Nicholas Tabarrok, Guest Blogger
Variety recently named my movie-producer brother, Nicholas Tabarrok, one of 10 Producers to Watch. Starting tomorrow he will be guest blogging for a week here at Marginal Revolution. Nicholas's firm, Darius Films, has produced a lot of good indie movies including Weirdsville, Cooper's Camera (starring Daily Show veterans Jason Jones and Samantha Bee) and one of my favorites The Life and Hard Times of Guy Terrifico which features Kris Kristofferson, Merle Haggard and many other country stars. His latest is Defendor, one of the few films to sell this year at the Toronto film festival and starring Woody Harrelson, Kat Dennings and Sandra Oh. No blockbusters or Academy Awards yet but Nick's track record of bringing investors, stars, directors and actors together–all of whom are utterly crazy in their own way– to make movies on-budget and on-time is truly amazing.
I'm not sure what he will be blogging this week but if you have questions or ideas to suggest feel free to put them in the comments.
Is Real Business Cycle Theory Dead?
No. Real business cycle theory is alive and kicking. If we write Y=a*F(K,L) and call “a” technology then an RBC theory is mostly about how fluctuations in “a” change output. Amusingly, Brad DeLong calls this the great forgetting theory of recessions and indeed it is hard to see how we could forget about technology, thus reducing output in some periods. But this view takes the term technology too literally.
I am in my office every day (L=1), my computer is here every day (K=1) but my output and thus my productivity fluctuates. Why? It’s not that I forget how to use STATA. Some days, however, a reporter calls and distracts, another day I need to tidy my office, on other days creativity just doesn’t strike. In short, everyone recognizes that at a micro-economic level productivity fluctuates a lot so why should macro productivity follow a smooth process?
In fact, there is a standard answer to that question which is the law of large numbers–spread idiosyncratic productivity shocks across many firms and in the aggregate volatility will be low. In an important paper, The Granular Origins of Aggregate Fluctuations, Xavier Gabaix takes on this answer with a simple but important point: large firms matter.
In the United States, for example, sales of the top 100 firms account for about 30% of GDP. (The share is even larger in most other developed economies.) In fact, we know from my GMU colleague, Robert Axtell, that firm size follows Zipf’s law. As a result, large firms get larger in larger economies so that firm-level productivity shocks do not disappear in the aggregate even in large economies.
Gabaix shows theoretically that combining idiosyncratic shocks and Zipf’s law for firm size can produce significant fluctuations in GDP. Empirically the difficulty is to distinguish aggregate shocks from firm-specific or sectoral shocks. Using one plausible, but no doubt debatable decomposition, Gabaix shows that idiosyncratic shocks to the top 100 firms can explain about one-third of aggregate volatility.
The bottom line is that Gabaix has opened the way for a much richer real business cycle theory in which real shocks can be identified and tied to specific firms and through transmission mechanisms these real shocks can affect the aggregate economy.
Assorted Links
- Predictions markets fail to win the gold. Blame it on Rio.
- "Inside the Wayne County morgue in midtown Detroit, 67 bodies are piled up, unclaimed, in the freezing temperatures. Neither the families nor the county can afford to bury the corpses. So they stack up inside the freezer…You can smell the plight of Detroit."
- A very good video profile of Tyler, who was honored yesterday at GMU for his many contributions to scholarship.
Teacher Performance Pay: Experimental Evidence from India
In an impressive new paper, Karthik Muralidharan and Venkatesh Sundararaman provide evidence on the power of teacher incentives to increase learning. The paper is impressive for three reasons:
1) Evidence comes from a very large sample, 500 schools covering approximately 55,000 students, and treatment regimes and controls are randomly assigned to schools in a careful, stratified design.
2) An individual-incentive plan and a group-incentive plan are compared to a control group and to two types of unconditional extra-spending treatments (a block grant and hiring an extra teacher). Thus the authors can test not only whether an incentive plan works relative to no plan but also whether an incentive plan works relative to spending a similar amount of money on "improving schools."
3) The authors understand incentive design and they test for whether their incentive plan reduces learning on non-performance pay margins.
The results are as follows:
We find that the teacher performance pay program was highly effective in improving student
learning. At the end of two years of the program, students in incentive schools performed
significantly better than those in comparison schools by 0.28 and 0.16 standard deviations (SD)
in math and language tests respectively….We find no evidence of any adverse consequences as a result of the incentive programs.
Incentive schools do significantly better on both mechanical components of the test (designed to
reflect rote learning) and conceptual components of the test (designed to capture deeper
understanding of the material),suggesting that the gains in test scores represent an actual
increase in learning outcomes. Students in incentive schools do significantly better not only in
math and language (for which there were incentives), but also in science and social studies (for
which there were no incentives), suggesting positive spillover effects….School-level group incentives and teacher-level individual incentives perform equally well in
the first year of the program, but the individual incentive schools significantly outperformed the
group incentive schools in the second year….We find that performance-based bonus payments to teachers were a significantly more cost
effective way of increasing student test scores compared to spending a similar amount of money
unconditionally on additional schooling inputs.
