underappreciated economist

Harold Innis, an underappreciated economist, on commodity-driven growth

This Canadian economist (1894-1952) deserves an installment in the “underappreciated economists” series.  In addition to his seminal work on the economics of media and communications (better and earlier than McLuhan), he has some excellent pieces on the fur trade in Canadian economic history, and they are more contemporary than at first meets the eye.  Innis’s editor, Daniel Drache, sums up the main point:

Innis could not stress strongly enough that internal markets respond to a different logic and set of needs than externally based systems of exchange.  This occurs because the international price mechanism is volatile and subject to violence and instability in income fluctuation.

Most of all, Innis is worried about commodity and resource-based growth.  Five or ten years from now, will Canadians, Australians, and Brazilians be talking about Harold Innis as we do Hyman Minsky?

Innis also argued that the importance of the fur trade gave Canada a somewhat more peaceful history with its Native Americans than we had in the United States.  Here is a very good Wikipedia entry on Innis, who is still worth reading.

Underappreciated economists: Eric van den Steen

Can a professor at HBS be underappreciated?  I believe so.  Eric van den Steen is in my view one of the best young microeconomists.  He is not a mere technician but rather a dealer in ideas.  Oddly, I don't hear his name mentioned often by ordinary, non-frontier economists.

Here is his page of research papers.  I am most struck by his paper on the theory of the firm.  It is an explicitly Knightian and non-Coasian model of the firm.  Unlike many authors, van den Steen does not require that the "firm mode of organization" lower transactions costs in the traditional sense (ever try to get a favor from your purchasing department?).

Instead his model starts with the Aumann model of disagreement and he suggests that control rights in the firm follow from a (figurative) auction over who gets to rule the cooperative venture.  It's bidding on the basis of relative certainty to break the initial disagreement.  If you bid for the capital goods, and turn the relationship into a "firm," you have greater authority over the other agent, because you can threaten to separate that agent from the capital goods.  The winner then installs low-powered incentives because the loser still disagrees with him, and the winner doesn't want the loser to be too motivated to pursue his own vision, thus subverting the winner's orders and recommendations.  Overall, the firm increases cooperation among agents but lowers motivation for non-ruling agents and that trade-off determines whether or not a firm will displace a market transactions based on decentralized control of separate decisions. 

It's one of the few articles on theory of the firm which make sense to me, the other candidate being Julio Rotemberg's brilliant but poorly explained "A Theory of Inefficient Intrafirm Transactions."  I view the Coasian tradition as somewhat of a dead end in industrial organization.  Internally, firms aren't usually more efficient than markets although there are good non-transactions cost reasons — including rent-seeking — why they exist.

Here is Eric's paper on the costs and benefits of homogeneity.  It's worth reading just about all of his work.  Hail Eric van den Steen!

Irving Fisher: Underappreciated economist

Tyler points to Malthus as a much underappreciated economist. John Cassidy points to Pigou.  For my money, Irving Fisher dominates.  Other people (e.g. London Banker and Yves Smith)
have also extolled Irving Fisher, but I would still rank
Fisher as highly underappreciated relative to insight and clarity of thought.

Here from his classic, The Debt-Deflation Theory of Great Depressions, are some choice insights. 

Then we may deduce the following chain of consequences in nine links: (1) Debt liquidation leads to distress selling and to (2) Contraction of deposit currency, as bank loans are paid off, and to a slowing down of velocity of circulation. This contraction of deposits and of their velocity, precipitated by distress selling, causes (3) A fall in the level of prices, in other words, a swelling of the dollar. Assuming, as above stated, that this fall of prices is not interfered with by reflation or otherwise, there must be (4) A still greater fall in the net worths of business, precipitating bankruptcies and (5) A like fall in profits, which in a "capitalistic," that is, a private-profit society, leads the concerns which are running at a loss to make (6) A reduction in output, in trade and in employment of labor. These losses, bankruptcies and unemployment, lead to (7) Hoarding and slowing down still more the velocity of circulation.

The above eight changes cause (9) Complicated disturbances in the rates of interest, in particular, a fall in the nominal, or money, rates and a rise in the real, or commodity, rates of interest.

Evidently debt and deflation go far toward explaining a great mass of phenomena in a very simple logical way.

