Month: October 2008

The Singularity is Near

Telepathy has always been a sign of kookiness but synthetic telepathy heh that’s just around the corner.

The U.S. Army is developing a technology known as synthetic telepathy that would
allow someone to create email or voice mail and send it by thought alone. The
concept is based on reading electrical activity in the brain using an
electroencephalograph, or EEG…

The idea of communicating by thought alone is not a new
one. In the 1960s, a researcher strapped an EEG to his head and, with some
training, could stop and start his brain’s alpha waves to compose Morse code

Here is a previous post in the series.

The new Obama economic plans

The main new proposals would:

– for the next two years, give businesses a $3,000 income-tax credit for each new full-time employee they hire above the number in their current workforce;

– allow savers with tax-favored Individual Retirement Accounts and 401(k)’s to withdraw 15 percent of those retirement savings, up to a maximum of $10,000, without paying a tax penalty as the law currently requires for withdrawals before age 59 and a half;

– bar financial institutions that take advantage of the Treasury’s rescue plan from foreclosing on the mortgages of any homeowners who are making “good-faith efforts” to make payments;

– direct the Treasury and the Federal Reserve to create a temporary facility for loans to state and local governments, similar to the Fed’s new arrangement to loan corporations money by buying their commercial paper, which are the I.O.U.s that help businesses with daily operating expenses like payrolls.

Here is the article.  I doubt if the substitution effect generated by #1 is large.  I fear the precedent set by #2 and I don’t understand the enforceability of #3.  Savings withdrawals are in effect a form of fiscal policy and I don’t yet see how fiscal policy is supposed to cure us of our current mess, which is rooted in coordination problems.  Let’s hope #4 does not become necessary.  Of course it is before an election and each candidate has to propose doing something in addition to the status quo.  But a lot will happen between now and 1/20; fortunately these proposals won’t be taken very seriously.

Here are McCain’s proposals, I may discuss them soon.

Ireland forces Europe, Europe forces the United States

Is this a race to the top or a race to the bottom?

“The Europeans not only provided a blueprint, but forced our hand,” said Kenneth S. Rogoff, a professor of economics at Harvard and an adviser to John McCain, the Republican presidential nominee. “We’re trying to prevent wholesale carnage in the financial system.”

Here is much more on today’s events.  In the current version of globalization the equilibrium seems to be that non-guaranteed banking systems are swiftly penalized and turned into zombies.  This suggests, by the way, that undoing current bank guarantees, when recovery comes, won’t be as easy as we might have thought.

Addendum: Here are the opinions of many economists.

Paragraphs to ponder

Via Mark Thoma, Susan Woodward has an idea:

The true values of mortgage assets are generally thought to be a mystery. But
little-mentioned among discussions … of the crisis is that the Treasury has
access to the best resources in the business for estimating the hold-to-maturity
values of mortgages and mortgage-backed securities. This team is at Fannie Mae,
which the government now effectively directs.

You might laugh, or cry, but the reality is that most proposed paths out of the crisis involve a circularity problem.  And, courtesy of Chris Masse, here is another paragraph to ponder:

Krugman’s award could bring Bush face-to-face with his
antagonist. The president typically invites Nobel Prize winners
to the White House in November or December.    

Paul Krugman on Austrian trade cycle theory

Here’s the problem: As a matter of simple arithmetic, total spending in
the economy is necessarily equal to total income (every sale is also a
purchase, and vice versa). So if people decide to spend less on
investment goods, doesn’t that mean that they must be deciding to spend
more on consumption goods–implying that an investment slump should
always be accompanied by a corresponding consumption boom? And if so
why should there be a rise in unemployment?

Here is the link once again.  But I think the point is more effective in reverse.  Why should the boom be a boom in the first place?  The shift toward investment goods, and thus away from consumption goods production, should mean falling real wages, not rising real wages.  In other words, the Austrian theory doesn’t generate the very high degree of comovement found in the data.  Or, in other words, there aren’t that many countercyclical assets.

One MR commentator suggests this, this, and this as responses.  They make various points against Krugman (who I might add is not as clear as usual in this piece) but they don’t solve this central problem of generating the amount of comovement found in the data.  The best shot is to relax the Austrian-favored methodological assumption of full employment; I leave it as an exercise for the reader whether that could work and what other problems for the theory it might create. 

