Category: Economics
More on the David Lang opera version of Wealth of Nations
In 18 parts, Lang explores some of Smith’s central themes, including one of the book’s most famous passages, where Smith uses a wool coat worn by a very poor Scottish worker as a way to examine trade. “He asks, ‘Did you ever think of how many people need to be employed in order to make that coat?’” says Lang, whose movement “the woolen coat” names all the artisans and laborers who contributed to the garment in song:
the shepherd
the sorter of the wool
the wool-comber or carder
the dyer
the spinner
the weaver
the fuller
There are also the workers on the ship that brought in the dye and all the people who built the ship. An ordinary coat is revealed to be a kind of miracle of skilled labor and global collaboration, the product of “many thousands” of workers coming together in (selfish) harmony. Part of me wanted to run out of the theater right then and buy something … perhaps a coat… for America.
Here is more from Bloomberg, via John De Palma. The opera seems to be ultimately a rather gloomy view of the book?
A Danish Fix for U.S. Mortgage Lock-in
In the Danish mortgage market every mortgage is backed by a corresponding bond. Thus, if a home buyer takes out a 500k mortgage at 3% interest, a bond is issued that pays the lender 3% interest on 500k. I’ve written about this system several times before. It has two distinct advantages.
- The correspondence principle means that mortgage banks don’t bear interest rate risk but instead specialize in evaluating credit risk (the risk that the borrower won’t pay). Deep markets rather than banks take on the interest rate risk. This makes the Danish system very stable.
- Mortgages can be pre-paid by buying the corresponding bond at market rates and extinguishing it. If a Danish borrower takes out a 500k mortgage at 3% interest and then rates rise to 6%, for example, the value of that mortgage falls to $358k and the borrower can buy the corresponding bond, deliver it to the bank, and, in this way, extinguish the loan.
In the US, a mortgage can be pre-paid only at a par. As a result, if interest rates rise, home owners don’t want to move because moving would require them giving up a 3% mortgage and replace it with say a 6% mortgage. This is called the lock-in effect. Lock-in can be quite severe. Fonseca and Liu find:
Using individual-level credit record data and variation in the timing of mortgage origination, we show that a 1 percentage point decline in the difference between mortgage rates locked in at origination and current rates reduces moving by 9% overall and 16% between 2022 and 2024, and this relationship is asymmetric. Mortgage lock-in also dampens flows in and out of self-employment and the responsiveness to shocks to nearby employment opportunities that require moving, measured as wage growth within a 50- to 150-mile ring and instrumented with a shift-share instrument.
What about in Denmark? The Danes definitely take advantage of the opportunity to buy-back. Part of this is due to tax advantages but those are just a transfer. More importantly, Danes don’t get locked in. A new paper by Berger, Jeong, Marx, Olesen, and Tourre compares mobility across Denmark and the US:
We study Danish fixed-rate mortgage contracts, which are identical to those in the United States except that borrowers may repurchase their mortgages at market value. Using Danish administrative data, we show that households actively buy back debt when mortgage prices fall below par and that household mobility is largely insensitive when existing mortgage rates are below prevailing market rates — unlike in the United States, where moving rates fall sharply as rates rise. We develop an equilibrium model that explains these patterns and show that introducing a repurchase-at market option into U.S. mortgages substantially reduces interest-rate-induced lock-in with limited effects on equilibrium mortgage rates.
The last point is especially important because you might wonder whether we are assuming a free lunch? After all, if US borrowers lose when they have to pre-pay at par then lenders surely gain. And if lenders gain on pre-payment then they will be willing to lend at lower rates on mortgage initiation. No free lunch, right? The logic is correct but note that the gain to lenders comes mainly from the relatively small set of households that move despite lock-in so the pre-payment bonus to lenders is quite small. Under the author’s calibrated model, mortgage interest rates in the US would rise by only 18 basis points on average if the US moved to a Danish type system.
