Month: October 2010

*Washington: A Life*, by Ron Chernow

When the news from Boston reached Mount Vernon around New Year's Day, Washington deplored the methods of the tea party, even if he loathed the tax on tea.  It was the next step in a fast-unfolding drama that would fully radicalize him.  The administration of the bluff, portly Lord North had decided that Boston should pay for the destroyed tea and that Parliament should assert its supremacy, cracking down on harebrained schemes of independence now beginning to ferment in the colonies…the tea party convinced many British sympathizers that colonial protestors had become a violent rabble who had to pay a steep price for their inexcusable crimes.

I read only a few hundred pages of this book.  The level of quality is high, but I find Alexander Hamilton's life much more interesting.  This book does have an especially good discussion of Washington's contradictory attitudes and behavior toward his slaves.

Two unemployment puzzles

The first puzzle about unemployment when thought about from within the search-matching framework is that unemployment rates are highest among the least skilled and most homogeneous skills, i.e. among those worker/jobs with the easiest matches.  It's hard to believe that it takes a year to match a construction worker to a job.  

Closely related is the issue of how much uncertainty is holding back employment. The case for uncertainty is that hiring a worker is like exercising an option–once you hire, there are sunk costs of hiring (and potentially firing) that go beyond the wage such as administrative and training costs.

Note that you may not need a lot of uncertainty (i.e. you may not need regime uncertainty) to reduce hiring because you don't have to explain why firms aren't hiring only why they aren't hiring this day.  Even if we assume, for example, that hiring would be profitable, all else equal, it doesn't take much uncertainty to make it worthwhile to delay hiring a little bit, to wait and see.  It's precisely when sales are low and unemployment is high that firms don't mind waiting because uncertainty may resolve in due course and the workers aren't going away.

Ok, that's the positive case for uncertainty but the second puzzle is that uncertainty should matter most when hiring and firing costs are high and once again these costs are lowest for those workers with the greatest unemployment rates.  It's one thing not to hire when you can't fire but when firing is easy what's the risk? Moreover, unemployment has increased more in the United States than in Europe even though hiring and firing costs are higher in Europe.

Search-matching models of unemployment have a lot to add but don't necessarily overthrow the importance of AD shocks, sticky wages and prices and other sources of unemployment.

What next on climate change?

David Leonhardt has a very interesting column, here is one excerpt:

…history shows that government-directed research can work. The Defense Department created the Internet, as part of a project to build a communications system safe from nuclear attack. The military helped make possible radar, microchips and modern aviation, too. The National Institutes of Health spawned the biotechnology industry. All those investments have turned into engines of job creation, even without any new tax on the technologies they replaced.

“We didn’t tax typewriters to get the computer. We didn’t tax telegraphs to get telephones,” says Michael Shellenberger, president of the Breakthrough Institute in Oakland, Calif., which is a sponsor of the proposal with A.E.I. and Brookings. “When you look at the history of technological innovation, you find that state investment is everywhere.”

Here's the good news, sort of: we often hear, especially from left of center economists, that ideas are a public good which require subsidy, especially at the level of pure science.  This argument has a strong pedigree, most of all from Kenneth Arrow.  In that framework, if the relevant idea is a public good, a higher price of fossil fuels may not encourage its creation very much.  If oil and coal are more expensive, it's still not worth it for a single firm or institution to produce this public good.  If you think that technologically, we are fairly far from solving the problem (my view), you will be less crushed by the absence of a price incentive for something which is a public good anyway.

If you think we are fairly close to solving the technological problem — maybe souped up wind, nuclear, and hybrids can do it — then you should be quite disappointed by our inability to raise the price of fossil fuels.  The switch to the already-available technologies is at least partially a private good and a higher price for fossil fuels would help a lot.

There is a kind of "utility diversification" at work here.  If you are happy on "technological closeness," you are very unhappy on "policy implementation."  If you are unhappy on technological closeness, you are less unhappy about failures at the policy level.