Surprisingly, since absent teachers are a big problem in India, reduced teacher absenteeism per se does not appear to be the primary mechanism by which incentives improve learning. Instead the primary mechanism appears to be more intensive teaching, including more homework and classwork and better attention to weaker students, this greatly increases the relevance of these results to teaching in the developed world.
Addendum: See also Karthik's comments on the comments at 26.
Progress
Sobering Reality
The Stiglitz-Prescott View
Here is Nobel prize-winner Joseph Stiglitz quoted by Free Exchange:
We’ve really extended the safety net beyond to big to fail, and my view is that there’s been no convincing argument that any of this was ever needed. It was based on the notion of fear – that if you didn’t do it, the whole financial set of markets would fail. Economics would have suggested that if you did a debt to equity conversion, converting long-term debt into equity, the financial institution would be well capitalized, there would be no reason to panic, and there would be more confidence in the market. But those who saw an opportunity to use scare tactics to get what they wanted did use those scare tactics, and it worked.
Here is Nobel prize-winner Ed Prescott quoted by Brad DeLong:
[P]eople got scared…. The press scared people. People running for office scared people. Bernanke scared people; Paulson scared people…. [P]eople began not to know what was going to happen. Then they stopped investing–by investing, I mean getting a new car or fixing up your house. And that led to the economy–it was depressed a bit that fourth quarter of last year…[With] benign neglect the economy would have come roaring back quite quickly…
Free Exchange says that Joseph Stiglitz's views are "insane" and Brad DeLong says that Prescott "does not live in the consensus reality with the rest of us." I am not sure why they are so confident.
Cartels and The Informant!
In the new Steven Soderbergh movie, The Informant!, Matt Damon plays Mark Whitacre, the Archers Daniel Midland executive who blew the whistle on the international lysine cartel. The movie is getting good early reviews but if you are strapped for time, Marginal Revolution has the key scene courtesy of a hidden camera. I love the opening and the section beginning around 2:05 as the conspirators discuss who is coming to the meeting is priceless.
Tyler and I feature this case in our chapter on cartels in Modern Principles: Microeconomics.
Enjoy the movie!
Assorted Links: God and Mammon Edition
- Art Carden asks can Francisco's money speech be reconciled with 1 Timothy 6:9-10 KJV?
- Can Christians be Capitalists?, AEI wants to know.
- "Accountants and clergy are both well educated and intelligent, yet we
pay accountants a lot more than the clergy. Is this because we care
more about money than about God?" Robert Whaples explains.
Teacher Absence in the United States
Yesterday I looked at teacher absence in the developing world, highlighting India where a quarter of teachers may be absent on a given day. Teacher absence isn't that high in the United States but it is still shockingly high. On a typical school day, 5-6% of teachers are absent, i.e. equivalent to an absence once every 20 days!
Bearing in mind that the typical school year is 180 days, add absences to all the school holidays, teacher workdays, staff development days (btw, ever seen a Walmart shutdown for a staff development day?), and other non-teaching days (e.g. in Fairfax, Mondays are half-days) and the number of days of true teachng greatly diminishes.
Teachers probably do get sick more often than other workers but teacher absence rates are three times higher than for managers and professional employees in the private sector. Moreover, are you surprised to learn that teacher absences are most frequent on Mondays and Fridays or that teacher absences are of a duration just short of that requiring medical certification of illness?
Finally, teacher absences reduce student achievement both in the United States and in the developing world.
Teacher Absence in the Developing World
In South Africa the problem of teacher absence is so bad that frustrated students rioted when teachers repeatedly failed to show up for class. But the problem is not limited to South Africa, teachers are absent throughout the developing world. Spot checks by the World Bank, for example, indicate that on a typical day 11% of teachers are absent in Peru, 16% are absent in Bangladesh, 27% in Uganda and 25% in India.
Even when teachers are present they are often not teaching. In India, where a quarter of the teachers are absent on any particular day, only about half of those present are actually teaching. (These are national averages, in some states the problem is worse.)
The problem is not low salaries. Salaries for public school teachers in India are above the norm for that country. Indeed, if anything, absenteeism increases with salary (and it is higher in public schools than in private schools, despite lower wages in the latter). The problem is political power, teacher unions, and poor incentives.
Teachers are literate and they vote so they are a powerful political force especially where teacher unions are strong. As if this were not enough, in India, the teachers have historically had a guarantee of representation in the state Legislative Councils so political power has often flowed to teachers far in excess of their numbers. As a result, it's virtually impossible to fire a teacher for absenteeism.
The situation in South Africa is not that different than in India. The NYTimes article on South Africa has this to say:
“We have the highest level of teacher unionization in the world, but their focus is on rights, not responsibilities,” Mamphela Ramphele, former vice chancellor of the University of Cape Town, said in a recent speech.
Some reforms are planned in South Africa, including greater monitoring of teacher attendance but this offhand remark suggests the difficulties:
“We must ask ourselves to what extent teachers in many historically disadvantaged schools unwittingly perpetuate the wishes of Hendrik Verwoerd,” [President Zuma] recently told a gathering of principals, implicitly challenging the powerful South African Democratic Teachers’ Union, which is part of the governing alliance (!). (Emphasis added, AT.)