In other words, there actually is a free or at least a low-priced lunch because lock-in is bad for homeowners and it doesn’t benefit lenders. As a result, moving to a Danish system would create net benefits.
Is AI currently helping economic research?
The third possibility, that AI helps to weed out mistakes, is trickier for the discipline. This stage could become even more important if journals do start to be hit by a wave of AI-generated slop — or, perhaps more likely, good papers with so many appendices and robustness checks that even the most dedicated referee is defeated. (The real “Dr Robust” does not have infinite energy.)
Eager to embrace the new technology, several of the top five economics journals are already experimenting with Refine, an impressive AI-powered reviewing tool that scours economics papers for errors. Ben Golub, one of its creators, shared that even with papers that had been through referees at top journals, Refine was picking up problems in at least a third of cases.
Here is more from Soumaya Keynes at the FT.
University of Chicago fact of the day
A team largely composed of economics majors who know their way around Milton Friedman and Gary Becker, Chicago (23-4) is a DIII powerhouse currently in the DIII Sweet 16 and chasing its first-ever NCAA national title.
“Nobody’s ever going to confuse this with Alabama football,” says head coach Mike McGrath, “but if you think about the student-athlete model, I think we show you can do both of those things very, very well.”
…“Obviously, the kids are really smart,” he says. “You can’t B.S. them. They’re going to challenge everything that you tell them, you have to be prepared for that…there’s a need to understand the why behind things.”
…a friend of the program, Chicago professor John List, is working with students on an analysis of player positioning.
Here is more from the WSJ, via Rama Rao.
*Recession*, by Tyler Goodspeed
The subtitle is The Real Reasons Economies Shrink and What To Do About It. Here is from the book’s summary:
Contrary to popular perception, recessions are not the inevitable bust that follows an unsustainable boom, and they do not operate like wildfires that clear out economic deadwood. Recessions are caused by adverse shocks like war and energy price spikes; and far from unleashing gales of creative destruction, post-recession economic growth typically resumes the same trend as before—all pain, no gain.
The book covers American history and focuses on verbal exposition of the theory, not mathematics. Overall, Goodspeed provides an underrated perspective in an era where 2008-2009 led people to become overly obsessed with issues of aggregate demand. Our current presidency may be curing this however!
International Comparison of Physician Incomes
We compare physician incomes using tax data from the United States, Canada, Sweden, and the Netherlands. Physicians are concentrated in the top percentiles of the income distribution in all four countries, especially in the United States and certain specialties. Physician incomes are highest in the United States, and a decomposition shows that this mainly reflects differences in overall income distributions, rather than physicians’ locations in those distributions. This suggests that broader labor market differences, and thus physicians’ outside options, drive absolute incomes. Shifting US physicians’ incomes to match relative positions in other countries’ distributions would only marginally reduce healthcare spending.
By Aidan Buehler, et.al., from a new NBER working paper.
Some simple economics of AI?
AI lowers the cost of building businesses. But it raises the bar for sustaining advantage. More companies can start. Fewer can dominate.
That implies greater dispersion. More volatility. Less structural concentration. A market that rewards adaptability rather than mere size.
And it raises the question that follows logically from duration compression: if software moats erode faster, where does durable advantage reconcentrate? The answer may be in the places that resist compression, physical infrastructure, energy constraints, material bottlenecks, regulatory barriers. The assets that cannot be replicated with model access and API credits. The things that still require time.
Equity does not disappear in this world.
It transforms.
From ownership of stability to exposure to speed.
From franchises to call options.
And that is the structural shift beneath the surface panic, the real story unfolding in the Age of Agents.
Here is more from Jordi Visser.
Understanding Demonic Policies
Matt Yglesias has a good post on the UK’s Triple Lock, which requires that UK pensions rise in line with whichever is highest: wages, inflation, or 2.5 percent. Luis Garicano calls this “the single stupidest policy in the entire Western world” — and I’d be inclined to agree, if only the competition weren’t so fierce.