I should add that Gordon Tullock has made much the same point, as has Bob Lucas or for that matter Piero Sraffa in 1932.

The Deal

Citigroup and JPMorgan Chase were told they would each get $25 billion; Bank of America and Wells Fargo, $20 billion; Goldman Sachs and Morgan Stanley, $10 billion each, with Bank of New York and State Street each receiving $2 to 3 billion. Wells Fargo will get an additional $5 billion, reflecting its acquisition of Wachovia, and Bank of America receives the same for amount for its purchase of Merrill Lynch.

…The government will purchase perpetual preferred shares in all the
largest U.S. banking companies. The shares will not be dilutive to
current shareholders, a concern to banking…executives, because
perpetual preferred stock holders are paid a dividend, not a portion of
earnings. The capital injections are not voluntary, with Mr.
Paulson making it clear this was a one-time offer that everyone at the
meeting should accept.

Here is the story.  No matter what your point of view, you ought to be stunned by this development.

Addendum: Brad DeLong adds musical commentary.

Did the world end today?

Not yet, the economy is staying above water.  Toward the future, here is a very good list of credit market indicators to follow.  A lot of the credit markets reopen tomorrow.  Felix Salmon is optimistic.  But in Iceland shoppers are emptying the shelves because it is hard to import food.  Kashkari says the Treasury will invest only in healthy banks; of course recapitalization makes the most sense for unhealthy banks.  One way to try to figure out what is happening is to work backwards from the lies but that can end up being very misleading.

What is New Trade Theory?

Congratulations to Paul Krugman on his Nobel.  Here is a primer on one of Krugman’s key contributions, New Trade Theory.  Tyler has more links below.

Ricardo showed that every country (and every person) has a comparative advantage, a good or service that they can produce at a lower (opportunity) cost than any other country (or person).  As a result, production is maximized when each country specializes in the good or service that they produce at lowest cost, that is in the good in which they have a comparative advantage.  Since specialization in comparative advantage maximizes production, trade can make every country better off.

But what determines comparative advantage?  In Ricardo it is the natural products of the soil, Portugal is good at producing wine and so England has a comparative advantage in cloth.  Heckscher, Ohlin and Samuelson among others extended the model to show how factor proportions can determine comparative advantage – countries with a lot of labor relative to capital, for example, will tend to have a comparative advantage in labor intensive goods production.

Notice, however, that in the Ricardian model and its extensions the determinants of comparative advantage like geography and factor proportions lie outside of the model.  New Trade Theory of which Paul Krugman can be said to be the founder, brings the determinants of comparative advantage into the model.

Consider the simplest model (based on Krugman 1979).  In this model there are two countries.  In each country, consumers have a preference for variety but there is a tradeoff between variety and cost, consumers want variety but since there are economies of scale – a firm’s unit costs fall as it produces more – more variety means higher prices.  Preferences for variety push in the direction of more variety, economies of scale push in the direction of less.  So suppose that without trade country 1 produces varieties A,B,C and country two produces varieties X,Y,Z.  In every other respect the countries are identical so there are no traditional comparative advantage reasons for trade.

Nevertheless, if trade is possible it is welfare enhancing.  With trade the scale of production can increase which reduces costs and prices.  Notice, however, that something interesting happens.  The number of world varieties will decrease even as the number of varieties available to each consumer increases.  That is, with trade production will concentrate in say A,B,X,Y so each consumer has increased choice even as world variety declines.

Increasing variety for individuals even as world variety declines is a fundamental fact of globalization.  In the context of culture, Tyler explains this very well in his book, Creative Destruction; when people in Beijing can eat at McDonald’s and people in American can eat at great Chinese restaurants the world looks increasingly similar even as each world resident experiences an increase in variety.

Thus, Krugman (1979) can be thought of as providing another reason why trade can be beneficial and a fundamental insight into globalization.

Moreover, Krugman (1979) began the task of bringing the reasons for comparative advantage within the model.  In that paper, Krugman also hypothesizes briefly about what happens when we allow migration within the model.  Recall, that in Heckscher-Ohlin-Samuelson factor proportions explain trade patterns but are themselves determined outside of the model.  When people and capital can move, however, factor proportions are themselves something to be explained.

