Economics

Capitalism with Chinese Characteristics

Posted by Peter on November 11, 2009
Posted in: China, Economics.

Book review: Capitalism with Chinese Characteristics: Entrepreneurship and the State by Yasheng Huang.

This is the most insightful book I’ve read so far on the Chinese economy. Most commentators only look at the most readily available data, but Huang dug through many obscure detailed records that were less likely to be manipulated.

The most important point of the book is to show that the widely held view of China as having gradual, steady improvement since 1978 is wrong. There was a dramatic political change in 1978 that allowed the rural parts of China (which still account for a large part of the economy, and where entrepreneurial culture had not been stamped out by communism) to prosper. Then starting in 1989 urban-focused leaders stifled rural businesses, causing stagnation there until 2002, when leaders more friendly to rural business gained power and allowed fairly healthy growth to resume.

Meanwhile urban areas have been dominated by crony capitalism which produced a good deal of gdp growth through massive state-directed investment in large companies, especially in the 1990s. This growth has produced fewer benefits to the average person than gdp numbers would lead us to expect.

Most of China’s success has been due to private enterprise. Beliefs that state-run businesses have produced growth are partly due to confusing reports about which companies are private.

I’m fairly impressed by the documentation of the changes in the rural political climate, but since the author seems to be the only one reading his sources of data and since it would be very time consuming to check them, it would be easy for errors to go unnoticed. For urban issues, he appears to be overstating the importance of problems that are not unique to China.

He partly clears up the puzzle of China doing better than should be expected for a country whose legal system doesn’t provide much rule of law. He provides evidence that some of the most important successes depend on British law imported via Hong Kong. But he doesn’t provide enough evidence to tell us how important this effect has been.

He leaves unanswered many questions I’d like answered. Why did government policies undergo these changes? Is the surprisingly reported steady gdp growth mostly the result of manipulated statistics? How much of the growth has been an investment bubble, and how much is sustainable? How did entrepreneurial culture survive communism in rural China so much better than in other countries?

Life Expectancy and the Business Cycle

Posted by Peter on October 18, 2009
Posted in: Health, Idea Futures.

I once proposed using life expectancy as the primary indicator of what society should try to maximize.

Recently there have been reports that life expectancy is negatively correlated with standard measures of economic growth. I accept the conclusion that depressions and recessions are less harmful than is commonly believed, but I want to point out the dangers of looking at only the life expectancy in the same year as an event that influences life expectancy. Depressions may have harmful effects that take a decade to show up in life expectancy figures (e.g. long-term wealth effects, effects on willingness to wage war, etc). So I’d like to see how life expectancy averaged over the ensuing 10 or 15 years correlates with a year’s gdp change.

Meltdown

Posted by Peter on August 28, 2009
Posted in: Book Reviews, Economics, U.S. Politics. Tagged: , , , .

Book review: Meltdown: A Free-Market Look at Why the Stock Market Collapsed, the Economy Tanked, and Government Bailouts Will Make Things Worse by Thomas E. Woods Jr.

This book describes the Austrian business cycle theory (ABCT) in a more readable form than it’s usually presented. Its basic idea that malinvestment creates business cycles, and that central bank manipulation of interest rates can cause malinvestment, is correct. But when Woods tries to argue that only errors by a government can cause business cycles, his ideological blinders become obvious. He’s mostly right when he complains about government mistakes, and mostly wrong when he denies the existence of other problems.

He asks why businesses made a “cluster of errors” that added up to a big problem rather than independent errors which mostly canceled each other out. The only answer he can find is misleading signals sent by the Fed’s manipulation of interest rates. He doesn’t explain why businessmen fail to learn from the frequent and widely publicized patterns of those Fed actions. It’s unclear why groupthink needs a strong cause, but one obvious possibility that Woods ignores is that most people saw a persistent trend of rising housing prices, and didn’t remember large drops in housing prices over a region as large as the U.S.

He shows no understanding of the problems associated with sticky wages which are a key part of the better arguments for Keynesian approaches.