The triple lock guarantees that pensioner incomes grow at the expense of everything else, and the mechanism bites hardest when the economy is weakest. During the 2009 financial crisis wages fell and inflation declined, for example, yet pensioner incomes rose by 2.5 percent! (Technically this was under a double-lock period; the triple lock came slightly later — as if the lesson from the crisis was that the guarantee hadn’t been generous enough.)
Now, as Yglesias notes, if voters were actually happy with pensioner income growing at the expense of worker income, that would be one thing. But no one seems happy with the result. The same pattern is clear in the United States:
As I wrote in January, there is a pattern in American politics where per capita benefits for elderly people have gotten consistently more generous in the 21st century even as the ratio of retired people to working-age people has risen.
This keeps happening because it’s evidently what the voters want. Making public policy more generous to senior citizens enjoys both broad support among the mass public and it’s something that elites in the two parties find acceptable even if neither side is particularly enthusiastic about it. But what makes it a dark pattern in my view is that voters seem incredibly grumpy about the results.
Nobody’s saying things have been going great in America over the past quarter century.
Instead, the right is obsessed with the idea that mysterious forces of fraud have run off with all the money, while the left has convinced itself that billionaires aren’t paying any taxes.
But it’s not some huge secret why it seems like the government keeps spending and spending without us getting any amazing new public services — it’s transfers to the elderly.
The contradictions of “Elderism” are an example of rational irrationality. Individual voters bears essentially no cost for holding inconsistent political beliefs — wanting generous pensions and robust public services and low taxes is essentially free, since no single vote determines the outcome. The irrationality is individually rational and collectively ruinous. Voters are not necessarily confused about what they want; they simply face no price for wanting incompatible things. Arrow’s impossibility theorem adds another layer: even if each voter held perfectly coherent preferences, there is no reliable procedure for aggregating them into a coherent social choice. The grumpiness Yglesias documents may not reflect hypocrisy so much as the incoherence of demanding that collective choice makes sense — collective choice cannot be rationalized by coherent preferences and thus it’s perfectly possible that democracy can simultaneously “choose” generous pensions and “demand” better services for workers, with no mechanism to register the contradiction until the bill arrives.
Why you should work much harder RIGHT NOW
If strong AI will lower the value of your human capital, your current wage is relatively high compared to your future wage. That is an argument for working harder now, at least if your current and pending pay can rise with greater effort (not true for all jobs).
If strong AI can at least potentially boost the value of your human capital, you should be investing in learning AI skills right now. No need to fall behind on something so important. You also might have the chance to use that money and buy into the proper capital and land assets.
So…WORK HARDER!
Addendum: From Ricardo in the comments:
Suppose you are the best maker of horse carriages in Belgium around the time the automobile is invented. You might want to take on as many orders as possible for new carriages because you know your future is precarious. Or, maybe you get your hands on one of these new-fangled automobiles as soon as possible and learn how fix them. Both options require you to WORK HARDER but these seem to be the two best options available. Paradoxical but true.
A New Order of Things
Big infrastructure projects in the developing world for things like water and electricity are under-pressure. Chinese and US funding is down and these projects often fall apart due to corruption and political incentives to build but not maintain. It is possible to break old institutions and establish new ones, but “there is nothing more difficult to take in hand, more perilous to conduct, or more uncertain in its success, than to take the lead in the introduction of a new order of things.” Connor Tabarrok gives a great example. Ek Son Chan in Cambodia:
In 1993, the Phnom Penh Water Supply Authority was a catastrophe. The city was emerging from decades of war and genocide. Only 20 percent of the city had connections at all, and water flowed for just 10 hours a day. 72 percent of the water was non revenue water. It was lost to leaks or stolen through illegal connections.
Into this mess walked Ek Son Chan, a young Cambodian engineer appointed as Director General. Over the next two decades he executed an incredible institutional turnaround.
