And the links came to enlighten us all

1. Tyler Cowen tells a good story at his 2009 TEDx Midatlantic talk. (HT: Patri)  His point that thinking in terms of a narrative often makes things too simple, and many existing narratives are misleading.  

On non-fiction: "Nonfiction is in a sense the new fiction. The book may happen to say true things, but again everything is taking the same form as these stories" 

On a useful heuristic: "As a good rule of thumb just imagine that every time you are tell yourself a good versus evil story, you are basically lowering your IQ by 10 points or more."

On books about cognitive biases: "None of these books identify what to me is the single central most important way we screw up. And that is, we tell ourselves too many stories or we are too easily seduced by stories. And why don't these books tell us that? It is because the books themselves are all about stories."

Listen to the whole thing, as they say.

2. Bryan Caplan discusses the rising return to hours put into college education.  This research is a big part of why I don't believe the premise from other science research that things are changing mainly because it is harder to reach the frontier of science. Science is changing because on the margin education is no longer about education and research is no longer about research.

3. Scott Sumner has already reacted to the Fed meeting later today.  If the market doesn't go up, he doesn't like it.  Of course, I'm left to wonder whether he would be that upset if the market stays relatively neutral, since it appears that some form of quantitative easing or reinvestment in mortgage bonds, or cut in the interest paid on excess reserves has already been priced into the market.

4. Greg Mankiw points out some unfortunate estimates on the future performance of Medicare. The health care sector is one of the least efficient parts of society, yet it doesn't seem like the United States is on any path close to slowing down the amount of resources wasted there.

Comparing NFP Surprises (Delayed)

The nonfarm payroll numbers were released by the BLS today (Note: This was written on Friday, but the post was delayed to a DNS attack on Posterous). The headline numbers were much worse than expected, with total jump numbers disappointing by 66 thousand workers (131k jobs lost) and the private sector disappointing expectations by 19 thousand workers (Only 71k jobs gained).  On the other hand, average hourly earnings and the average weekly hours of all employees was slightly higher than expected at 0.2% MoM for earnings instead of 0.1% and 34.2 hours worked instead of 34.1 hours. 

The markets reacted to this data by selling off.  This isn't surprising, as the headline number is what everyone looks at. However, it is interesting to note that the payroll surprises in hourly earnings and average weekly hours amount to be equivalent to an earnings increase of more than 500k in new jobs.

Something is going on here. 

1. The headline number is still more important because it is a better predictor of future economic activity.
2. Average weekly hours and hourly earnings are not that meaningful or accurate as more and more of the economically important jobs are no longer based on hourly earnings or weekly hours.
3. Average weekly hours and hourly earnings have rounding issues where the actual surprise only looks large because not enough significant figures are used for the estimates/reports. Maybe economists thought the hourly pay would go up by .013% and it ended up going up by .018%, which is half the effect that the headline numbers suggest).
4. Other revisions are more important than the headline numbers.

The most important of these factors is number 2, as the reasons behind the variations in hours such as the fluctuations in pay to overtime manufacturing workers is definitely less significant in an economy with fewer manufacturing jobs relative to the total number of jobs.

Vague Fed

Arnold Kling complains about vague fed policy.

Everyone is acting as if in order to maintain the Fed's independence, the Fed must be allowed to be vague about its targets, vague about how it might achieve those targets, secretive about how it thinks its actions influence those targets, and ad hoc in its approach to deciding when to take action. I would suggest re-examining such assumptions.

Part the Fed's focus in non-panic times is spent making sure they don't surprise the markets too much. In order to avoid surprising the markets, the Fed has to be vague in order to slowly walk the market towards their plans, which they are probably still in the process of figuring out.

"My suggestion is that, if you get asked those questions, just say we're examining nontraditional methods and there are many different ways in which we can address the issue. I would be as nonspecific as you know how to be. The major reason is that I don't think we will know until we start to address the issue." - Greenspan in 2003, discussing what the Fed might do as interest rates approach the zero bound

If they stated their shifting views in real time the market might react in an extreme manner when the message changed, and unexpected sources of volatility are generally harmful to a leveraged economy. Furthermore, if the message changed too often, there would eventually be points where the market might ignore the Fed due to the low signal to noise ratio. Then the Fed would lose control of the very useful tool of managing future expectations. So in order to keep this tool, they have to be very sparing with their use of clear messaging.

Links from last week

1. Falkenblog presents a business cycle theory based on mimicry. Basically, in every boom there are entrepreneurs who know how to make money and then other overconfident entrepreneurs who are merely copying some measurable quality of these entrepreneurs.  Each time, the traits being copied are somewhat different, and because these qualities have worked in the past it means that quantitative investors can "prove" what they are investing in will work (Housing prices never go down!). At the same time the differences in each cycle make sure economic models will not correctly predict how the cycle will play out.  It will be a very good framework for thinking about things during the next boom. Read the whole thing.