Krugman (1991) (JSTOR and here) brings increasing returns together with capital and labor migration and transport costs into one model.  Krugman’s (1991) model has become a workhorse of economic geography and international trade.  The model is too complex to explain here but the reasons for that complexity are clear to see – when everything becomes "endogenous" small initial differences can make for big effects.  To minimize transport costs, for example, firms want to locate near consumers but consumers want to locate near work!  Thus, there are multiple equilibria and at a tipping point the location decisions of a single firm or consumer can snowball into big effects.  So Krugman has been a leader in introducing tipping points, network effects and thus the importance of history into international trade as well as into economics more generally. 

Paul Krugman wins the Nobel Prize

He is cited for trade theory and, appropriately, location theory and economic geography.  He could have been cited for his work on currency crises as well.  Here are the most basic links on Paul, it is hard to know where to start.  I have to say I did not expect him to win until Bush left office, as I thought the Swedes wanted the resulting discussion to focus on Paul’s academic work rather than on issues of politics.  So I am surprised by the timing but not by the choice.

Here’s Krugman’s NYT column from today; there is so so much on him and by him.  Here is his blog.  Here is a short post-prize interview.  He has been influential in pushing the United States toward a bank recapitalization plan.  Here is Krugman on video, from just the other day, talking about the crisis and how bad it might get.  Krugman, of course, also called the housing bubble in advance.

Krugman is very well known for his work on strategic trade theory, as it is now called.  Building on ideas from Dixit, Helpman, and others, he showed how increasing returns could imply a possible role for welfare-improving protectionism.  Krugman, however, insisted that he did not in practice favor protectionism; it is difficult for policymakers to fine tune the relevant variables.  Boeing vs. Airbus is perhaps a simple example of the argument.  If a government can subsidize the home firm to be a market leader, the subsidizing country can come out ahead through the mechanism of capturing the gains from increasing returns to scale.  Here are some very useful slides on the theory.  Here is Dixit’s excellent summary of Krugman on trade.  Krugman himself has admitted that parts of the theory may be less relevant for rich-poor countries trade (America and China) rather than rich-rich trade, such as America and Japan.

I am most fond of Krugman’s pieces on economic geography, in particular on cities and the economic rationales for clustering.  He almost single-handedly resurrected the importance of "location theory," an all-important but previously neglected branch of economics.  Here is the best summary piece of Krugman’s work in this area.  I believe this work will continue to rise in influence.

I have my own favorite pieces by Krugman.  This include his short critique of Austrian trade cycle theory and his short piece on why the British had such bad food.

He is also, by the way, a loyal MR reader but he is not the first reader to win the prize.

Krugman’s books:

Here is my review of Conscience of a Liberal.  That book argued that politics and policy can reshape the distribution of income in a more egalitarian direction.  Peddling Prosperity is one of the best-written economics books, ever, as are also The Age of Diminished Expectations and Pop Internationalism.  The latter started a trend of Krugman as a debunker of erroneous economic claims.  The supply-siders and the low-level industrial policy advocates were early targets of his pen.  Pop Internationalism is also the work of Krugman’s most likely to be popular with market-oriented economists.  Here is a collection of Krugman’s earlier writingsThe Great Unraveling — circa 2004 — is for me too under-argued.  His book Currencies and Crises is in my view his most underrated work; it provides a very readable introduction to some of his ideas on financial crises and it has a nice use of the concept of option value.  Development, Geography, and Economic Theory is a very good and very readable introduction to his work on economic geography.  That and the currency book are my two favorites by Krugman.  Geography and Trade is useful plus here is a more technical collection on the spatial economy.

Krugman has a widely used Principles text, co-authored with his wife Robin Wells.  He also has a leading text in international economics co-authored with Maurice Obstfeld.

Here are profiles and bio pieces, none very recent.  Here is Krugman on how he works — very personal and insightful.  Some of Krugman’s thinking on the liquidity trap — a key issue today for the crisis — can be found here.

Krugman of course is a controversial figure in the blogosphere and in politics but I believe for today it is best to set those issues aside.  His Wikipedia page has lots on the critics plus some bio as well.  Daniel Klein for instance argued that Krugman should do more to speak out for freer markets in various settings.