Chan replaced corrupt managers with qualified engineers. He got rid of unmetered taps. Every single connection received a meter and was billed. The old system of manual billing was replaced with a computerized system, which cut down on low level employees giving out free water and receiving kickbacks. Bill collection rates went from 48 percent to 99.9 percent. These changes were intensely unpopular, and Chan faced fierce resistance from rent seekers, from freeloading customers to his own employees. He established an incentive system based on bonuses among the workers, introduced an internal discipline system with a penalty for violators, and set up a discipline commission for all levels of the organization to deal with corruption
He divided the distribution network into pressure zones with flow monitoring. A 24 hour leak detection team walked the streets at night with listening bars to identify underground leaks.
The institutional change dwarfed the infrastructural change, but was absolutely necessary to make the infrastructure investment worthwhile….
This commitment would not be untested. When Chan tried to enforce bill payment on Cambodia’s elite, and sent his team out to install a water meter on the property of a high ranking general who had been freeloading. The general refused the installation of a meter, so the team attempted to disconnect the water. The general and his bodyguards ran them off the property. When Chan heard of this, he decided not to back down, and mobilized his own team to dig up the pipe and install the meter. Always a leader from the front, Chan jumped in the hole to take a shift at digging. When he looked up, his team had fled, and he was facing down the general himself, pointing a gun at his head. In Cambodia in the 90s, consequences for such a high ranking official were unlikely. CHan didn’t give up. He mobilized the local armed police and returned with 20 men to standoff against the general, disconnected him from service and left him out to dry. Chan said this about the dispute:
”He had no water. My office was on the second floor and the general came in with his ten bodyguards to look for me. I said, “ No. You can come here alone, but with an appointment”. He couldn’t do anything. He had to return. He said, “Okay”! At that time we had a telephone, a very big Motorola. He came in to make an appointment for tomorrow. I said, “ Okay, tomorrow you come alone”. So he comes alone, we talk. “Okay. I’ll reconnect on two conditions. The first condition is that you have to sign a commitment saying that you will respect the Water Supply Authority and second, you need to pay a penalty for your bad behavior and you must allow us to broadcast the situation to the public, or no way, no water in your house”. So he agreed. “
….By 2010, coverage in the city went from 25 percent to over 90 percent with 24 hour service. The utility became financially self sustaining and turned a profit. It was listed on the Cambodia Securities Exchange in 2012. Chan won the Ramon Magsaysay Award in 2006.
By separating the utility company from the low-capacity local government, Ek and PPWSA proved that:
- Functional infrastructure relies on institutional quality and mechanism design.
- State capacity need not exist within the state
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Christopher Sims, RIP
Here is one notice. Here are previous MR posts on Sims, with a survey of his Nobel contributions at the top.
Some simple spatial analytics of Cape Town
Rio de Janeiro let its hillsides be filled in with lower-cost dwellings. The result was a significant increase in the crime rate. On the more positive side of the ledger, upward mobility increased too. If you live in a decent favela, you can get to a downtown job with not too much difficulty, albeit with some travel risk. Note however that some of those jobs include “theft.”
Cape Town has not filled in its hillsides, and you see empty, valuable land all over the place. The townships have remained remarkably segregated, both racially and spatially. The nicer parts of Cape Town also have remained relatively safe, both for whites and for upper class blacks.
One secondary consequence of this equilibrium is very high unemployment in the townships, staggeringly high in fact. It is expensive to get from most of the townships to a job in the nicer part of town. For South Africa as a whole, GPT Pro reports:
OECD reports that around 70% of discouraged jobseekers cite location as the main obstacle to looking for work, and that commuting can absorb up to 37% of post-tax income for the lowest quintile, or up to 80% once time costs are included. The World Bank estimate is even harsher for the poorest households: up to 85% of daily income once the opportunity cost of time is counted. In effect, many low-wage jobs are too costly to search for, reach, or keep.
