your savings in the long run.”

From the latest and very excellent issue of Works in Progress.

The Generalist interviews me

I was happy with how this turned out, here is one excerpt:

I think we’re overestimating the risks to American democracy. The intellectual class is way too pessimistic. They’re not used to it being rough and tumble, but it’s been that way for most of the country’s history. It’s correct to think that’s unpleasant. But by being polarized and shouting at each other, we actually resolve things and eventually move forward. Not always the right way. I don’t always like the decisions it makes. But I think American democracy is going to be fine.

Polarization has its benefits. In most cases, you say what you think, and sooner or later, someone wins. Abortion is very polarized, for example. I’m not saying which side you should think is correct, but states are re-examining it. Kansas recently voted to allow abortion, and Arizona is in the midst of a debate. Over time, it will be settled—one way or another. Slugging things out is underrated.

Meanwhile, being reasonable with your constituents is overrated. Look at Germany, which has non-ideological, non-polarized politics. They’ve gotten every decision wrong. Their whole strategy of buying cheap energy from Russia to sell to China was a huge blunder. They bet most of their economy on it, and neither of those two things will work out. They also have no military whatsoever. It’s not like, “Ok, they don’t spend enough.” They literally had troops that didn’t have rifles to train with and were forced to use broomsticks.

Germany is truly screwed and won’t face up to it. But when you listen to their politicians speak – and I do understand German – they always sound intelligent and reasonable. They could use a dose of polarization, but they’re afraid because of their history, which I get. But the more you look at their politics, the more you end up liking ours, I would say.

I would note that Germany’s various “centrist” or “coalition of the middle” regimes have brought us AfD, which is polarizing in the worst way and considered to be an extremist party worthy of being spied upon.

And this:

What craft are you spending a lifetime honing?

Shooting a basketball. I’ve done that for the longest, outside of eating and breathing. I’m just not very good at it.

I started doing it when I was about eight. We moved close to a house with a hoop, and all the other kids would gather there and play. It was a social thing, and I started doing it. I kept it going in all the different places I’ve lived. The only country I couldn’t keep the habit going was Germany. But when I was living in New Zealand, I made a special point of it. It’s good exercise, it’s relaxing, you get to be outside. It’s a little cold today, but I did it yesterday, and I’ll do it tomorrow.

It’s important to repeatedly do something you’re not that good at. Most successful people are good at what they do, but if that’s all they do, they lose humility. They find it harder to understand a big chunk of the world that doesn’t have their talent or is simply mediocre. It helps you keep things in perspective.

I’m not terrible at it. I have gotten better, even recently. But no one would say I’m really good.

Interesting throughout, as they like to say.

Saturday assorted links

1. The OpenAI library (NYT).

2. Switzerland fact of the day.  Trains.

3. Are women psychologists more censorious than male psychologists?

4. New meta-study on social media and mental health, research paper here.

5. African embassies: “Many of their embassies have just a handful of diplomats. Those diplomats often are underpaid; some take side jobs in Washington such as Uber or delivery drivers, or even at gas stations, according to a current and a former State Department official familiar with the issue.”

6. Vegetarian correlations?

7. Gary Charness, RIP.

Why is Africa so expensive?

Here is a very good Substack post by Oliver Kim, here is the key paragraph:

Intuitively, poorer countries have more of their labor forces and consumption baskets tied up in non-tradable subsistence agriculture, so when agricultural productivity grows, it lowers the price level—the exact reverse of the conventional Balassa-Samuelson relationship. But at some point, enough people have moved into manufacturing that agricultural productivity growth becomes less relevant, and the traditional upward-sloping Balassa-Samuelson relationship reasserts itself. Hence: a U-shape between incomes and prices.

A very good point, noting I would cite rent-seeking and local monopoly privilege — often more common in Africa than say Latin America or Southeast Asia — as well.

The Balassa-Samuelson relationship, by the way, is the notion that exchanges are determined by tradeables, where productivity differences are large, so non-tradeables (haircut in Mexico anyone? massage in Thailand?) are usually relatively cheap in poor, low-wage countries.  For a further explanation, do read the whole thing, and query GPT if you need to.

Why Did We Stop Building Beautiful? The Economics and Ideology Behind an Aesthetic Revolution

“Why are buildings today drab and simple, while buildings of the past were ornate and elaborately ornamented?,” that’s the question asked by Samuel Hughes in the latest Works in Progress. There are two extant theories:

The naive explanation for the decline of ornament is that the people commissioning and designing buildings stopped wanting it, influenced by modernist ideas in art and design. In the language of economists, this is a demand-side explanation: it has to do with how buyers and designers want buildings to be. The demand-side explanation comes in many variants and with many different emotional overlays. But some version of it is what most people, both pro-ornament and anti-ornament, naturally assume.

However, there is also a sophisticated explanation. The sophisticated explanation says that ornament declined because of the rising cost of labor. Ornament, it is said, is labor-intensive: it is made up of small, fiddly things that require far more bespoke attention than other architectural elements do. Until the nineteenth century, this was not a problem, because labor was cheap. But in the twentieth century, technology transformed this situation. Technology did not make us worse at, say, hand-carving stone ornament, but it made us much better at other things, including virtually all kinds of manufacturing and many kinds of services. So the opportunity cost of hand-carving ornament rose. This effect was famously described by the economist William J Baumol in the 1960s, and in economics it is known as Baumol’s cost disease.

