Month: February 2012

J.C. Bradbury emails me on the allocation of talent

by  Tyler Cowen in

I hope you are doing well. I have a Micro III question that I thought might interest you. I often have such Tyler questions, but keep them to myself, yet this morning I decided to share with you.

What does Jeremy Lin tell us about talent evaluation mechanisms? This article ( http://www.wired.com/wiredscience/2012/02/what-jeremy-lin-teaches-us-about-talent/?utm_source=dlvr.it&utm_medium=twitter ) argues that the standard benchmarks for evaluating basketball and football players at the draft level are flawed. The argument is that Jeremy Lin couldn’t get the opportunity to succeed because his skill wasn’t being picked up by the standard sorting procedure. This got me thinking.  Baseball sorts players in a different way than basketball.  In professional basketball (and football), college sports serve as minor leagues, where teams face a high variance in competition (the difference between the best and worst teams in a top conference is normally quite large), with very little room for promotion. There is some transferring as players succeed and fail at lower and higher levels, but for the most part you sink or swim at your initial college. This is compounded by the fact that the initial allocation of players to college teams is governed by a non-pecuniary rewards structure with a stringent wage ceiling, which likely hinders the allocation of talent.  At the end of your college career, NBA teams make virtually all-or-nothing calls on a few players to fill vacancies at the major-league level.  In baseball it’s different. Players play their way up the ladder, and even players who are undrafted can play their way onto teams at low levels of the minor league. At such low levels, the high variance in talent is high like it is in college sports; however, promotions from short-season leagues through Triple-A, allow incremental testing of talent along the way without much risk.  I have looked at metrics for predicting major-league success from minor-league performance and found that it is not until you reach the High-A level (that is three steps below the majors) can performance tell you anything.  Players in High-A who are on-track for the majors are about-the age of college seniors.  Performance statistics from Low-A and below have no predictive power. Baseball is also much less of a team game than basketball, so this should make evaluation easier in baseball but it is still quite difficult by the time most players would be finishing college careers.  Also, a baseball scout acquaintance, who is very well versed in statistics, tells me that standard baseball performance metrics in college games are virtually useless predictors of performance (this is contrary to an argument made in Moneyball).  Even successful college baseball players almost always have to play their way onto the team.

Back to Lin. He played in the Ivy League and his stats weren’t all that bad or impressive in an environment that is far below the NBA. If Lin is a legitimate NBA player, he didn’t have many opportunities to play his way up like a baseball player does.  In the NBA, he experienced drastic team switches, and even when making a team he received limited opportunities to play. MLB teams often keep superior talent in the minors so that they can get practice and be evaluated through in-game competition.  An important sorting mechanism for labor market sorting is real-time work.  Regardless of your school pedigree, most prestige professions (lawyers, financial managers, professors, etc.) have up-or-out rules after a period of probationary employment where skill is evaluated in real world action. Yes, there is a D-League and European basketball, but the D-league is not as developed as baseball’s minor-league system, and European basketball has high entry cost and may suffer from the same evaluation problems faced by the NBA.  Thus, I wonder if the de facto college minor-league systems of basketball and football hinder the sorting of talent so that the Jeremy Lins and Kurt Warners of the world often don’t survive.  Thus, another downside of these college sports monopsonies is an inferior allocation of talent at the next level.

J.C.’s points of course apply (with modifications) to economics, to economies, and to our understanding of meritocracy, not to mention to how books, movies, and music fare in the marketplace.  Overall I would prefer to see economics devote much more attention to the topic of the allocation of talent.

Here is J.C. on Twitter, here are his books.

Political markets in everything

by  Tyler Cowen in

Forgive the music at the link, from Lucknow:

Your vote would not only change the fate of Uttar Pradesh, but it could also fetch extra marks for your child. In a unique first, many schools in the city have decided to award extra marks to students whose parents will cast vote in the assembly election.

