Month: May 2006

Have you seen this man?  Spot him in the next thirty days and it could be worth $100.  Rules here.

P.S.  I think you-know-who has underestimated who much money he will have to shell out.  Oh yeah, sometimes he wears glasses.

The market for economists was in a slump when I graduated.  I was fortunate to earn a visitor’s position at the University of Virginia and then a tenure-track position at Ball State University in Muncie, Indiana, but I had few alternative offers.  My colleagues in Muncie were good but after a few years I was unhappy enough with the university and the town to take a flying leap to become director of research at the Independent Institute in Oakland, CA.  At the time, I thought this was the end of my academic career.

David Theroux at the Independent Institute encouraged my academic work, however, seeing it as consistent with the Institute’s focus on research, and I kept publishing.  Events (and especially Tyler!) then conspired to bring me to GMU for which I am very grateful.

All this is by way of introducing Austan Goolsbee’s latest column in the NYTimes.  Goolsbee discusses two new papers which demonstrate that economic conditions in the year in which you graduate can have a surprisingly long-lasting effect on career earnings. 

The Stanford class of 1988, for example, entered the job market just
after the market crash of 1987. Banks were not hiring, and so average
wages for that class were lower than for the class of 1987 or for later
classes that came out after the market recovered. Even a decade or more
later, the class of 1988 was still earning significantly less. They
missed the plum jobs right out of the gate and never recovered….

These data confirm that people essentially cannot close the wage gap by
working their way up the company hierarchy. While they may work their
way up, the people who started above them do, too. They don’t catch up.
The recession graduates who actually do catch up tend to be the ones
who forget about rising up the ladder and, instead, jump ship to other
employers.

I take three points from my career and this research.  Leaving the academy turned out to be the just the thing to set me apart from the pack.  It didn’t have to work out that way but when your mean is low you need to throw some variance into the mix.  Finance theorists will recognize this lesson from options pricing theory. 

Second, I moved across the continent twice – from Fairfax, to Charlottesville, to Muncie, to Oakland and then back to Fairfax – sometimes with my wife and sometimes not – all in the space of about 10 years.  After moving so often, when I browsed book stores my decision to buy was based more on the weight of the book than on the price.  Jumping ship repeatedly, however, did help me to recover from a difficult beginning.

Third, luck matters.

Addendum: Now Open to Comments.

The Capital Asset Pricing Model specifies that the expected return on an asset is a function of the market rate of return plus another factor ("Beta") for the covariance of that asset with the market portfolio.  The intuition is that pro-cyclical assets are riskier and thus they must give you higher expected return.  But I don’t buy the whole Beta bit, especially not for equity markets:

1. For the marginal investor today, the marginal utility of money doesn’t vary much across world-states.  Let’s say you expect to earn a few million dollars over your lifetime and you have access to capital markets.  How much do you care about the covariance of a single stock?

2. Tossing in any second variable will improve predictive performance of the model.  To me the broader multi-factor models just look like data mining.

3. I can see that Beta might lower the expected return to holding gold, a traditional safe harbor in tough times.  I just don’t believe Beta matters for most equity assets.  Yes construction is pro-cyclical but does this affect real world thinking about which stocks to buy?  I think views on cyclicality are dwarfed by idiosyncratic expectational factors about particular facts of the world.

4. Unlike say, profit maximization, CAPM-reasoning will not evolve in the marketplace unless people are at some level aware of the fundamental principals of the theory and take care to minimize systematic risk.  If you are ignorant of CAPM you might have lower utility but you needn’t earn less money over time.  You don’t drop out of the marketplace as a broken down beggar.

5. People compartmentalize their fears.  Insofar as you worry about systematic risk it will affect your human capital decisions and real estate decisions, not your equity investments.

6. Risk affects your equity investments by getting you to diversify.  The story ends there.  Greater fear might mean you buy more individual stocks, but you don’t look into their Betas to prefer one stock over another.

7. Did I mention that ex post Beta is not always accurate as a predictor of future Beta?

8. Fama and French have shown that the line connecting Beta and expected returns has an almost flat slope, at least if we adjust for the size of a firm relative to its book value. 

For risky equity assets in the United States, my preferred economic model is simple.  Expected return equals seven.  That is my model, "Seven."

Plus of course an random or error term.  How’s that for Occam’s Razor?

I love the main ideas of Jane Jacobs.  Her passing was truly sad for me.  I read her as a teenager.  It shook my world.

Nonetheless I think she is a tiny-teeny bit overrated.  She never coped with the problems of scale.  Nor did she explain how infrastructure should be built.

It is fine to juxtapose the old Greenwich Village against the gargantuan planning of the corrupt Robert Moses.  Few other social scientists of her time grasped the idea of  spontaneous order.  But what to do if a city grows from one million to ten million people, as has happened many times in the Third World?

To be sure, favelas and shanties work far better than their reputations.  Drug gangs aside, they embody many of the best qualities of Jacob’s analysis, or for that matter Hayek’s.  But surely it is a problem when there is no piped water or reliable electricity.  How can you get those services into new areas without some serious planning?  You can call for private sector involvement but it is planning nonetheless and it probably will involve some use of eminent domain.  Or how about new roads?

Perhaps I am unfair to Jacobs, but I read her as thinking we can confront the problems of cities without answering those questions.

It is perhaps unfair to note that Jacobs’s "straight economics" often made little sense, but surely this is relevant to how she understood the major problems of cities.  She doubted the necessity of the nation-state and was suspicious of internal economies of scale under a common legal order.  She promoted "import substitution," which is now a discredited idea among both left-wing and right-wing economists.

Here is a list of Moses’s projects for New York City.  Could the Big Apple have prospered and grown without them?

A Wall Street lawyer gave new meaning to the term
"futures market" when he tried to auction his future Social Security
checks – money did doesn’t now have – on eBay for $200,000 so he could
use the cash for a down payment on a Manhattan apartment.

"I’ve put a lot of money into the Social Security system, so why can’t I sell it to someone else?" mused Thaddeus Wojcik.

File that under "Department of HA!."  Ebay yanked the auction.  Here is the full story, and thanks to Chris D. for the pointer.