Month: October 2010

Negative real rates of return

Inflation-protected securities sold at negative yields for the first time ever on Monday as traders anticipate that the Federal Reserve will start a new round of asset purchases.

There are liquidity issues, hedging issues, reinvestment risk issues, supply-side finance management issues, and so on.  This does not show that our real economy has a negative real rate of return.  Maybe, for reasons of institutional constraint, people buy these securities as an inflation hedge rather than investing in the real economy.  Still…

There is more here.

Question: When the measured expected real return is below zero, how well can any recovery program work?  

Popularizing the Arrow Impossibility Theorem

Arnold Kling presents it as an under-popularized idea, so here is my attempt to popularize it:

Let's say you had two people on a desert island, John and Tom, and John wants jazz music on the radio and Tom wants rap.  Furthermore any decision procedure must be consistent, in the sense of applying the same algorithm to other decisions.  In this set-up (with a further assumption), there is only dictatorship, namely the rule that either "Tom gets his way" or "John gets his way."

Arrow's axioms, by invoking "the independence of irrelevant alternatives" (read: pairwise comparisons) require that all information in the problem be ordinal.  A decision procedure such as: "Turn the radio (and allocate other resources) to which station makes the winner happier" is ruled out per se.  Which person is happier cannot be expressed in the language of pairwise comparisons, which allow you to claim only that "John prefers jazz to rap" and so on.  "Let Tom and John trade" also won't do, whether or not transactions costs are high.  That's not a social welfare function as Arrow defined it.

I sense the above paragraph isn't a very charming popularization (it wouldn't make the Freakonomics movie), but let's continue.

That's a two-person example.  With 17 persons, Arrow's clever method of partitioning shows that conflicted decisions ultimately must break down to one-on-one comparisons of different individual preferences, returning us to the island/radio example.

For a truly popular audience, you could go on about the difference between inter-profile and intra-profile social welfare functions.

I believe that a popularized version of Arrow's theorem, which explains where the main result actually comes from (strong IIA), is not very impressive to most people.  That may be one reason why the theorem doesn't get popularized so much.

Here is one very good transparent version of a proof, which requires virtually zero mathematics.  If you work through this paper, you will understand the theorem and where it comes from.  Here is a related journal article.

Real vs. nominal exchange rates

Ed Dolan writes:

In nominal terms, the yuan has strengthened about 2.5% since China's June 19 decision to ease its currency policy. That works out to an annualized rate of nominal appreciation of almost 8%. The simplest way to calculate real appreciation is to add on the difference between China's inflation rate (3.5%, according to August data) and US inflation (about 1%, or even less if the dip in the September figures holds up). Doing so gives us an annual rate of real appreciation of more than 10%. Two or three years of that would pretty well eliminate the 20 to 40% undervaluation that critics are talking about.

I would stress the point that the general rate of inflation is not the ideal measure here (what is the inflation rate for tradeables or would-be tradeables?), but the point remains an important one.

Which economic ideas are hard to popularize?

Ryan, a loyal MR reader, asks:

1. What are the most important economic ideas that are not popularized, i.e. not accessible to laypeople in books and articles by credible authors? …Are there any theories that have gained traction over competing theories based primarily on their ability to be more easily conveyed to a layperson audience as opposed to their providing a better solution to a particular problem?

As for non-popularized theories, I have a few nominations. First, the sensitivity of many economic results to assumptions about Bertrand, Cournot-Nash, and other solution concepts is not easily popularized.  Second (until the Cowen-Tabarrok macro text), the Solow growth model was not easily popularized.  The difference between a "once-and-for-all" change and a "change in the rate of growth" is not well understood, probably not at any level, yet it is important.  Tax incidence theory is not easily popularized, although an incorrect version of it — "they'll pass it all along to consumers" — circulates.

Most behavioral economics can be easily explained in popular terms and that partially accounts for its broad influence.  Most people are also capable of grasping a crude version of Keynesian economics, albeit without the subtleties of Keynes ("we should spend more" resonates).  The insights of supply-side economics and monetarism have been popularized without much difficulty.

Most of all, it is hard to popularize "maybe" claims, agnoticism, uncertainties, confidence intervals, and contingencies.  The marketing process encourages excess certainty.