And there is this:

The incentive would not be limited to exams alone, it would also find a mention in the character certificate of a student. Mishra suggested that a column for marking whether or not the child successfully convinced his/her parents to vote and hence displayed a sense of civic consciousness will be added in the report card. In case of a student is of 18 years then the relevant entry will be a mark on his/her own performance on the election day.

For the pointer I thank Sharath Rao.

What good are hedge funds?

by  Tyler Cowen

How can they beat the market consistently, especially if we take EMH seriously at all?  And if they don’t beat the market, how is 2-20 to be justified?  Here is a snippet from an interesting Amazon review:

…this kind of comparison misses the entire point of most hedge funds. A market-neutral fund is not designed as a stand-alone investment, but as a diversifier for an equity portfolio. It can have half the return of equities with the same volatility, and still be valuable. The question isn’t whether putting 100% of your money in hedge funds did better than putting 100% in stocks, it’s what portion of assets an investor should allocate to hedge funds. Using the author’s own numbers, an investor would have done best to have 30% of assets in hedge funds, rebalancing annually, from 1998 to 2010. That produced 4.2% annual alpha (return in excess of what you could have gotten investing in stock index funds and t-bills with the same volatility). That number is certainly overstated, hedge fund investors typically do worse than the index suggests, but it demonstrates that you can’t consider only stand-alone returns. This point is borne out by the finding that endowments and pension funds that make use of hedge funds have consistently better risk-adjusted performance than those that do not.

The review, by Aaron C. Brown, offers other points of interest.  I’ve ordered the underlying asset itself (the book) and I will report back on it.  It was reviewed in today’s FT, still no permalink.

Here is a recent story on hedge fund closures.

Assorted links

by  Tyler Cowen

1. Measuring the output gap, an excellent post looking at capacity utilitzation and changes in inflation rates to back out an answer to this question.  The bottom line is that the output gap probably isn’t nearly as large as is often claimed.  And Karl Smith comments, I would note the connection between the ppf and trust.

2. Obama’s hardline turn against medical marijuana.

3. Markets between everything and everyone, and Literary Saloon reviews Allan Meltzer.

4. Testing Milton Friedman, new TV show with Caplan, Yglesias, Dalmia, Williams, others.

5. Graphs about Hollywood.

The Patrick Melrose novels

by  Tyler Cowen in

I usually find “derelict fiction” unappealing (I don’t for instance enjoy Trainspotting, although I admit its aesthetic merits, nor did I like Drugstore Cowboy; someone should write an essay on the merits and demerits of drug-based fiction), but these books are for me compulsively readable and the prose is more vital than almost anything else being written.  They are by Edward St. Aubyn and you can buy the first four of them here, the final one here.   By no means should you let these novels be defined by their excerpts, but here are a few:

How could he ever hope to give up drugs?  They filled him with such intense emotion.  The sense of power they gave him was, admittedly, rather subjective (ruling the world from under the bedcovers, until the milkman arrived and you thought he was a platoon of stormtroopers come to steal your drugs and splatter your brains across the wall), but then again life was so subjective.

And:

If he got her he would give up drugs forever, or at least have someone really attractive to take them with.  He giggled wildly, wrapping a towel around himself and striking back into his bedroom with renewed vigour.

And:

Fergus took me to the coast and forced me to go snorkeling.  All I can say is that the Great Barrier Reef is the most vulgar thing I’ve ever seen.  It’s one’s worst nightmare, full of frightful loud colours, peacock blues, and impossible oranges all higgledy-piggledy while one’s mask floods.

If you are wondering, drug addiction is a central theme in only some of these books, no more than half actually.  There are also scenes of child abuse, family, and Australia.