And see this link. Young male workers in particular find it hard to get the experience that would enable them to prove themselves reliable and then keep on climbing a skills ladder. So they stay in the townships, maybe engage in some black or gray market labor, and collect some welfare payments. They also might commit crimes against each other.
Which in turn makes the notion of filling in the hillside with low-cost housing all the less appealing.
It is difficult to solve the problems of South Africa.
Addendum: Note also that South African agriculture is capital-intensive, as you might expect from a wealthier country. So subsistence agriculture is less of an option here, compared to many other African nations, and that leads to all the more overcrowding in the poorly located townships.
Studying with Ludwig Lachmann
Since I am in South Africa, I am reminded of my time studying with Ludwig Lachmann, the South African economist from University of the Witwatersrand. I was seventeen, and Lachmann teaching a graduate seminar at New York University. Someone (Richard Ebeling maybe?) had told me he was interesting, so I wanted to sit in on the seminar. I showed up, introduced myself to Lachmann, and asked if I could listen to the lectures. I obviously did not belong, but he was very gracious and said yes of course. He wore a suit and tie, had a very Old World manner, and he had been a Jewish refugee from Germany. He was 73 or so at the time, this was 1979.
His manner of speaking was very distinctive. Of course I now recognize the South African accent, but there is more to it than that.
Lachmann was best known for his connections to the Austrian School, as he was visiting at the NYU Austrian program at the time, under the aegis of Israel Kirzner. Nonetheless Austrian economics was not what I learned in the seminar.
On the first day, I heard plenty about Sraffa and Garegnani, and all that was new (and fascinating to me). Lachmann had studied with Werner Sombart, so I learned about the German historical school as well.
Lachmann also was my first teacher who made sense of Keynes for me, moving me away from obsessions with the hydraulic IS-LM interpretations of the General Theory. He flirted with views of cost-based pricing, brought me further into the kaleidic world of G.L.S. Shackle, and he insisted that a market economy had no overall tendency toward the constellation of a general equilibrium of prices and quantities. (He did believe that most though not all individual markets tended to equilibrate.) He inveighed against W.H. Hutt’s interpretation of Say’s Law, of course some of you here will know that Hutt also was South African. I kept on trying to read Hutt, to see if I could defend him against Lachmann’s critiques. I also imbibed Hutt’s economic critique of apartheid.
Lachmann did not talk about South Africa, other than to mention how long the journey to New York was. You may know that Israel Kirzner, another early mentor of mine, had South African roots as well. He also did not talk about South Africa.
“South African economics,” if you wish to call it that, played a significant role in my early intellectual development.
To this day, when I think about the economics of AI, and many other matters, Lachmann’s book Capital and its Structure is one of my go-to inspirations.
And I am still grateful to Lachmann for letting “a kid” sit in on his class. I paid avid attention.
Why is the USDA Involved in Housing?!
In yesterday’s post, The 21st Century ROAD to Housing Act, I wrote that Trump’s Executive Order “cuts off institutional home investors from FHA insurance, VA guarantees and USDA backing…”. The USDA is of course the United States Department of Agriculture. In the comments, Hazel Meade writes:
USDA? Wait, what????
Why is the USDA in any way involved in housing financing?
Are we humanly capable of organizing anything in a rational way?
It’s a good question. The answer is a great illustration of the March of Dimes syndrome. The USDA got involved with housing in the late 1940s with the Farmers Home Administration. The original rationale was to support farmers, farm workers and agricultural communities with housing assistance on the theory that housing was needed for farming and the purpose of the USDA was to improve farming. Not great economic reasoning but I’ll let it pass.
Well U.S. farm productivity roughly tripled between 1948 and the 1990s as family farms became technologically sophisticated big businesses. So was the program ended? Of course not. Over time the program subtly shifted from farmers to “rural communities”–the shift happened over decades although it was officially recognized in 1994 when the Farmers Home Administration was renamed the Rural Housing Service. Today rural essentially means low population density which no longer has any strong connection to agriculture.