With perhaps the qualification that even real rates of interest may fall is this not a brilliant summary of current events?  And on the solution to the crisis:

On the other hand, if the foregoing analysis is correct, it is always economically possible to stop or prevent such a depression simply by reflating the price level up to the average level at which outstanding debts were contracted by existing debtors and assumed by existing creditors, and then maintaining that level unchanged.

With a few changes to growth rates rather than levels is this not fully modern?  And the following, with its hint of the importance of expectations, strikes a very Sumnerian tone (or rather, of course, Sumner's analysis strikes a very Fisherian tone).

…The fact that immediate reversal of deflation is easily achieved by the use, or even the prospect of use, of appropriate instrumentalities has just been demonstrated by President Roosevelt. Note Charts VII and VIII.

And behavioral economics was nothing new to Irving Fisher:

The public psychology of going into debt for gain passes through several more or less distinct phases: (a) the lure of big prospective dividends or gains in income in the remote future; (b) the hope of selling at a profit, and realising a capital gain in the immediate future; (c) the vogue of reckless promotions, taking advantage of the habituation of the public to great expectations; (d) the development of downright fraud, imposing on a public which had grown credulous and gullible.

When it is too late the dupes discover scandals like the Hatry, Krueger, and Insull scandals. At least one book has been written to prove that crises are due to frauds of clever promoters. But probably these frauds could never have become so great without the original starters of real opportunities to invest lucratively. There is probably always a very real basis for the "new era" psychology before it runs away with its victims.

Underappreciated economists, a continuing series

Vivian Hoffman, currently a Ph.d. candidate at Cornell.  When I read this description of her research I think that modern economics is very much on the right track:

I study the economics of anti-poverty and health interventions using household survey and experimental economics methods.  Most of my work to date has been in East Africa.  For my dissertation research on demand for and intra-household allocation of insecticide-treated mosquito nets, I conducted fieldwork in southwestern Uganda. Ongoing projects include a study on the impact of food aid receipt on labor supply and agricultural production in Malawi, estimateing the returns to farm assets in rural Ethiopia, and an experimental investigation into the effect of stigma on HIV testing behavior.  I hope to continue working at the intersection of health and development economics.  My interests also include health and poverty-related issues in Canada and the United States.

Here is the abstract on her main paper:

This paper reports results from a field experiment in Uganda. Whether a mosquito net was purchased or received for free affected who within the household used the net. Free nets were more likely to be allocated to those members of the household most vulnerable to malaria, whereas purchased nets tended to be used by the household’s main income earners. The effect was strongest for free nets received by the mother, increasing the probability that all children five and younger slept under nets by 26 percent relative to when nets had been purchased by either parent or given to the father.

In other words, within the household the breadwinners have a greater practical ability to control priced goods than non-priced goods.  This hints at one reason why men are often more willing to "think like economists" within the family.

You might think that Vivian has not yet done enough to be judged, but surely she has done enough to be judged as underappreciated.  So go appreciate her and remove that label from her name!

Underappreciated economists: a continuing series

Today I will pick E. Glen Weyl, a mere Youngling, who is studying at Princeton University.  Here is his paper on neural networks, and the abstract:

I consider a potential neural basis of overconfidence, the well-documented tendency of individuals to overestimate the precision of their predictions. I present a simple, classic connectionist model for predicting a binary variable. I show that while the network initially makes weak predictions (in the middle of the probability range) regardless of input, after observing randomly generated data it learns to be overconfident in the sense that when presented with other, unrelated random data it makes strong predictions. The model matches behavioral data in that it shows overconfidence growing with experience and then, eventually, declining. The model shows how overconfidence, far from being a surprising fallacy, can be seen as a natural outgrowth of statistical over-fitting in the brain.

Glen probably won’t be underappreciated for long.  Here is his seminal paper on two-sided markets (e.g., Match.com).  There is already talk he will be a leading economist of the next generation.

Here is Glen’s home page, and his other papers.

Here is Dave Warsh on Weyl.  Here is an article full of praise.  (He’s already looking non-underappreciated; note the CV, A.B. 2007, Ph.d. expected 2008.)  Here is Glen’s commencement address.  Here is Glen’s fight against protectionism.  Here are Glen’s film reviews.  Here is Glen’s dining guide for Princeton cuisine (hmm…).

