Month: April 2008

The erotics of investing

When young men were shown erotic pictures, they were more likely to
make a larger financial gamble than if they were shown a picture of
something scary, such as a snake, or something neutral, such as a
stapler, university researchers reported.

The arousing pictures lit up the same part of the brain that lights up when financial risks are taken.

…The study conforms with recent research that indicates men shown a
pornographic movie were more likely to make riskier sexual decisions.
Another suggests straight men think less about their financial future
after being shown pictures of pretty women.

Here is more.  One question — and perhaps a more direct test of the hypothesis — is whether traders in more sexually integrated firms do in fact behave differently.  Or how about companies located next to modeling agencies?  I suspect in real social settings the effect washes out, for reasons identified by Freud (among others) some time ago.  The more literally minded among us might also question whether a stapler is in fact a neutral image.  It isn’t for me.

Jeff Sachs on biodiversity

His new book Common Wealth devotes an entire chapter to this important topic.  Sachs writes:

The main lesson of ecology is the interconnectedness of the various parts of an ecosystem and the dangers of abrupt, nonlinear, and even catastrophic changes caused by modest forcings…It is a basic finding that biological diversity increases the productivity and resilience of ecosystems.  With more species filling more niches in a given location, a biodiverse ecosystem is better buffered against external shocks in is more adept at cycling nutrients, capturing solar radiation, utilizing water resources, and preventing the takeover of the system by single predators, weeds, or pathogens.  In other words, preserving biodiversity helps to preserve all aspects of ecosystem functions.  Removing one or more species from an ecosystem, for example, by selective harvesting of trees or fish or hunted animals, can lead to a cascade of ecological changes with large, adverse, and nonlinear effects on the functioning of the ecosystem.

Now, loyal MR readers may remember that I am genuinely uncertain how much we should worry about the loss of biodiversity.  I do know the following:

1. Many smart people who know much more science than I do are very worried about the loss of biodiversity.

2. Given that the human population has ballooned for the foreseeable future, massive losses in biodiversity are inevitable.  The question is how bad the marginal losses will be, if we do not adapt policy accordingly.

3. If I had to conduct a debate and argue that the marginal loss of biodiversity was going to be a tragedy for human beings (obviously, I can see the loss to animals, and yes I do count that for something), I would not do very well.  Yes Yana’s children won’t eat tuna and then I would sputter something about carbon and nitrogen cycles.

So OK readers, help me out.  I’ve read Sachs’s passage and I don’t think I disagree with any of the claims in it.  But I still cannot articulate to a skeptic exactly what marginal disaster will come if we do not take drastic action to preserve biodiversity.

Please use the comments to set me straight.  What exactly will go wrong?  And do not compare seven billion humans to pristine nature.  Compare seven billion humans with bad biodiversity policy to, say, five billion humans with a pretty good biodiversity policy.  What exactly is the difference?  What are these costs as a percentage of gdp? 

Please be as specific as possible; I genuinely would like to learn more.

Car patrol vs. foot patrol

Car patrol eliminated the neighborhood police officer.  Police were pulled off neighborhood beats to fill cars.  But motorized patrol — the cornerstone of urban policing — has no effect on crime rates, victimization, or public satisfaction.  Lawrence Sherman was an early critic of telephone dispatch and motorized patrol, noted, "The rise of telephone dispatch transformed both the method and purpose of patrol.  Instead of watching to prevent crime, motorized police patrol became a process of merely waiting to respond to crime."

That is from Peter Moskos’s Cop in the Hood: My Year Policing Baltimore’s Eastern District; here is my previous post on the book.

Why economics was late in starting

I’ve already posed the question, I’d like to add two points.  First, sustained economic growth in the Western world starts in 17th century England, as shown by Greg Clark.  Interest in economic reasoning then comes rapidly, first from the mercantilists, then in Adam Smith and some earlier free trade thinkers, such as Dudley North and Nicholas Barbon.

Second, the idea of "private vices, publick virtues" was central for eighteenth century economic thought and for social science more generally.  This came from Bernard Mandeville (drawing upon the French Jansenists) in 1720.  It’s no accident that Mandeville lived in the Dutch Republic, which had very little censorship.  No, I am not a Straussian but the merits of that viewpoint are often overlooked.

The School of Salamanca had an excellent marginal utility theory in 17th century Spain, the framework simply did not go anywhere.  For that matter we can look later and see that Samuel Bailey, Mountifort Longfield (1834), and others had critical components of Marshall.  But no one really cared because they could not yet see how important those contributions would turn out to be.  This is a central theme in why the growth of economic thought took so long.

It also suggests that today we might have some very important ideas amongst us, we simply cannot yet see how fruitful they will be.  Their own proponents may not even know it.

Predictions about 2008

From 1968:

A typical vacation in 2008 is to spend a week at an undersea resort,
where your hotel room window looks out on a tropical underwater reef, a
sunken ship or an ancient, excavated city. Available to guests are two-
and three-person submarines in which you can cruise well-marked
underwater trails.