Does unemployment drive rebellion?

by  Tyler Cowen in

Maybe not.  There is a new piece out by Eli Berman, Michael Callen, Joseph H. Felter and Jacob N. Shapiro, in Journal of Conflict Resolution, August 2011.  Here is an ungated version, excerpt:

Most aid spending by governments seeking to rebuild social and political order is based on an opportunity-cost theory of distracting potential recruits. The logic is that gainfully employed young men are less likely to participate in political violence, implying a positive correlation between unemployment and violence in places with active insurgencies. We test that prediction on insurgencies in Iraq and the Philippines, using survey data on unemployment and two newly- available measures of insurgency: (1) attacks against government and allied forces; and (2) violence that kills civilians. Contrary to the opportunity-cost theory, we find a robust negative correlation between unemployment and attacks against government and allied forces and no significant relationship between unemployment and the rate of insurgent attacks that kill civilians.

Here is a WQ summary of some additional findings from the paper.

A wee bit of financial history

by  Tyler Cowen in

From William R. Gruver:

If March 4, 1933, and February 11, 2009, marked the nadirs of public confidence in Wall Street, then the years 1928 and 1999 marked the zeniths, when Goldman Sachs sold shares to the public for the only two times in its history. In December 1928, the partners of Goldman Sachs sold shares in a subsidiary called Goldman Sachs Trading Corporation–for its day, a complex, highly leveraged instrument with many layers that made transparency all but impossible. By the time of Roosevelt’s inauguration in 1933, the shares were nearly worthless. For the next 70 years, burned by that experience and FDR’s excoriation in 1933, the firm’s partners retreated to their roots as a private partnership, using their own personal capital with only modest leverage to advance their role as a financial intermediary.

By 1999, Goldman’s reputation had recovered to its previous zenith–to the point that a public offering again was possible. Its partners had debated the merits of such a change for years, and, even when the decision was made to go forward, the decision was reached only after vigorous debate and much disagreement. In favor of going public were those partners who saw a need for a larger capital base to allow the firm to compete in the increasingly globalized economy with the larger players both in the U.S. and overseas. Furthermore, once a public market was established for its shares, Goldman would have a currency other than cash with which to acquire other businesses and grow into financial services it could not afford to enter as a private partnership. On the other side of the argument were those partners who were worried about the impact that transition to a public firm would have on the firm’s culture. Heretofore, the firm had been known for its low ego and gang-tackling ethos, with aggressive personalities kept in check by the partnership potential that was strongly linked to both productivity and cultural fit.

What neither the firm’s partners nor outside observers were able to foresee was the resulting change in the firm’s risk tolerance…

For the pointer I thank John Phillips.

*Library Journal* review of *An Economist Gets Lunch*

by  Tyler Cowen in

Part In Defense of Food: An Eater’s Manifesto and part Roadfood, this is a culinary coming-out party for Cowen (economics, George Mason Univ.), who up to now has been known for more standard economic works like The Great Stagnation. This latest book combines economic and environmental messages, all written in a highly entertaining and informative style—often with a counterintuitive twist. The real story, though, is the author and his techniques for finding and eating delicious, inexpensive food from all over the world. Thus, we get tips on how to obtain good Chinese food from local, not-so-authentic places; which strip malls are likely to have the best restaurants (who knew they were in strip malls to begin with?); using Google to turn up unexpected restaurant gems; and why places filled with fun, laughing, drinking people often don’t have good food. An entire chapter is devoted to barbecue, and another provides specific suggestions for eating well in numerous countries.

VERDICT A fun and informative book that environmentalists, economists, and (most of all) foodies will enjoy. Recommended for all. [See Prepub Alert, 10/7/11.]—Susan Hurst, Miami Univ. Libs., Oxford, OH

Scott Winship summary on mobility and inequality

by  Tyler Cowen in

Read it here, excerpt:

…evidence on earnings mobility in the sense of where parents and children rank suggests that our uniqueness lies in how ineffective we are at lifting up men who were poor as children. In other words, we have no more downward mobility from the middle than other nations, no less upward mobility from the middle, and no less downward mobility from the top. Nor do we have less upward mobility from the bottom among women. Only in terms of low upward mobility from the bottom among men does the U.S. stand out.