In terms of good but hard to popularize economic theories, what else can you think of?

Words of wisdom

The best advice about how to conduct yourself at work is to know yourself, and get new information–from outside your own experience–about what is possible in the world. And that is what fiction, and plays, and poetry, and this blog, are about.

More here.  I thank Alex and Garett for having done a short (very short) jaunt to El Salvador with me; more on that soon.


The iTunes version of 4'33" offers all three movements, a snip at $1.99.  Strangely, they only add up to 4'31".  You might have thought a duration of four minutes and thirty-three seconds the minimum prerequisite for a recording of 4'33": apparently not.

That is by Wesley Stace, from his review "Hush Now: The silent of music and the music of noise," TLS 15 October 2010.

The Industrial Organization of the Miami Heat

A new study by Northwestern's Adam Galinsky looked at 11 NBA seasons and found that on average, teams that pay one star a lot and the rest not as much, win more games.  "The study shows how pay is tied up with status," Galinsky says.  Exhibit A: Kobe.  He makes nearly 25 mil a year, roughly equal to all the subs combined.  That payscale ensures his teammates know their roles, and that leads to better team play.  In Miami, LeBron, Chris Bosh and D-Wade all earn about the same.

That is from the new ESPN magazine, not yet on-line.  Here is one related bit:

“Status is such an important regulating force on people’s behavior, hierarchy solves so many problems of conflict and coordination in groups,” says Adam Galinsky, a psychologist at Northwestern University’s Kellogg School of Management who did the research on social hierarchies on basketball teams. “In order to perform effectively, you often need to have some pattern of deference.”

Here is Galinsky's home page, and here, though I cannot find the NBA paper on-line.   

When I look at the Miami Heat, I think of Bengt Holmstrom, and his models of why the input suppliers in a firm require strong external constraint.  When I look at the Miami Heat, I think of Hart and Moore 1990 — their chef, skipper, and tycoon example – which suggests a successful small enterprise should not have three separate veto points.

Overall, I put greater stock in Holmstrom, Hart, and Moore (and Bryant) than I do in James, Bosh, and Wade.

Life inside the PPF

The plane came down despite no apparent mechanical problems during an internal flight in the Democratic Republic of Congo.

It has now emerged that the crash was caused by the concealed reptile escaping and causing a stampede in the cabin, throwing the aircraft off-balance

A lone survivor apparently relayed the bizarre tale to investigators.

The crocodile survived the crash, only to be dispatched with a blow from a machete.

The goal had been arbitrage, namely to sell the crocodile in the destination locale.  The full story is here and for the pointer I thank A.L. and also R.

*Why the West Rules — For Now*, the new book by Ian Morris

Most of the book is intelligent, well-sourced, easy to read, and non-dogmatic.  It is a "big book" on the scale of Jared Diamond or Paul Kennedy and the author is obviously highly intelligent.  There is a good use of archaeology and mostly the author supports geographical theories of the rise of the West and other civilizations.  It considers energy use, urbanization, and war-making explicitly, all pluses in my view.  Eventually you realize it is going nowhere and has only a weak theoretical framework.  The first two-thirds are still better to read than most books.  It raised my opinion of the importance of coal in the Industrial Revolution.  The final chapter collapses into the lamest of conventional wisdoms.

The WSJ gave it a big review which somehow I cannot find on-line.  Here are other reviews.

Parentheticals to ponder

Geoffrey Johnson, who gave a speech that attempted to debunk any ideas that a machine could have emotions or self-consciousness and could, therefore, be said to think in a human way (Johnson was a pioneer of the frontal lobotomy).

That is from Jane Smiley's new and worthwhile The Man Who Invented the Computer, The Biography of John Atanasoff, Digital Pioneer.  My favorite part of the book was the discussion of Konrad Zuse, who deserves his own popular biography.

What does a utilitarian approach to animal rights suggest?

The most dangerous form of malaria originated in gorillas…

And AIDS seems to have come from chimpanzees.

Add up the numbers and figure out the utilitarian-preferred policy.

That is one reason why I believe a pure utilitarian approach to animal (or human animal) welfare does not work, namely that it leads to morally horrible consequences.  This is one topic I wished I had brought up with Peter Singer.