He wants to credit ABCT with having predicted this downturn. If you try to figure out when was the last time it didn’t predict a downturn (the early 1920s?), this seems less impressive than, say, Robert Shiller’s track record for predicting when bubbles burst.

His somewhat selective use of historical evidence carefully avoids anything that might present a picture more complex than government being the sole villain. He describes enough U.S. economic expansions to present a clear case that credit expansion contributed to the ensuing bust, and usually points to a government activity which one can imagine caused excessive credit expansion. But he’s unusually vague about the causes of the expansion that led to the panic of 1857. Could that be because he wants to overlook the role that new gold mining in California played in that inflationary cycle?

He mostly denies that free market approaches have been tested for long enough to see whether we would avoid business cycles under a true free market. He points to a few downturns when he says the government followed a wise laissez faire policy, and compares the shortness of those downturns with a few longer downturns where the government made some attempts to solve the downturns. When doing this, he avoids mention of the downturns where massive government actions were followed by mild recessions. Any complete survey comparing the extent of government action with the ensuing economic conditions would provide a much murkier picture of the relative contributions of government and market error than Woods is willing to allow.

The most interesting claim that I hadn’t previously heard is that a large decrease in the money supply in 1839-1843 coincided with healthy GNP growth, which, if true, is hard to explain without assuming Keynesian and monetarist theories explain a relatively small fraction of business cycle problems. My attempts to check this yielded a report at http://www.measuringworth.org/usgdp/ saying GDP in 2005 dollars rose from $31.37 in 1839 to $34.84 in 1843, but GDP per capita in 2005 dollars dropped from $1884 in 1839 to $1869 in 1843. Declining GDP per capita doesn’t sound very prosperous to me (although it’s a mild enough decline to provide little support for Keynesians/monetarists).

He tries to blame the “mistakes” of credit rating agencies on an SEC-created cartel of rating agencies. That “cartel” does have some special privileges, but he doesn’t say what stops bloggers from expressing opinions on bond risks and developing reputations that lead to investors using those opinions in addition to the “cartel”‘s ratings (Freerisk is a project which is planning a sophisticated alternative). I say that anyone who understands markets would expect the yield on the bonds to provide as good an estimate of risk as any alternative. Credit rating agencies must be performing some other function in order to thrive. An obvious function is to mislead bosses and/or regulators who don’t understand markets into thinking that the people making investment decisions are making choices that are safer than they actually are. It appears that the agencies performed that function well, and helped many people avoid being fired for poor choices.

His discussion of whether WWII spending cured the Great Depression points out that mainstream theories falsely predicted a return to depression in 1946. But it’s unclear whether all versions of Keynesianism make that mistake, and it’s unclear how ABCT could predict the U.S. would be much more prosperous in 1946 than at the start of the war.
Here’s an alternative explanation that lies in between those theories: wages were being kept too high for supply and demand to balance through 1941. Inflation and changes in government policy toward wage levels during WW2 eliminated the causes of that imbalance.

Arnold Kling has a good quasi-Austrian alternative here and here.

Depression Economics

Posted by Peter on August 26, 2009
Posted in: Book Reviews, Economics, U.S. Politics. Tagged: .

Book review: The Return of Depression Economics and the Crisis of 2008 by Paul Krugman.

Large parts of this book accurately describe some processes which contribute to financial crises, but he fails to describe enough of what happened in crises such as in 2008 to reach sensible policy advice.

He presents a simple example of a baby-sitting co-op that experienced a recession via a Keynesian liquidity trap, and he is right to believe that is part of what causes recessions, but he doesn’t have much of an argument that other causes are unimportant.

His neglect of malinvestment problems contributes to his delusion that central banks reach limits to their power in crises where interest rates approach zero. The presence or absence of deflation seems to provide a fairly good estimate of whether liquidity trap type problems exist. If you recognize that malinvestments are part of the problem that caused crises such as that of 2008, the natural conclusion is that the Fed solved most of the liquidity trap type problem within a few months of noticing the severity of the downturn. There is ample reason to suspect that the economy is suffering from a misallocation of resources, such as workers who developed skills as construction workers when perfect foresight would have told them to develop skill in careers where demand is expanding (nurses?). Nobody knows how to instantly convert those workers into appropriate careers, so we shouldn’t expect a quick fix to the problems associated with that malinvestment. It appears possible for he Fed to make that malinvestment have been successful investment by dropping enough dollars from helicopters to create an inflation rate that will make home buying attractive again. Krugman’s suggested fiscal stimulus looks almost as poor a solution as that to anyone who sees malinvestment as the main remaining problem.