But many of the predictions are good, at least in part.  Get this:

The single most important item in 2008 households is the computer.
These electronic brains govern everything from meal preparation and
waking up the household to assembling shopping lists and keeping track
of the bank balance. Sensors in kitchen appliances, climatizing units,
communicators, power supply and other household utilities warn the
computer when the item is likely to fail. A repairman will show up even
before any obvious breakdown occurs.

Computers also handle travel reservations, relay telephone messages,
keep track of birthdays and anniversaries, compute taxes and even
figure the monthly bills for electricity, water, telephone and other
utilities. Not every family has its private computer. Many families
reserve time on a city or regional computer to serve their needs. The
machine tallies up its own services and submits a bill, just as it does
with other utilities.

Via  As usual, it is presumed that traffic and transportation problems will have seen a lot of progress when in fact they have not.  Nor was it understood how unevenly the benefits of progress would be distributed and how possible it would be to continue a life basically devoid of these advances.

Capital requirements smackdown watch

Eric Falkenstein writes:

How much capital for derivatives? Good question. Should it be weighted by risk? If so, how does one measure risk? Considering that risk is a function of the collateral, which comes in many different flavors (traded debt, pools of mortgages, pools of bank lines), and then are structured very differently, with differing levels of subordination, differing rules for the waterfalls of cashflows depending on various metrics of collateral quality. It’s a mess.

…You may think this is no different than regular lending, but you would be wrong. For example, lets say you have two swaps, but they both offset each other almost exactly for interest rate risk, but as they have different counterparties, they have differing credit risk. How about swaps from the same counterparty, but differing interest rate exposures, partially netted. How much should capital be netted? And if the US banks have capital requirements greater than economically necessary, how many seconds before all swaps would move offshore?

I take him to be saying that financial institutions can never be transparent in their risk-taking, or at least not in the sense that can be made accountable to a regulator.  Read the whole thing.  Read also Doug Colkitt’s comment here.  Note by the way that Bear Stearns, at the time of its collapse, had met Basel capital requirements.

Mark Thoma writes:

I’d argue that even though Basel was not perfect it was much better than having no regulation at all…If the regulations under Basel caused banks to move assets off the books, then without regulation they wouldn’t have needed to move them, but the assets still could have been used in the same way, financial institutions could have taken the same risks and would have had the same or more incentive to do so without regulatory oversight, and they could have caused the same troubles. I don’t see how the regulations themselves caused the risk taking. Regulation caused evasion of regulation, and Basel II is trying to deal with that problem, but the regulations did not cause the risk-taking itself.

Currently my view is closer to Thoma’s.  The case against regulation requires that derivatives risk is observable (by the bank itself, and of course if it is not observable to anyone run the other way!) but not verifiable to an outside regulator (otherwise it could be controlled by regulation).  Even in that case, however, more informal systems of regulation should work, albeit imperfectly.  Yes banks will sometimes lie and trick the regulators but at least another layer of protection is in place.

There’s lot of talk about the government buying up mortagages.  Even if you favor that plan, it’s a one-off measure, not a long-term solution to stop a future crisis.  There is in fact a paucity of good regulatory proposals on the table.  There are plenty of ideas for how to stop what went wrong "last time" but fewer good ideas for how to stop the next version of a financial crisis.

The future of economics

In a nutshell, foreigners and empirical work:

This short paper collects and studies the CVs of 112 assistant professors in the top-ten American departments of economics. The paper treats these as a glimpse of the future. We find evidence of a strong brain drain. We find also a predominance of empirical work.

Three-quarters of the bachelor degrees were obtained from abroad.  Macro, econometrics, and labor economics are the most popular fields, see p.8 for the full list.  Here is the paper, hat tip to Pluralist Economics Review.


The brain’s store of willpower is depleted when people control their
thoughts, feelings or impulses, or when they modify their behavior in pursuit of
goals. Psychologist Roy Baumeister and others have found that people who
successfully accomplish one task requiring self-control are less persistent on a
second, seemingly unrelated task.

In one pioneering study, some people were asked to eat radishes while others
received freshly baked chocolate chip cookies before trying to solve an
impossible puzzle. The radish-eaters abandoned the puzzle in eight minutes on
average, working less than half as long as people who got cookies or those who
were excused from eating radishes.

From the NYTimes with some good advice on test taking, dieting and how to increase your will power over time.

Katrina recommendations

Steven Horwitz, who notes that Wal-Mart did a better job than FEMA, has a study and a plan:

1. For relief and recovery efforts and ensure that its role [the private sector] is officially recognized as part of disaster protocols.

2. Decentralize government relief to local governments and non-governmental organizations and provide that relief in the form of cash or broadly defined vouchers.

3. Move the Coast Guard and Federal Emergency Management Agency (FEMA) out of the Department of Homeland Security (DHS).

4. Reform “Good Samaritan” laws so that private-sector actors are clearly protected when they make good faith efforts to help.

My favorite things Utah

Lately there has been too much travel, yes, but writings these posts is fun.  I am headed toward Sundance.  Here goes:

1. Author: Orson Scott Card’s The Ender Trilogy (start with Ender’s Game) is a modern landmark which will be read for years to come.  Next on my list is Wallace Stegner’s Angle of Repose.