What it means to predict a crisis
Some economists are trying to get macroeconomics off the hook by arguing that by their very nature crises are unpredictable. Thus David Levine aggressively argues that "our models don't just fail to predict the timing of financial crises – they say that we cannot."
There are three problems with this argument. First, it assumes what is it at question – namely whether what Levine calls "our models" are good models. Perhaps behavioral models could better predict the timing of financial crises. I will not push this argument but I do believe that current events call for a greater than normal willingness to think beyond the confines of the models that one defends.
Second, it's not true that "our models" tell us that we can never predict a financial crisis. In some cases, our models predict the exact moment that a crisis will occur and these models are perfectly consistent with, indeed require, rational expectations. It is perhaps no accident that Paul Krugman has specialized in these types of models.
Third, the word timing is misleading. Let's accept that a crisis cannot be predicted to the day or even to the year. Nevertheless, it is perfectly reasonably and fully consistent with rational expectations to predict an increased probability of a crisis.
If you play Russian Roulette with 1 bullet and 100 chambers in your pistol, I can't predict when the crisis will occur. If you play with 10 bullets, I still can't predict when the crisis will occur but I can say with certainty that the risk has increased by a factor of ten. Analogously, nothing in modern economics makes it theoretically impossible to forecast that greater leverage and higher than normal price to rental rates, to name just two possibilities, increase the probability of crisis. Nor does modern theory make it theoretically impossible to forecast that conditions are such that if a crisis does occur it will be a big one.
All of this is true even in the context of stock markets. Efficient markets theory implies that any two stocks will have similar risk-adjusted returns it does not imply that the risk of bankruptcy is the same for any two firms. It is perfectly reasonable to say that Google revenues are going to have to increase at a historically unprecedented rate or the stock will plummet. It is even consistent with efficient markets theory to predict that the probability of Google stock falling is much greater than the probability of it rising (but if it rises it will rise very far, very fast).
Thus the "we could not have predicted the crisis even in theory" argument is a weak defense–even with rational-actor, rational-expectations models there are plenty of senses in which economists could have better predicted the crisis and, although this is yet to be seen, perhaps they could and will do even better with other sorts of models.
The Price of Magic Pills
Greg Mankiw's column today is one of his best. Here are the key points:
Imagine that someone invented a pill even better than the one I take. Let’s call it the Dorian Gray pill, after the Oscar Wilde character. Every day that you take the Dorian Gray, you will not die, get sick, or even age. Absolutely guaranteed. The catch? A year’s supply costs $150,000.
Anyone who is able to afford this new treatment can live forever. Certainly, Bill Gates can afford it. Most likely, thousands of upper-income Americans would gladly shell out $150,000 a year for immortality.
Most Americans, however, would not be so lucky. Because the price of these new pills well exceeds average income, it would be impossible to provide them for everyone, even if all the economy’s resources were devoted to producing Dorian Gray tablets.
So here is the hard question: How should we, as a society, decide who gets the benefits of this medical breakthrough? Are we going to be health care egalitarians and try to prohibit Bill Gates from using his wealth to outlive Joe Sixpack? Or are we going to learn to live (and die) with vast differences in health outcomes? Is there a middle way?
Two Million Books Printable on Demand
Two million out-of-copyright books that have been scanned by Google could come back into limited printed form after the search giant signed a deal with On Demand Books, the company that makes the Espresso Book Machine – a custom book printer able to produce a bound one-off 300-page paperback, with a full-colour cover, in about five minutes.
Leland Yeager on Say’s Law
In a post titled, Friends Don’t Let Friends Mix Say’s Law with Money, David Beckworth of Macro and other Musings quotes the great Leland Yeager:
The catch is this: while an excess supply of some things necessarily mean an excess demand for others, those other things may, unhappily, be money. If so, depression in some industries no longer entails boom in others…
[T]the quantity of money people desire to hold does not always just equal the quantity they possess. Equality of the two is an equilibrium condition, not an identity. Only in… monetary equilibrium are they equal. Only then are the total value of goods and labor supplied and demanded equal, so that a deficient demand for some kinds entails and excess demand for others.
Say’s law overlooks monetary disequilibrium. If people on the whole are trying to add more money to their total cash balances than is being added to the total money stock (or are trying to maintain their cash balances when the money stock is shrinking), they are trying to sell more goods and labor than are being bought. If people on the whole are unwilling to add as much money to their total cash balances as is being added to the total money stock (or are trying to reduce their cash balances when the money stock is not shrinking), they are trying to buy more goods and labor than are being offered.
The most striking characteristic of depression is not overproduction of some things and underproduction of others, but rather, a general “buyers’ market,” in which sellers have special trouble finding people willing to pay more for goods and labor. Even a slight depression shows itself in the price and output statistics of a wide range of consumer-goods and investment-goods industries. Clearly some very general imbalance must exist, involving the one thing–money–traded on all markets. In inflation, an opposite kind of monetary imbalance is even more obvious.
See David’s post if you don’t know the context. David also has an excellent post on using MV=PY to understand current events.