His claim that central bank policy is ineffective is misleading because he pretends that controlling interest rates is all that central banks do to “stimulate” the economy. If instead you focus on changes in the money supply (which central banks can sometimes cause with little effect on interest rates), you’ll see they have plenty of power to inflate.

He dismisses the problem of sticky wages as if it were minor or inevitable. But if you understand the role that plays in unemployment, and analyze Singapore’s policy of automatically altering payroll taxes to stabilize jobs, you should see that’s more cost-effective than the fiscal stimulus Krugman wants.

I’m not satisfied with his phrasing of lack of “effective demand” being caused by people “trying to accumulate cash”. If we apply standard financial terminology to changes the value of a currency (e.g. saying that there’s a speculative bubble driving up the value of the currency, or that there’s a short squeeze – highly leveraged firms have what amounts to a big short position in dollars), then it seems more natural to use the intuitions we’ve developed for the stock market to fluctuations in currency values.

He doesn’t adequately explain why most economists don’t want a global currency. He says labor mobility within the area that standardizes on a currency is important for it to work well. I’m unconvinced that much mobility is needed for a global currency to work better than the mediocre alternatives, but even if it is, I’d expect economists to advocate a combination of a global currency and reducing the barriers to mobility. How much of economists dislike for a global currency is due to real harm from regional fluctuations and how much is it due to politicians rewarding people like Krugman for biasing their arguments in ways that empower the politicians? Or do they not give it much thought because they’ve decided it’s politically infeasible even if desirable?

His description of the shadow banking system clarifies quite well how regulatory efforts to avoid crises failed. His solution of regulating like a bank anything that acts like a bank would work well if implemented by an altruistic government. But his “simple rule” is too vague for his intent to survive in a system where politicians want to bend the rules to help their friends.

The Law Market

Posted by Peter on July 21, 2009
Posted in: Book Reviews, Economics, Freedom, U.S. Politics. Tagged: , , , .

Book review: The Law Market by Erin A. O’Hara and Larry E. Ribstein.

This book describes why it has become easier for parties to a contract to choose which legal system will be applied to their contract, both in terms of the political forces that enabled choice and why it’s good that choice is possible.

The political forces include the ability of some parties to physically leave a jurisdiction if they have inadequate choices about what law will be applied to them. Often enough those parties are employers that legislators want to remain in their jurisdiction.

The benefits include simple things like predictability of contract interpretation when the contract covers things that involve physical locations associated with multiple jurisdictions where there otherwise would be no reliable way to predict which court would assert jurisdiction over disputes. They also include less direct effects of providing incentives for legal systems to improve so as to attract more customers.

The book mostly deals with contracts between corporations, and is much more tentative about advocating choice of law for individuals.

The book provides examples showing that as with most markets, competition for law produces better law. But is also mentions more questionable results, such as competition for most effective tax shelters or the easiest terms for divorce (for divorce, the book suggests those who want divorce to be hard should try to arrange contracts that allocate assets in a way that discourages divorce; it would be harder for easy-divorce states to justify ignoring those contracts). There’s also a risk that the competition will sometimes benefit lawyers rather than their clients, as clients often rely on lawyers to decide which legal system to use without having a practical way to check who benefits from some of those choices.

The book is often dull reading because it often describes case law to explain quirks of current law that will be of interest to few non-lawyers.

One part that disappointed me was the assumption that the choice of jurisdiction should dictate the physical location in which plaintiffs must argue their case (the travel costs can make some lawsuits unpractical to a consumer suing a company if the company decides the location at which a suit is argued). Why are we trapped in a set of rules that requires travel to a possibly distant court when we have technology that provides reasonable remote communications?

Confusing S&P Index Earnings Numbers

Posted by Peter on July 4, 2009
Posted in: Investing. Tagged: .