I believe we are far at the technological level because of institutional constraints.  Wind and nuclear, whatever you think of them, run into fierce local opposition and they are not allowed to reach their potential.  It seems we're only going to adopt a solution which is quite easy and cheap in any case, and doesn't crash into NIMBY; maybe that's a much-improved form of solar.  And with that constraint in place, our inability to raise the price of fossil fuels may matter less than is sometimes suggested.  Maybe only really cheap solutions will be adopted in any case and the rate of their discovery may depend more on research subsidies than on prices at the user level.

In the meantime, it still makes sense to clean up dirty coal, limit cow farts by taxing meat, and spread better indoor heating and cooking technologies in the poorer countries.

Addendum: Here is more from Leonhardt.

The Mortensen and Pissarides employment model

I have been seeing and hearing misunderstandings of it.  Here is one link to the piece and here are a few points:

1. Simulating the model, it is possible to generate something approximating the time series of U.S. employment changes, at least up through the 1990s.

2. This can be done by combining shocks to labor productivity, as measured (not calibrated to get the required result), combined with changes in search and matching profitability.  No bizarre assumptions are required about the intertemporal substitutability of leisure, as the matching function does the work in this regard.

3. The results do not require sticky wages or AD shocks.  Do not.

4. Mortensen and Pissarides do not explain "structural unemployment" in the traditional sense.  Instead the model shows that one overall negative shock — to all sectors — can make good matches harder.  In other words, unemployment can look like it is structural when it is not and in this regard the model can be viewed as a threat to traditional structural explanations.  Furthermore unemployment can look like it is AD shock-induced even when it is not.  Another way to read the model (my words, not theirs) is that it deconstructs the traditional distinction between cyclical and structural unemployment.

5. The model is built upon earlier theoretical contributions by Peter Diamond, but it is a mistake to speak of a unified Diamond-Mortensen-Pissarides model.  I read Diamond's view as closer to Keynesianism and the Mortensen and Pissarides story as much more Schumpeterian.  It is worth reading Paul Krugman's MIT-centric account of the prize, though I would stress the diversity of views among the winners.

6. Mortensen and Pissarides do not analyze monetary and fiscal policy in their basic model, but it is not obvious that such reflationary policies will solve the employment problem, which is defined in real terms, not nominal terms.

7. In the pure model, the Beveridge curve can have either slope and so we should not infer much from an observed Beveridge curve.

The Mortensen-Pissarides model is daring and subversive and it is impressive that the committee would award a prize for what is essentially a single paper.  Yet I don't see too many bloggers trying to come to terms with it.

How would Beijing respond to yuan revaluation?

Most of all the Chinese leadership is worried about maintaining jobs (sound familiar?).  And so:

It will lower real interest rates and force credit expansion 

This of course will have the effect of unwinding the impact of the renminbi appreciation.  As some Chinese manufacturers (in the tradable goods sector) lose competitiveness because of the rising renminbi, others (in the capital intensive sector) will regain it because of even lower financing costs.  Jobs lost in one sector will be balanced with jobs gained in the other.

But there will be a hidden cost to this strategy – perhaps a huge one.  The revaluing renminbi will shift income from exporters to households, as it should, but cheaper financing costs will shift income from households (who provide most of the country’s net savings) to the large companies that have access to bank credit.  So China won’t really rebalance, because this requires a real and permanent increase in the household share of GDP.  Instead what will happen is that it will reduce Chinese overdependence on exports and increase China’s even greater overdependence on investment.

This will not benefit China.  It will fuel even more real estate, manufacturing and infrastructure overcapacity without having rebalanced consumption.  Expect, for example, even more ships, steel, and chemicals in a world that really does not want any more.

That's from Michael Pettis, and here is more.

Gay Sex Statistics

OKTrends has another great post, gay sex v. straight sex, analyzing data on millions of customers who use the dating site OKCupid.  Here is one piece of the long post that I found surprising.

Another common myth about gay people is that they sleep around, but the statistical reality is that gay people as a group aren't any more slutty than straights.