I very much liked Glen’s paper on Simon Kuznets: Economist of the Russian Jewish Diaspora.

Here is Glen’s muse, Alisha Holland.  Here is Glen’s path to Unitarianism.

Let us all be grateful for people like Glen Weyl.

Underappreciated economists, a continuing series: Daniel Chen

Here is an incredibly interesting reading list, on the political economy of belief, courtesy of the young Daniel Chen.  Even better, here is one of his recent papers, check out the abstract:

Religious intensity as social insurance may explain why fiscal and social conservatives and fiscal and social liberals come hand-in-hand. We find evidence that religious groups with greater within-group charitable giving are more against the welfare state and more socially conservative. Libertarians (fiscal conservatives–social liberals) are more abundant than the religious left (fiscal liberals–social conservatives). The alliance reverses for members of a state church: social conservatives become fiscal liberals. Increases in church-state separation precede increases in the relationship between fiscal and social conservatism. The framework provides a novel explanation for religious history: as credit markets develop, elites gain access to alternative social insurance and legislate increasing church-state separation to create a constituency for lower taxes. This holds if religious voters exceed non-religious voters, otherwise, elites prefer less church-state separation in order to curb the secular left. This generates multiple equilibria where some countries sustain high church-state separation, high religiosity, and low welfare state, and vice versa. We use this framework to explain the changing nature of religious movements, from Social Gospel to the religious right, and why church-state separation arose in the US but not in many European countries.

Maybe this is not fully sound, but it is one of the most interesting papers I have read in years.  I have high hopes for the guy.

Underappreciated economists, a continuing series

Jesse Shapiro.  Yes, he is a mere Youngling, having just finished his Ph.d. at Harvard (he was a Shleifer student, and now visiting at Chicago).  But he is likely to be one of the leading economists of the next generation.  He studies why and how large numbers of people can make, or appear to make, systematic errors.  This is perhaps the frontier question in contemporary economics.  Here is the abstract from Jesse’s paper on advertising:

I present a model of advertising in the presence of bounded memory and limited recall.  In the model, consumers’ memories record the quality of their experiences with a product.  Exposure to advertising leads to memories of good experiences.  Crucially, I assume that consumers cannot recall whether a memory orginates from a genuine consumption experience or from exposure to advertising.  The model yields several novel implications.  First, advertisers will concentrate their efforts on past customers, because experienced consumers will be more likely to trust that their positive feelings toward the brand are genuine.  The model may therefore help to explain why established, familiar brands continue to advertise extensively.  Second, the firm’s desire to "saturate" the consumer with positive memories can lead to the commonly observed phenomenon of "pulsing," in which a firm oscillates between no advertising and some positive amount.  Third, exaggeration is limited, in the sense that advertisers may not cause consumers to remember haivng extraordinary experiences with the brand.  Indeed, under some conditions an equilibrium in which advertising conveys the best possible impression of the brand can exist only when the total amount of advertising is small.

Another paper of Jesse’s challenges analytical egalitarianism — the entire foundation of economics.  Here is a previous installment of underappreciated economists.

Underappreciated economists, a continuing series

Julio Rotemberg.  OK, so being tenured at Harvard Business School is not the same as lost in the woods.  But you don’t hear enough about him in the economics profession, when in fact he is one of our most creative thinkers.

My favorite Rotemberg paper is "A Theory of Inefficient Intrafirm Transactions," American Economic Review, 1991.  It is poorly written and the model is clumsy but I love the idea.  Firms do not exist to lower transactions costs, rather they usually raise transactions costs (price aside, wouldn’t you rather go buy a new computer from a retail outlet than try to order one through your purchasing department?).  An asset is brought into a firm when an entrepreneur sees that the asset is currently underpriced.  The firm buys the asset to capture future rents, but don’t expect ex post transactional efficiency to result.  That being said, it makes sense to allow this process to continue, given the absence of serious alternatives to market bidding, however imperfect it may be.

Rotemberg’s paper on altruism explores the idea that you often feel altruism for your co-workers, but you rarely feel altruism for your boss.  This will limit the degree of hierarchy; furthermore some firms may fear inter-employee altruism, knowing that it will be used against them.  His paper on fairness constraints on market pricing is a brilliant, sprawling mess on a vitally important topic.  Why do firms hold poorly publicized temporary sales?  They want one group of customers to think the firm cares about their welfare, while those who buy after the sale ends feel no regret at paying the higher prices.