I just noticed some confused arguments between Jeremy Siegel and Standard and Poors over how to aggregate earnings for companies in a stock index to produce a meaningful report of what the companies in the index earned.
See here and here.

Siegel provides an example involving percent changes in Exxon-Mobil and Jones Apparel. But that has a weak resemblance to what S&P is doing. A more accurate analogy to what S&P is doing would use changes to market cap rather than percent changes. If Jones Apparel declined in market cap by $10 billion, it would hurt the index just as badly as a $10 billion decline in Exxon-Mobil’s market cap. Looked at that way, S&P’s approach looks sensible.

But since Jones Apparel has a market cap of less than $1 billion, the current bankruptcy laws make it far-fetched that Jones Apparel could lose more than $1 billion in market cap.

If you’re using earnings as a proxy for the health of the economy, S&P’s method doesn’t create a problem – the bankruptcy laws affect who loses money, but the money is still lost. But for an investor, Siegel has a point which is half right.

Siegel’s solution of weighting earnings by market cap may work well under any realistic conditions, but has no sensible theory behind it, and can fail badly under some far-fetched conditions. Imagine that Jones Apparel reports an unexpected one-time windfall of $1 trillion, which ought to raise the market cap of Jones Apparel by about $1 trillion. The way S&P computes S&P 500 earnings, an investor looking at S&P 500 earnings would see a strong hint that the value of the S&P 500 ought to rise by about $1 trillion. But under Siegel’s method, the initial effect on S&P 500 earnings would suggest a barely noticeable rise in the value of the S&P 500 of under $1 billion. Then at some point the Jones Apparel market cap would soar and the S&P 500 earnings would be recomputed with much different weights and investors would see a much different picture. So Siegel has proposed something which could result in a potentially large change in reported S&P 500 earnings without any change in the what shares someone who invests in the S&P 500 holds and without any changes in reported earnings.

Morningstar has a method (PDF) designed for evaluating portfolios that uses a harmonic weighted average and ignores companies with negative earnings. That has advantages, but the magnitude of losses provides some hints about how far a company is from profitability, so an ideal method should pay some attention to losses.

Siegel mentions comments by Shiller that suggest Shiller has better (but possibly impractical) ideas. I doubt Shiller’s analysis provides as much support for Siegel’s argument as Siegel claims.

Any sensible investor looks at a multi-year average of earnings along the lines suggested by Shiller, which minimizes the problems associated with faulty weighting of earnings.

Economics of Piracy

Posted by Peter on May 5, 2009
Posted in: Book Reviews, Economics. Tagged: , .

Book review: The Invisible Hook: The Hidden Economics of Pirates by Peter Leeson.

This is an interesting history of early eighteenth century pirates with an economist’s insights into what influenced them to have institutions such as democracy and to be in many ways pleasanter to serve on than commercial or military ships of the same time.

He has a fairly open bias toward portraying pirates favorably. I sometimes wondered whether there’s enough evidence to support his sometimes surprising conclusions. He makes plausible claims to be getting his historical information from the relevant experts, but without careful checking I can’t tell whether he has slanted his story to make it more entertaining.

He describes some good reasons why “workers’ democracy” doesn’t work as well in modern corporations as it did on pirate ships. But he is too willing to accept the observed absence of corporate democracy as evidence of its inefficiency. I can easily imagine that managers grab more power than is good for the company, and that principal-agent problems let them get away with it (pirates’ relations with the law made it easier for them to remedy this via mutiny). Also, he overstates the claim that “workers don’t have the finances required” for worker ownership of corporations. There are plenty of companies with low enough capital requirements for this to be unimportant. The big difference I see between modern corporations and pirate ships is that pirates had strong reasons to stick together until their venture got enough loot for them to all retire at once and divide the results. Employees in modern corporations want much more flexibility in when they leave the company, which creates complications for workers’ democracy or for the employee who wants to leave however it is handled.

One analysis whose absence disappointed me was whether the long-term benefits to joining a pirate ship were better than those of commercial or military ships. What fraction of pirates retired wealthy? How many of them were fooled by a temporary shortage of law enforcement into adopting a career with an abnormally high death rate once governments increased law enforcement?