2. Robin Hansen provides reasons for an ambitious person to be somewhat overconfident if they want to be an executive. He doesn't think he is doing this, but it is the conclusion that I reach from reading the data he provides. CEOs, doctors and lawyers are all overconfident, so these are probably useful signals to send if joining their ranks is a personal goal. Along the same lines, this is why people in finance are inflationary because they do not make money in a deflationary environment.

3. Macroblog notes that the correlation between median CPI & the M2 is back.  He also has a post up discussing the interest paid on excess reserves. First, he notes that because the interest paid is small it didn't effect the choice between deciding to accumulate reserves vs. lend to the private sector by very much. Towards the end of the article, he notes that paying interest on excess reserves is to make sure that banks hold more reserves so that the payment system runs efficiently.  This contradiction is a little confusing to me. Regardless, the point in the middle of the post about a zero interest rate on reserves being unlikely because this would interfere with the liquidity of the money market market is interesting because it highlights that many of the more unique propositions like setting a slightly negative interest on reserves to encourage lending are beyond the pale at this point.

4. Starcraft 2 came out this past week. Rather than discuss whether or not it is a good idea to bet against South Korea of the performance of the US tech sector for the next quarter, I'll point you to this comic.

Rounding

I remember learning the rules about rounding significant figures when the variable to be rounded is a 5 (Round to even numbers, not odd numbers), but my teachers never explained why this was done. While trying to verify whether odds or evens were preferred, I learned the true reason behind why the seemingly weird rounding system exists.

Fantasies about fives
Students are sometimes told to increment the least significant digit by 1 if it is odd, and to leave it unchanged if it is even. One wonders if this reflects some idea that even numbers are somehow “better” than odd ones! (The ancient superstition is just the opposite, that only the odd numbers are "lucky".)
In fact, you could do it equally the other way around, incrementing only the even numbers. If you are only rounding a single number, it doesn’t really matter what you do. However, when you are rounding a series of numbers that will be used in a calculation, if you treated each first-nonsignificant 5 in the same way, you would be over- or underestimating the value of the rounded number, thus accumulating round-off error. Since there are equal numbers of even and odd digits, incrementing only the one kind will keep this kind of error from building up.
You could do just as well, of course, by flipping a coin!

Over 10 years later the rule finally makes sense to me, but I might decide try the coin flipping approach instead the next time this comes up.

Wordsum Sample Test

Over at MR, Alex Tabarrok highlighted a chart made by Razib Khan about a Wordsum test (a test given in the GSS survey that correlates with IQ) and those who drink alcohol.  In the comments, Razib pointed us towards the GSS browser to test a commenter’s theory that drinking alcohol matters less among those that have completed college.

Attended college:

Didn’t attend college:

After looking at this post, one of my friends wanted to see an actual Wordsum test. Here is one illustrative example that I found in a paper:

From: Huang, Min-Hsiung, Hauser, Robert M. Trends in Black-White Test Score Differentials: II. The WORDSUM Vocabulary Test (1996) (page 30 of the pdf)

Guessing at China's Steady State

When discussing China's economic convergence with the rest of the world, where it will end up is a very important issue.  It is a very difficult question; even China's different provinces are converging to different steady states.  The parts of the country that still have bad institutions and infrastructure, mainly in inland China, are converging to a lower steady state than the outlying regions in special economic zones. Internal convergence is restricted by rules that discourage capital and labor mobility. 

1. Economic Freedom vs. GDP per capita: While there are certain problems with using the economic freedom index for poor countries, it is considered by some to be a decent proxy for neoliberalism

Looking at the G20, China’s PPP GDP per capita is pretty close to where it is expected.  This is a somewhat biased sample since countries that are not significant economic players in the world financial system are not included in this sample. Including all of the countries would show that the index’s correlation to economic success is very noisy within the 50’s and 60’s.  This is particularly true for China, where the methodology gives China a score that would penalize it for the poor economic institutions in its poorer regions without getting a boost for having areas with significantly better institutions.

2. IQ vs. GDP per capita: One measure of a country’s potential output level is the measured IQ of its current workforce.  As previously mentioned, IQ’s correlation with variables other than intelligence makes it particularly significant for economic growth.

Source: IQ and Global Inequality, calculated IQ for 113 countries

A simple linear regression done on countries with IQ measurements and the natural log of GNI per capita suggests that if all other things were equal China would be converging towards a PPP GNI per capita of about 25,000 dollars (the number is closer to 18,000 if the regression includes 79 countries with IQ estimates).

3. China’s large advantage over other countries with similar economic freedom scores lies in its human capital. Human capital can also be measured by years of schooling or life expectancy, both of which China excels at relative to its current level of income. The textbook estimate of Barro and Sala-i-Martin is that the income gap between two countries with the same human capital endowment has traditionally narrowed by about 2 percent a year. Of course, this doesn’t show us where the steady state will be unless the answer is “at the same level as similar countries”, which suggests that the economically free parts of China are converging to an income level comparable to Korea’s.

While trying to track these different factors, keeping tabs on any reverse liberalization is important.  To the extent China is copying Korea or Japan instead of the US China is still on a path where its eventual steady state is so much higher than its current value that it is insignificant, but downturns are politically volatile times and that will be where the biggest risk to China’s growth lies. If China starts replacing private businesses with SOEs, it won’t matter that they have good human capital.