Here is a previous installment in this series on Brian Loasby.

Underappreciated economists, a new installment

Brian Loasby.  He has been a Professor of Economics at the University of Stirling, now emeritus.

I read Loasby’s Choice, Complexity, and Ignorance (alas, not to be found in Loasby’s Amazon list) at a very young age.  Here was an "Austrian" theory of choice and the firm that was both dynamic and had empirical content.  Who else started with Marshall and Joan Robinson but integrated Lachmann, Cyert and March, and the best of institutionalist thought, all without falling in dogma?  Loasby also embodied the kaleidic best of G.L.S. Shackle without flying off the rails into analytic nihilism.  If you want a phenomenological description of how firms deal with radical uncertainties about the future, this is the place to go.

Here is an interview with Brian Loasby.  Here is one nice bit, intended as a general point but also in defense of Marshallian reasoning:

I have never been able to question very much at a time, I think.  I got a note somewhere of something that G.K. Chesterton once said, that a man must be orthodox on most things, or he will never have time able to practice his own particular heresy.

The Economist covers Why Are the Prices So D*mn High?

The Economist does a very nice job covering Why Are the Prices So D*mn High.

Baumol’s earliest work on the subject, written with William Bowen, was published in 1965. Analyses like that of Messrs Helland and Tabarrok nonetheless feel novel, because the implications of cost disease remain so underappreciated in policy circles. For instance, the steadily rising expense of education and health care is almost universally deplored as an economic scourge, despite being caused by something indubitably good: rapid, if unevenly spread, productivity growth. Higher prices, if driven by cost disease, need not mean reduced affordability, since they reflect greater productive capacity elsewhere in the economy. The authors use an analogy: as a person’s salary increases, the cost of doing things other than work—like gardening, for example—rises, since each hour off the job means more forgone income. But that does not mean that time spent gardening has become less affordable.

It’s an implication of the Baumol effect that everyone ends up working in a low productivity industry!

The only true solution to cost disease is an economy-wide productivity slowdown—and one may be in the offing. Technological progress pushes employment into the sectors most resistant to productivity growth. Eventually, nearly everyone may have jobs that are valued for their inefficiency: as concert musicians, or artisanal cheesemakers, or members of the household staff of the very rich. If there is no high-productivity sector to lure such workers away, then the problem does not arise.

Misunderstanding the Baumol effect can lead to a cure worse than the “disease”:

These possibilities reveal the real threat from Baumol’s disease: not that work will flow toward less-productive industries, which is inevitable, but that gains from rising productivity are unevenly shared. When firms in highly productive industries crave highly credentialed workers, it is the pay of similar workers elsewhere in the economy—of doctors, say—that rises in response. That worsens inequality, as low-income workers must still pay higher prices for essential services like health care. Even so, the productivity growth that drives cost disease could make everyone better off. But governments often do too little to tax the winners and compensate the losers. And politicians who do not understand the Baumol effect sometimes cap spending on education and health. Unsurprisingly, since they misunderstand the diagnosis, the treatment they prescribe makes the ailment worse.

My only complaint is that the excellent reviewer has not followed our lead and called it the Baumol effect–cost disease is a misleading name!

Addendum: Other posts in this series.

What made Buchanan special as an economist?

Matt asks this question.  I am a bit on the run, so I will do this in link-less form, but all the sources should be easily googled.  Here goes:

1. He developed the “theory of clubs,” which sets out the conditions under which private associations supply excludable public goods at optimum levels.

2. For his time he had the best and most rigorous analysis of the incidence of public debt.

3. With Gordon Tullock he pioneered the economic analysis of voting rules in terms of transactions costs and external costs imposed on others.  Any current blogosphere discussion of say the filibuster will rely on this approach, though we now take it so for granted we don’t realize how impressive it was at the time.

4. He had pioneering economic analyses of bicameralism, logrolling, and other aspects of legislatures, again with Tullock.

5. Along with Harsanyi, he formulated aspects of the “original position” before Rawls did and he was a major influence on Rawls.  By the way, I have seen Buchanan numerous times with top professional philosophers, and he has no problem holding his own or better.