Krugman’s early columns for were an important model for shaping what the econ blogosphere later became.  They are models of clarity and rigor which we all would do well to emulate.  His exposition of Ricardo’s theory of comparative advantage is remarkably good and it is one of the best pieces of popular economics writing I know.

Award analysis: This was definitely a "real world" pick and a nod in the direction of economists who are engaged in policy analysis and writing for the broader public.  Krugman is a solo winner and solo winners are becoming increasingly rare.  That is the real statement here, namely that Krugman deserves his own prize, all to himself.  This could easily have been a joint prize, given to other trade figures as well, but in handing it out solo I believe the committee is a) stressing Krugman’s work in economic geography, and b) stressing the importance of relevance for economics.  Daniel Davies also sees it as a career-based award. 

Who are the big losers?  Avinash Dixit and Elhanan Helpman and Maurice Obstfeld have to feel their chances for the prize went down significantly.

Addendum: Here is Bryan Caplan on "Paul Krugman, Guilty Pleasure."

What is a bank?

Via Matt Yglesias, Justin Fox writes:

If you borrow short and lend long, you’re effectively a bank. It’s
becoming ever less clear to me what justification there is for nonbank
borrow-short-lend-long-institutions other than regulatory arbitrage.

I cannot sign on to this principle.  Business-to-business trade credit is huge in the United States (it’s not all short term) as is commercial lending, as you might get from General Motors or for that matter Sears or Nordstrom.  Pawn shops are more common than you might think.  If we regulate these lenders like banks we presumably have to give them comparable privileges, which could mean discount window access, FDIC access, and the use of Fed Wire.  Plus they would be subject to other regulations on banks, including restrictions on affiliations with commercial firms.  I don’t want to do that and in many cases I don’t even see what it would mean to do that (how can we stop Sears from affiliating with a commercial firm?).  I conclude that we cannot escape some important legal distinction between bank and non-bank lenders.  Admittedly any such distinctions can become more problematic with the march of technology and the increasing sophistication of regulatory arbitrage.

The Secret Scripture

When I was a very young man I thought places for the sick and mad should be made very bright and attractive, given a sort of festiveness to alleviate our human miseries.  But maybe these places are like animals and cannot change their spots and stripes no more than leopards and tigers.

That is from Sebastian Barry’s The Secret Scripture, the current favorite to win the Booker Prize this Tuesday.  I read it on the flight back from London and enjoyed it very much.

In addition to the Booker Prize, there is a lot coming up this week, including the beginning of the Kramnik-Anand chess match, the economics Nobel Prize, and whether a new Great Depression is on the way.  Please stay tuned…

Facts about publication bias

In 1995, only 1 percent of all articles published in alternative medicine journals gave a negative result.  The most recent figure is 5 percent negative.

That is from Ben Goldacre’s excellent Bad Science, right now available only in the UK.  This is one of the best books I have read on how to think like a scientist and how to critically evaluate evidence and also on why we don’t have a better press corps when it comes to science.

I thank Michelle Dawson for the pointer to the book.

Fruitless Fall

The subtitle is The Collapse of the Honeybee and the Coming Agricultural Crisis and the author is Rowan Jacobsen.  Many books on biodiversity have bad economics but this book has very good economics:

Sometimes the fraud is chemical, as when rice syrup is doctored to resemble honey, and sometimes it’s ontological.  For instance, what is honey?  If you answered something like "a syrup made entirely out of nectar by bees," then consider yourself hopelessly out-of-date.  Let me introduce you to "Packer’s Blend," the latest offering from China.  It appeared on the market in 2006, shortly after the bond-posting loophole was closed by Congress.  Chinese honey may be subject to tariffs, but if a product is less than 50 percent honey, it isn’t covered by the law.  This "funny honey," as beekeeprs call it, is between 40 and 49 percent honey.  The rest is syrup; corn syrup, but also rice syrup, lactose syrup — whatever’s on hand and cheap.  The importers who bring in these blends may sell them to manufacturers as blends or as pure honey, adding some nice American or Canadian clover honey to give the blend a semblance of the real thing and get it past the manufacturers.

This book also offers a thoughtful analysis of the dangers facing biodiversity, a fascinating look at what Gordon Tullock called "the economics of insect societies," and a revision of Steven Cheung’s "Fable of the Bees" (the story now involves almond growers in a major role).  It is one of the best popular science books I have read in the last few years.