He occasionally digresses into standard economics rants that have no relevance to pirates, such as the two pages on lobbyist rent-seeking.

Evidence-Based Technical Analysis

Posted by Peter on April 17, 2009
Posted in: Book Reviews, Investing. Tagged: .

Book review: Evidence-Based Technical Analysis: Applying the Scientific Method and Statistical Inference to Trading Signals, by David Aronson.

This is by far the best book I’ve seen that is written for professional stock market traders. That says more about the wishful thinking that went into other books that attempt to analyze trading rules than it does about this author’s brilliance. There are probably books about general data mining that would provide more rigorous descriptions of the relevant ideas, but they would require more effort to find the ideas that matter most to traders.

There hasn’t been much demand for rigorous analysis of trading systems because people who understand how hard it is to do it well typically pick a different career, leaving the field populated with people who overestimate their ability to develop trading systems. That means many traders won’t like the message this book sends because it doesn’t come close to fitting their preconceptions about how to make money. It is mostly devoted to explaining how to avoid popular and tempting mistakes.

Although the book only talks specifically about technical analysis, the ideas in it can be applied with little change to a wide variety of financial and political forecasting problems.

He is occasionally careless. For example: “All other things being equal, a TA rule that is successful 52 percent of the time is less valuable than one that works 70 percent of the time.” There might be a way of interpreting this that is true, but it’s easy for people to mistake this for a useful metric, when it has little correlation with good returns on investment. It’s quite common for a system’s returns to be dominated by a few large gains or losses rather than the frequency of success.

The book manages to spell Occam three different ways!

Hollywood Economics

Posted by Peter on April 8, 2009
Posted in: Book Reviews, Economics. Tagged: , .

Book review: Hollywood Economics: How extreme uncertainty shapes the film industry, by Arthur De Vany.

This rather dense and scholarly book that contains some good insights into how markets for information differ from markets for physical goods. But few people will want to read the whole book. Much of the book was originally published as papers in economics journals. It’s better organized than that suggests, but the style is mostly oriented toward professional economists.

Much of the book can be summed up by the conclusion that nobody knows anything about how successful a movie will be. The typical film loses money, and the expected returns are heavily dominated by rare films that are huge successes.

He says through much of the book that returns on investment in movies have infinite variance, and only at the very end admits that that’s not literaly true, and then provides a more credible description of the variance as unstable and generally increasing over time.

His argument that Hollywood makes too many R-rated films takes a good deal of effort to follow. Table 5.3 is confusing, because it shows a mean return on R-rated films as much higher for the returns on PG13 films. This sounds like the opposite of his conclusion. It took 13 more pages before I figured out that that was due to some high rates of return on low budget R-rated films that had little effect on aggregate profits. It appears that his conclusion ought to have been that Hollywood makes too many high-budget R-rated films, and too few low-budget R-rated films.

His description of the antitrust cases that transformed the movie industry provides convincing evidence that the courts were confused and didn’t help the independent exhibitors that the lawsuits were allegedly designed to help. The arguments about how they affected consumers are less clear.

Commons and Transaction Costs

Posted by Peter on December 23, 2008
Posted in: Economics, Freedom.

Mike Linksvayer describes a good perspective on why it’s important to have most information in a commons rather than restricted by copyright.
Most economists have a strong bias toward assuming transaction costs are unimportant. Coase has fought this. It sure looks to me like the Coase Theorem ought to be understood as demonstrating that one of the most important tasks for economists is to improve our understanding of how to reduce transaction costs. Economists have invested too much in models which depend on transaction costs being insignificant to easily be persuaded to adopt such a different focus.

Lessig’s book The Future of Ideas: The Fate of the Commons in a Connected World describes why having some commons can be as valuable as having some resources protected by secure property rights, and why it matters for science and technology. But his argument style is designed for ordinary political debates, and doesn’t provide the breadth or power that a good economist would produce when attempting to reform economics.

I have little idea whether Creative Commons will put additional money to good use, but the value of its goals should not be overlooked.