6. He helped pin down, including on the technical side, the economic concept of externality.

7. He provided the most important revision to optimal tax theory since Ramsey, namely the point that supposedly efficient methods of taxation can be too easy to use.  That was in The Power to Tax, with Brennan.  His piece on static vs. dynamic versions of the Laffer curve, with Dwight Lee, is also significant.

8. He provided a public choice analysis of why Keynesian economics would not lead to the appropriate budget surpluses during good times and thus would contain dangerous ratchet effects toward excess deficits.

9. He thought through the conflict between subjective and objective notions of value in economics, and the importance of methodologically individualist postulates, more deeply than perhaps any other economist.  Most economists hate this work, or refuse to understand it, either because it lowers their status or because it is genuinely difficult to follow or because it requires philosophy.  Yet it stands among Buchanan’s greatest contributions even if a) I do not myself agree with his approach, and b) I do not think it is easily summarized or even well-explained.  Buchanan took Knight and Shackle very seriously and he understood that the typical pragmatic dismissal of their caveats was not in fact  well-founded.

10. His Hayekian work on “order defined only through the process of emergence” and “economics as a science of exchange and catallactics” is a very important take-down of the scientific pretensions of much of economics.  It doubted whether the notion of efficiency could be independently conceptualized at all.  Again, this work is disliked or ignored.  Buchanan may be going too far, but it is a very important and neglected perspective.

11. He thought more consistently in terms of “rules of the games” than perhaps any other economist.  This point remains underappreciated and underapplied.  It makes technocracy out to be a fundamentally different endeavor.

12. He did important work in the history of economic thought, reviving interest in the Italian school of public finance and public choice.

13. His late papers with Yoon on the work ethic, increasing returns, and economic growth remain underappreciated.  I also admire his work with Yoon on the anti-commons.

There is more, but that is a start.  Try his article on why pollution should be taxed for Pigouvian reasons.  I could add that Buchanan understood the importance of monetary rules, and favored a regime where the supply of money would be elastic in response to negative economic circumstances.

Jeff Biddle on migration and air conditioning

Here is the abstract of his piece “Air Conditioning, Migration, and Climate-Related Rent Differentials“:

This paper explores whether the spread of air conditioning in the United States from 1960 to 1990 affected quality of life in warmer areas enough to influence decisions about where to live, or to change North-South wage and rent differentials. Using measures designed to identify climates in which air conditioning would have made the biggest difference, I found little evidence that the flow of elderly migrants to MSAs with such climates increased over the period. Following Roback (1982), I analyzed data on MSA wages, rents, and climates from 1960 to 1990, and find that the implicit price of these hot summer climates did not change significantly from 1960 to 1980, then became significantly negative in 1990. This contrary to what one would expect if air conditioning made hot summers more bearable. I presented evidence that hot summers are an inferior good, which would explain part of the negative movement in the implicit price of a hot summer, and evidence consistent with the hypothesis that the marginal person migrating from colder to hotter MSAs dislikes summer heat more than does the average resident of a hot MSA, which would also exert downward pressure on the implicit price of a hot summer.

The pointer is from Ross Emmett in the MR comments section, very useful comments overall.  Biddle has two other pieces on the history of air conditioning, and Biddle has other interesting pieces as well, he is apparently an underappreciated economist.

Here Scott Sumner details the import of state income taxes.  In my view not the “main” factor, but a significant factor nonetheless, excerpt: “On the west coast, all states grew faster than the national average. Yes, its climate is nicer that the south central region.  But look at the more detailed data and you’ll see that hot and sunny Washington state and Alaska grew the fastest of five bordering the Pacific.  And oh by the way, Washington and Alaska are the only two with no state income tax.”  I’ll add this point: to the extent income inequality is rising, a relatively small number of cross-state migrants can lead to a noticeable difference in cross-state growth and job creation rates.  And the high earners are precisely those who are most able and most likely to leave a high-tax state for a low-tax state.

Johannes Fedderke and the importance of good governance

File him in the category underappreciated economists.  Does good governance matter for growth?  Could there be a more important question for economists? The standard cross-sectional growth tests do not show much of a robust effect.  But Johannes, along with co-authors Robert Klitgaard and Kamil Akramov, has a 150-page paper showing that if you take all the relevant heterogeneities into account yes, Adam Smith and Doug North were right after all.

Or do you prefer simple regressions which meet the eyeball test?