Median Reported Sex Partners

  • straight men: 6
  • gay men: 6
  • straight women: 6
  • gay women: 6

Here's how the distribution curves compare:

  • 45% of gay people have had 5 or fewer partners (vs. 44% for straights)
  • 98% of gay people have had 20 or fewer partners (vs. 99% for straights)

It turns out that a tiny fraction of gays have single-handedly two-handedly created the public image of gay sexual recklessness–in fact we found that just 2% of gay people have had 23% of the total reported gay sex, which is pretty crazy.

Evaluating the Millennium Villages

Michael Clemens writes:

Here I discuss a new research paper that I wrote with Gabriel Demombynes of the World Bank. We ask when it’s important to take great care in measuring a project’s impacts, and we illustrate one concrete case: the Millennium Village Project. We show how easy it can be to get the wrong idea about the project’s impacts when careful, scientific impact evaluation methods are not used. And we detail how the impact evaluation could be done better, at low cost.

There are some good graphs at the first link and here is the associated podcast.

Lionel W. McKenzie has passed away at 91

Here is his Wikipedia page.  McKenzie was one of the most important figures in proving the existence of a competitive general equilibrium and also in developing the turnpike theorem.  Here is a short bio.  He was a formative factor in founding and shaping the graduate economics program at the University of Rochester, where he taught for decades.  He was especially famous in Japan for having taught and guided so many Japanese doctoral students.  His paper "Demand theory without a utility index" remains a classic, as it helped show how much of standard economics was independent of particular assumptions about utility.  He was an early influence on the idea of computing economic equilibria.  He also had respected papers in trade theory; here is McKenzie on

Google is constructing a price index

Google is using its vast database of web shopping data to construct the ‘Google Price Index’ – a daily measure of inflation that could one day provide an alternative to official statistics.

Google has not yet decided whether it will publish its index, but "Mr Varian said that the GPI shows a “very clear deflationary trend” for web-traded goods in the US since Christmas."

The full article is here, including the story of Hal Varian's pepper grinder and for the pointer I thank Brent Depperschmidt.

Economic Misconceptions

Students typically come to an economics class with many misconceptions, not just random errors but systematic biases (see especially Caplan 2002).

Bill Goffe recently (2009) surveyed one of his macro principles classes and found, for example, that the median student believes that 35% of workers earn the minimum wage and a substantial fraction think that a majority of workers earn the minimum wage (Actual rate in 2007: 2.3% of hourly-paid workers and a smaller share of all workers earn the minimum wage, rates are probably somewhat higher today since the min. wage has risen and wages have not).

When asked about profits as a percentage of sales the median student guessed 30% (actual rate, closer to 4%).

When asked about the inflation rate over the last year (survey was in 2009) the median student guessed 11%.  Actual rate: much closer to 0%.  Note, how important such misconceptions could be to policy.

When asked by how much has income per person in the United States changed since 1950 (after adjusting for inflation) the median student said an increase of 25%.  Actual rate an increase of about 248%, thus the median student was off by a factor of 10.

I would add that there are also theoretical misconceptions that are probably even more important than factual misconceptions.  For example, I think it would be useful to ask questions such as:

1.  A number of new furniture manufacturers open in North Carolina, since the new competition forced existing manufacturers to reduce prices the effect of this additional competition was to reduce wages for workers in the furniture industry.

Rate this argument on a 1 to 10 scale from least to most plausible or likely.

2.  Competition from Korean automobile manufacturers caused US manufacturers to cut quality in order to reduce their costs.  Rate this argument on a 1 to 10 scale from least to most plausible or likely.

3.  A law that prevents supermarkets from advertising the prices of their products will reduce the supermarket costs and in turn this will reduce prices to consumers. Rate this argument on a 1 to 10 scale from least to most plausible or likely.

Note that the point here is not to say that an answer is wrong but to understand the implicit models that students are using. It can help a teacher to know what these conceptions and misconceptions are in advance so that they can be addressed.

To further this research, Bill Goffe is putting together a colloborative database on economic misconceptions that teachers are welcome to contribute towards.  See also Bill's page on the large literature on teaching in physics much of which is also relevant to economics.