2. Actor: James Woods, as he plays in Casino and Virgin Suicides, two fine movies.

3. Best Robert Redford movie: Out of Africa, schmaltz yes but I love it.

4. Film, set in: Butch Cassidy and the Sundance Kid comes to mind.

5. Novel, set in: Norman Mailer’s The Executioner’s Song.  The first half in particular is a knockout.

6. Can I have a category for kidnapping victim?  Jeopardy champion?

The bottom line: I love Utah.  I love its baked goods, its Mexican food, its sense of building a new world in the wilderness.  I love that it has a uniquely American religion and I find Salt Lake City to be one of America’s most impressive achievements.  I regard southern Utah as quite possibly the most beautiful part of the United States.  That said, I had a tough time filling out these categories and of course plenty of the usual categories are blank altogether.

What I’ve Been Reading

1. Nudge: Improving Decisions About Health, Wealth, and Happiness, by Richard H. Thaler and Cass R. Sunstein.

I liked Alan Schwartz’s Amazon review: ""Buy on apples, sell on cheese" is an old proverb among wine merchants. Taking a bite of an apple before tasting wine makes it easier to detect flaws in the wine, and the buyer who does so will not as easily make the mistake of paying more than the wine is worth. Cheese, on the other hand, pairs well with wine and enhances its flavor, so a seller who offers cheese may command a higher price for the wine (and may even deserve it, if the wine is intended to be drunk with cheese).""

2. Clay Shirky, Here Comes Everybody: The Power of Organizing Without Organizations.  Yes, that’s the Clay Shirky.  This is (implicitly) a very good Hayekian, spontaneous order treatment of social software on the web.  The book poses a simple and important question: what happens when it is virtually costless to organize people into groups?

3. Starved for Science: How Biotechnology is Being Kept Out of Africa, by Robert Paarlberg.  The point is unassailable, the subtitle says it all.

4. Steve Coll, The Bin Ladens: A Saudi Family in the American Century.  So far it’s great.  I know you’re sick of reading about Bin Laden; just think of it as a (partial) history of the Saudis.

Addendum: The new "Nudge" blog is here.

Was Avner Greif right about the Maghribi traders?

Jeremy Edwards and Sheilagh Oglivie write:

Economists draw important lessons for modern development from the medieval Maghribi traders who, according to Greif, enforced contracts multilaterally through a closed, private-order ‘coalition’. We show that this view is  untenable. The Maghribis used formal legal mechanisms and entered business associations with non-Maghribis. Not a single empirical example adduced by Greif shows that any ‘coalition’ actually existed. The Maghribis cannot be used  to argue that the social capital of exclusive networks will facilitate exchange in developing economies. Nor do they provide any support for the cultural theories of economic development and institutional change for which they have been mobilised.

Here is the paper, which if it is correct amounts to a stunning refutation of what was once a seminal contribution to economic history and the theory of social norms.  Thanks to a loyal MR reader for the pointer.

Foul Weather Austrians

I am puzzled by the resurgence of Austrian Business Cycle theory among Sachs, Krugman, Baker and many others who you would not ordinarily associate with the theory.  Sachs, for example, writes:

…the US crisis was actually made by the Fed… the Fed turned on the monetary spigots to try to combat an economic
slowdown. The Fed pumped money into the US economy and slashed its main
interest rate…the Fed held this rate too low for too long.

Monetary expansion generally makes it easier to borrow, and lowers
the costs of doing so, throughout the economy. It also tends to weaken
the currency and increase inflation. All of this began to happen in the

What was distinctive this time was that the new borrowing was concentrated in housing….the Fed, under Greenspan’s leadership, stood by as the credit boom gathered steam, barreling toward a subsequent crash.

What is puzzling about this is two-fold.  First, there is no standard model that I know of (say of the kind normally taught in graduate school) with these kinds of results.  Second and even more puzzling is that the foul-weather Austrians don’t seem to draw the natural conclusion from their own analysis.

If the Federal Reserve is responsible for what may be a trillion dollar crash surely we should think about getting rid of the Fed?  (n.b. I do not take this position.)  The true Austrians, like my colleague Alvaro Vargas Llosa, have long taken exactly this position.  So why aren’t Sachs, Krugman et al. calling for the gold standard, a strict monetary rule, 100% reserve banking, free banking or some other monetary arrangement?  Each of these institutions, of course, has its problems but surely after a trillion dollar loss they are worthy of serious consideration.

Nevertheless, I haven’t heard any ideas, from those blaming the crash on the Fed and Alan Greenspan, about fundamental monetary reform.  (Can Sachs, Krugman et al. really believe that it was Greenspan the man and not the institution that is to blame?  That seems naive.)

Instead, the foul weather Austrians seem at most to call for regulatory reform.  But that too is peculiar.  Put aside the fact that banking is already heavily regulated, have these economists not absorbed the Lucas critique?  In short, suppose that whatever regulation these economist want had been put in place in earlier years.  Would the crash have been avoided or would the Fed have simply pushed harder to lower interest rates?  After all, the Fed lowered rates for a reason and if the regulation reduced the effectiveness of monetary policy in creating a boom well then that just calls for more money.