Here is the full paper.  Here is Johannes’s long paper on South African economic history.

Why is the top one percent earning more?

Brad DeLong writes:

The big rise in inequality in the U.S. since 1980 has been
overwhelmingly concentrated among the top 1% of income earners: their
share has risen from 8% in 1980 to 16% in 2004. By contrast, the share
of the next 4% of income earners has only risen from 13% to 15%, and
the share of the next 5% of income earners has stuck at 12%. The top 1%
have gone from 8 to 16 times average income, the next 4% have gone from
3.2 to 3.7 times average income, and the next 5% have been stuck at 3
times average income.

It’s hard to attribute this pattern to a rise in the premium salary
earned by the well-educated by virtue of the skills their formal
education taught them. Such a rise in the education premium would
produce a much smoother rise in relative incomes among the whole top
tenth of the income distribution. The cross-percentile pattern doesn’t

It is especially hard because most theories of the rising education
premium attribute it to skill-biased technological change generated by
the high-tech computer industrial revolution. But the high-tech boom’s
effects on overall productivity became large only in the second half of
the 1990s, well after the biggest increases in inequality. The timing
doesn’t fit either.

Something else is going on.

Leisure time improvements, opportunities like the Internet, and CPI quality mismeasurement have made the lot of the bottom tiers somewhat better than these statistics indicate.  (The absorption of would-have-been real wage gains into more expensive health benefits is another relevant factor.)  Still the relative pattern is undeniable.

My intuition is that there has been an increase in the ability of very smart and very wealthy people to buy up undervalued assets and turn them into greater value.  Improvements in capital markets and market liquidity are behind this trend, as well as the mere demonstration effect that many people have tried this and succeeded.  Julio Rotemberg remains an underappreciated economist.  American entrepreneurs were building up capabilities which exploded in value once the economy stabilized in the early 1980s.  Michael Milken-as-we-knew-him could not have existed in 1973.

Note two features of this hypothesis: First, it is correlated with but not coincident to productivity improvements, which will follow with some lag, thus fitting the data.  The capital gains come before the improvements.  Second, it might explain the non-linearity of the spike in incomes.  A modest multi-millionaire is not wealthy enough to play at T. Boone Pickens or Warren Buffett.  He can "go along for the ride" in a hedge fund, but won’t reap most of the value from the major arbitrage opportunities.  Those end up concentrated in a relatively small group of people and of course this tendency may be self-reinforcing with the accumulation of wealth and arbitrage expertise.

It might also help explain why the Bush changes in marginal tax rates seem to have produced more revenue than had been expected (yes I know about the weird baselines and projections and the like, but still it was a surprise and a welcome one).  It is not a classic supply-side substitution labor supply effect, but rather a wealth effect.  The very wealthy can put their assets to especially productive uses, or at least especially high capital-gains-producing uses.  That puts high capital gains revenue, high productivity, and growing disparity of incomes all together in the same pot.  Sound familiar?

Addendum: Here is Brad DeLong on press coverage of the revenue boost, and also on the small size of the self-financing effect; we also thank him for the endorsement (though note I’ve never been a member of any political party).

When is it bad to disclose good news?

Rick Harbaugh and Theodore To offer an abstract:

Is it always wise to disclose good news?  We find that the worst sender with good news has the most incentive to disclose it, so reporting good news can paradoxically make the sender look bad.  If the good news is attainable by sufficiently mediocre types, or if the sender is already expected to be of a relatively high type, withholding good news is an equilibrium.  Since the sender has a legitimate fear of looking to anxious to reveal good news, having a third party disclose the news, or mandating that the sender disclose the news, can help the sender.  The predictions are tested by examining when economics faculty at different institutions use titles such as "Dr" and "Professor" in voicemail greetings and course syllabi.

Here is the paperHarbaugh’s home page has many interesting papers, most of all "Too Cool for School," which concerns the underexplored topic of "countersignaling."  He also has a paper on why the favorites save up their effort for the final round, and why status can make you risk-averse in gains but risk-loving in losses.  He is an underappreciated economist, and I thank Robin Hanson for the pointer to his work.

The bottom line: When it comes to titles, if the book lists "Ph.d." after the author’s name, run the other way.  Gregory Stock’s The Book of Questions is one notable exception to this rule.

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