So that’s the story of how the US Department of Agriculture came to run a roughly $10 billion annual housing program for non-farmers in non-agricultural communities. And how does it do this? By supporting no-money-down direct lending and a 90 percent guarantee to approved private lenders. Lovely.
It’s a small program in the national totals, but an amusing example of the US government robbing Peter to pay Paul and then forgetting why Paul needed the money in the first place.
The 21st Century ROAD to Housing Act
The 21st Century ROAD to Housing Act appears likely to pass the Senate. The bill contains some genuinely good ideas alongside some very popular—but bonkers ideas.
Let’s start with the good ideas.
The bill would streamline NEPA review for federally supported housing, primarily by expanding categorical exclusions. Federal environmental review does impose real costs and delays on housing construction, so reducing unnecessary review is a step in the right direction. The gains will probably be modest—most housing regulation occurs at the state and local level—but removing friction is good.
The bill would also deregulate manufactured housing by eliminating the permanent chassis requirement and creating a uniform national construction and safety standard. The United States once built far more factory-produced housing; in the early 1970s, by some accounts a majority of new homes were factory-built (mobile or modular). Long-run productivity growth in housing almost certainly requires greater use of factory construction. Land-use regulation remains the dominant constraint on supply, but enabling scalable manufacturing is still welcome.
Another interesting provision involves Community Development Block Grants (CDBG). The bill allows CDBG funds to be used for building new housing rather than being largely restricted to rehabilitation of existing housing. More federal spending is not automatically appealing, but the bill adds an unusual incentive mechanism.
The bill creates a tournament for CDBG allocations. Localities that exceed the median housing growth improvement rate among eligible CDBG recipients receive bonus funding. Those below the median face a 10 percent reduction. The key feature is that the penalties fund the bonuses, so the system reallocates money rather than expanding spending.
This is a clever design. It creates competition among localities and benchmarks them against peers rather than against a fixed national target. In effect, the program rewards relative improvement rather than absolute performance—a classic tournament structure. (See Modern Principles for an introduction to tournament theory!).
Ok, now for the popular but bonkers ideas. Section 901 (“Homes are for People, Not Corporations”) restricts the purchase of new single-family homes by large institutional investors. Elizabeth Warren is a sponsor of the bill but this section was driven almost entirely by President Trump. Trump passed an Executive Order, Stopping Wall Street from Competing With Main Street Home Buyers, that cuts off institutional home investors from FHA insurance, VA guarantees, USDA backing, Fannie/Freddie securitization and so forth. The bill goes further by imposing a seven-year mandatory divestiture rule, forcing institutional investors to convert rental homes to owner-occupied units after seven years.
No one objects to institutional investors owning apartment buildings. But when the same investors own single-family homes, it breaks people’s brains. Consider how strange the logic sounds if applied elsewhere:
…a growing share of apartments, often concentrated in certain communities, have been purchased by large Wall Street investors, crowding out families seeking to buy condominiums.
Apartments are fine, hotels are fine, but somehow a corporation owning a single family home is un-American. In fact, the US could do with more rental housing of all kinds! Why take the risk of owning when you can rent? Rental housing improves worker mobility. When foreclosures surged after 2008 and traditional buyers disappeared, institutional investors stepped in and absorbed distressed supply — helping stabilize markets. Who plays that role next time?
Institutional investors own only a tiny number of homes, so even if this were a good idea it wouldn’t be effective. But it’s not a good idea, it’s just rage bait driven by Warren/Trump anti-corporate rhetoric.
What does “Homes are for People, Not Corporations” even mean?–this is a slogan for the Idiocracy era. “Food is for People, Not Corporations,” so we should ban Perdue Farms and McDonald’s?