The constant productivity of the bottom 10%

Lane Kenworthy has a presentation on The Politics of Helping the Poor.  In this PowerPoint, he looks at the differences between countries where households at the 10th income percentile have earnings growth along with GDP growth and in countries where the 10th percentile hasn’t had an income increase despite significant GDP growth. 

Countries with income growth in the 10th percentile of households: Denmark, Sweden, Finland, Norway, Austria, Belgium, France, Netherlands, Spain, Ireland, United Kingdom

Countries with no income growth in the 10th percentile of households: Australia, Canada, Germany, Italy, Switzerland, United States (except for the late 1990s)

Afterwards, the sources of income for bottom-income-decile households were analyzed.  The explanatory factor of income growth was that in countries where the bottom decile have kept up, it has been due to an increase in government transfers and not an increase in earnings or other market income. The exceptions to this are Norway, where everyone benefited from an oil boom, and the Netherlands which had increased government transfers and an increase in income in the late 1990s.

The PowerPoint concludes that in order to help the bottom decile of households, strong social programs are the only way and that if these social programs are pushed through, the population will come to support them even if they don’t want them right now.  It should be noted that focusing on increasing the average income of the bottom decile shouldn’t be confused with the actual goal of humanitarian policies, since a generous immigration policy would help far more people even if it generated a decrease in income for households at the bottom decile in the statistics.  The approach of only looking at the income of those in the bottom decile each year also ignores that some of the bottom decile households are households with large amounts of human capital such as graduate students, and many people in the bottom decile in one year won’t be there 10 years from now.

Overall, this is a very bearish perspective on the bottom decile of workers. This presentation highlights that there is almost nowhere in the world where workers in bottom decile are increasing their private sector earnings, so the conclusion takes for granted that the only way to help these people is to encourage them to be economic parasites.  It certainly seems like the globalized world is leaving this group behind, but it might be better to not treat them as a group and focus on upwards income mobility than to focus on raising average levels.

Links: Biased scholars, odd fed policy and a Keynesian prediction

1. Megan McArdle points out that the Obama administration may be appointing an agenda driven researcher to the consumer financial protection agency.  If Obama wants to throw a bone to someone who has fought the progressive fight in trying to bend public opinion towards the creation of the agency, Elizabeth Warren looks like the obvious choice. However, if Obama is still in the mood to appoint competent technocrats over political allies, he may want to think twice about picking her.

2. Scott Sumner highlights a 2001 Pimco article by Paul McCulley about "opportunistic disinflation".  This is the theory that the Fed should not try to control inflation outright but that they should take advantage and lock in the decreased inflation expectations that occur after positive supply shocks and recessions by tightening before inflationary expectations return to prior levels. Scott's view it that this opportunistic disinflation policy is procyclical and therefore leads to the monetary policy mistake of allowing a deflationary downturn to get much worse than it should and that this policy exacerbated the recent recession.

To me, this type of approach suggests that the reason the Fed doesn't do more is that it isn't confident that it can easily fine tune inflation expectations, only stabilize them. It could also be that it is politically easier for the Fed to shift inflation expectations when it is not clear to everyone that they are shifting policy.  Either way, taking the policy of "opportunistic disinflation" seriously leads to a better understanding of Fed policy.

3. David Henderson analyzes a famous Keynesian's prediction of post WWII economic collapse.  The collapse, predicted due to a drastic drop in government spending, showed up in GDP (which includes private spending) but not in private consumption.  The 1945-1947 economic performance is on anecdote that suggests that austerity isn't always going to have knock on effects of large negative multipliers. 

The Resurgence of Chinese SOEs?

A paper on the Chinese housing market (See FT, econbrowser, MR for more details) highlights that its market has gone up almost 800% since 2003 Q1. In contrast, the Shanghai A share market and Chinese real GDP are both up about 90% since Q1 2003.

 While the paper highlights a potential bubble, What is more interesting to me is from the chart the FT takes from the paper.  They find that the market is being taken over by Central State Owned Enterprises (SOEs).  These SOE developers have been driving up the price of the housing market, paying on average 27% more for similar properties.  

 

It is worrisome to see SOEs start to dominate an economy that was growing precisely because they had reduced the impact of SOEs in their economy. A large part of their convergence growth can be attributed to their switch from a communist towards a neoliberal system. A good rule of thumb is that the smaller the impact of SOEs, the richer the area. The trend of decreasing SOE employment has been a positive driver of China’s economy since the Asian crisis in 1998*.

In China’s response to the crisis, workers at state owned enterprises have stabilized and even increased slightly from its bottom in 2008.

During an economic downturn, it makes sense that the transition from SOEs towards the private sector would slow down. However, if there is a crisis and a resurgence of SOEs, then that could be one more reason to be worried about China’s long term future.

 

 

*The causation can also be said to go the other way, as decrease in SOEs is also due to China’s liberalization of the economy which allowed private companies to force SOE’s to privatize or be uncompetitive.