In a twist, Hughes offers sophisticated arguments in favor of the naive theory. Hughes argues that even in the past, when labor was relatively cheap, many labor-saving devices were used to make ornament even more affordable and more such devices could have been used if demand were present. In addition, the greater scope for economies of scale and reductions in transportation costs reduced the cost of ornament.

Hughes, however, doesn’t give us the key piece of evidence, namely prices! Still, although I have written extensively on the Baumol theory, I am not wedded to it as the explanation for the decline in ornament. Indeed, I would note that Baumol predicts that the price of labor-intensive goods and services increases because productivity increases faster in other industries. It does not necessarily predict, however, that consumption declines, as it has not for medical care and education. Indeed, one virtue of the Baumol theory is precisely because the price increases are produced by productivity improvements in other industries, Baumol price increases are always accompanied by income increases. Thus, Baumol is the only unitary theory that allows for a rising price of education along with greater purchases of education. Thus, preferences must play some role in the decline in ornament at least to the extent that people weren’t willing to use more of their income to purchase ornament as the price rose.

Hughes, however, puts more weight on a large shift in tastes among the elite:

to exaggerate a little, it really did happen that every government and every corporation on Earth was persuaded by the wild architectural theory of a Swiss clockmaker and a clique of German socialists, so that they started wanting something different from what they had wanted in all previous ages. It may well be said that this is mysterious. But the mystery is real, and if we want to understand reality, it is what we must face.

I think that is correct. For many public buildings in particular, ugly was a choice.

I am also in agreement with Hughes that robots are greatly reducing the cost of stone carving as I wrote in my post Overcoming Baumol. Thus, we have two reasons for optimism. if tastes can change once they can change again and prices are falling. Thus, perhaps today we are due for some magnificent buildings that will last the ages as did many of the great buildings of the past.

Experimental Evidence on Large Language Models

This paper investigate the formation of inflation expectations using Large Language Models (LLMs) based on different text data. Employing a new experimental design, I integrate generative AI with economic analysis to explore the impact of different information treatments on LLMs’ responses. Results from six distinct knowledge sources reveal that the type of information accessible to an LLM significantly affects the variance of its generated expectations. LLMs with access to relevant economic documents exhibit lower variance compared to those with irrelevant information. Furthermore, information treatments, particularly the one related to mortgage rates, influence the updating of LLMs’ prior inflation expectations, showing similar findings from human surveys. The findings underscore the importance of providing domain-specific knowledge to LLMs and showcase the potential of AI agents in studying expectation formation and decision-making processes in economics.

That is from a new paper by Ali Zarifhonarvar.

Will very large baby bonuses work?

That is the topic of my latest Bloomberg column.  Here is one bit:

South Korea, which has the world’s lowest total fertility rate — just above 0.7, far below the replacement level of 2.1 — is pondering a radical solution: baby bonuses of 100 million won each, or about $70,000. For perspective, that is about twice South Korea’s annual per-capita income. At current birth rates, the plan would cost more than $16 billion a year; if it is successful, it will cost even more.

And this:

In principle at least, these kinds of policies are self-financing. Most babies born today or over the next few years will grow up to be taxpayers. In the long run, the birth subsidies in net terms need not cost anything at all. If, for instance, you pay two years’ average income to a family to have another child, you might plausibly expect to later receive about 45 years of tax receipts.

But will such policies actually result in population growth? After all, the government may end up making a lot of payments to families which would have had children anyway. Imagine that, after putting the policy into practice, only one-tenth of the kids born were induced by the subsidy. In that case, in expected-value terms, the two years’ investment of per-capita income yields only one-tenth of the calculation presented above — that is, 4.5 years of additional tax receipts. Given that those receipts are discounted for a rather distant future, and perhaps constitute only about a third of income, in fiscal terms this is not a profitable deal.

You still might think it is worth spending money to increase the number of Korean babies. After all, people in prosperous countries are on average happy, and that is worthwhile in itself, quite aside from their contribution to the public till. Still, if addressing public budget imbalances is one of the motivations for this policy, it could make fiscal problems worse.

Worth a ponder…

The culture of Hollywood vs. the culture of Bollywood

And a comment: “In Bollywood movies throughout multiple eras, the most shameful thing has always been disrespect of parents/family. By a wide margin.”

Substitutes are everywhere

  • The typical plasma donor was younger than 35, did not hold a bachelor’s degree, earned a lower income and had a lower credit score than most Americans. Donors sold plasma primarily to earn income to cover day-to-day expenses or emergencies.
  • When a plasma center opened in a community, there were fewer inquiries to installment or payday lenders. Inquires fell most among young (age 35 or younger) would-be borrowers.
  • Four years after a plasma center opened, young people in the area were 13.1% and 15.7% less likely to apply for a payday and installment loan, respectively.
  • Similarly, the probability of having a payday loan declined by 18% among young would-be borrowers in the community. That’s an effect on payday loan borrowing roughly equivalent to a $1 increase in the state minimum hourly wage.

Here is the St. Louis Fed study, via the excellent Kevin Lewis.