Marginal Revolution

The Storm

The storm ravaged the city’s architecture and infrastructure, took hundreds of lives, exiled hundreds of thousands of residents. But it also destroyed, or enabled the destruction of, the city’s public-school system—an outcome many New Orleanians saw as deliverance....The floodwaters, so the talk went, had washed this befouled slate clean—had offered, in a state official’s words, a “once-in-a-lifetime opportunity to reinvent public education.” In due course, that opportunity was taken:...Stripped of most of its domain and financing, the Orleans Parish School Board fired all 7,500 of its teachers and support staff, effectively breaking the teachers’ union. And the Bush administration stepped in with millions of dollars for the expansion of charter schools—publicly financed but independently run schools that answer to their own boards. The result was the fastest makeover of an urban school system in American history.

That's from The Atlantic just over a year ago.  Guess what?  It's working. The storm is coming.

New site about prediction markets

Here you will find regular updates on prediction markets, with the blog-like news function here.  You'll see there that the CFTC is requesting public comments on how to regulate "event contracts."  The site is launched by these people.

I thank Chris F. Masse for the pointer.

Does the high oil price reflect a bubble?

Paul Krugman writes (and here):

The only way speculation can have a persistent effect on oil prices, then, is if it leads to physical hoarding — an increase in private inventories of black gunk. This actually happened in the late 1970s, when the effects of disrupted Iranian supply were amplified by widespread panic stockpiling.

But it hasn’t happened this time: all through the period of the alleged bubble, inventories have remained at more or less normal levels.

I've never been one to push the bubble hypothesis to explain the high price of oil but I find this an unusual argument to make against bubbles.  Isn't it easy enough to argue that the relevant hoarding is of oil in the ground rather than oil in strategic reserves or panic stockpiles?  We have lots of state-owned oil companies and maybe their way of speculating is simply to remain sluggish in their exploration and extraction activities, at least for the time being.

I think of a bubble as a market price which is above the fundamental value of the asset, largely for psychological reasons.  But with a commodity like oil the fundamental value of the asset depends on the marginal unit and thus how much oil is supplied.  Fundamental value, at least at the margin, adjusts to the price and in that sense the bubble hypothesis can seem tautologically false if we apply the traditional definition of a bubble. 

The key question, in my view, is how much more the oil-producing nations could bring to the market if a) their state-owned oil companies were not incompetent, and b) they did not tolerate this incompetence as an implicit form of speculation and collusion.  I will not offer an estimate here (I genuinely don't have one) but b) does leave some room for bubbly-like phenomena, whether or not stockpiles of pumped oil are high.  Note that in b) collusion and speculation work together and a) tosses incompetence into the mix.  The whole foul brew is probably easier to sustain in times of rising demand and thus oil price explanations are not going to be very simple, or easily separable, by the nature of the problem.

Addendum: Read Arnold Kling, here and here.

Hedge funds in everything

AdultVest, Inc., the Beverly Hills-based investment bank, which concentrates its practice exclusively on adult industry investments, mergers, and acquisitions, announced today it had been selected by Alternative Investment News as one of four funds nominated for the "Hedge Fund Launch of the Year" award.

Here is the link.  That's from John DePalma, who also points our attention to this Dilbert cartoon.

In case you were sleeping

In December, the Fed had $775B worth of Treasury securities. That stock will soon have dwindled to $300B, give or take. The difference, about $475B, represents an investment by the central bank in risky assets of the US financial sector. $475B is an extraordinary sum of money. It is as if the Fed borrowed more than $1500 from every man, woman, and child in the United States, and invested that money on our behalf in Wall Street banks that private financiers were afraid to touch. For bearing all this risk, if things work out well, taxpayers will earn about what they would have earned investing in safe government bonds.

...If the Fed were to blow through the rest of its current stock of Treasuries, it would have invested more than $2500 for every man, woman, and child in America. Public investment in the financial sector would have exceeded the direct costs to date of the Iraq War by a wide margin.

Here is much more; the Interfluidity post focuses in fact on the implications of paying interest on reserves.  The sad thing is: if I had my finger on the button, I would not have reversed these loans.  Ouch!

Letter to the NEJM

The issue of off-label prescribing is heating up again.  A recent article in the New England Journal of Medicine by Randall Stafford made the case for greater regulation.  I am concerned that the benefits of off-label prescribing are not fully appreciated.  Dan Klein and I wrote a letter to the NEJM - which they declined to publish - in response.  Here's the letter:

Dear NEJM,

R.S. Stafford writes that off-label prescribing “permits innovation in clinical practice … offers patients and physicians earlier access to potentially valuable medications and allows physicians to adopt new practices based on emerging evidence.”  Nevertheless, he calls for greater FDA regulation.

In contrast, we argue that the efficacy of off-label usage suggests that less FDA regulation of first or on-label usage would increase innovation and offer patients earlier access to new medications. 

Off-label prescribing is regulated by the judgments of doctors, medical researchers, industry, the patient community, and patients.  This system offers patients a more nuanced approach to care than a top-down approach.  We should extend this approach to new drugs as well as to new uses for old drugs.

Our perspective is bolstered by a large survey of physicians which demonstrates strong support for off-label prescribing and considerable support for reducing FDA regulations on new drugs.

Daniel Klein
Alexander Tabarrok
George Mason University

Where do the kept women go?

Zubin Jelveh reports:

If you're a married woman living in the New York City area, there's a better than 50 percent chance that you don't work, according to a recent analysis of Census data by economists affiliated with the St. Louis Federal Reserve Bank.

More specifically, only 49 percent of white high school-educated married women in their prime working ages were holding down jobs in the New York area as of the 2000 Census. To put that in perspective, there are roughly 2 million woman over 15-years-old who are married in the New York area.

The national average for this particular demographic is 67 percent. At the other end of the spectrum is Minneapolis where almost 80 percent of these married women are employed -- that's larger than the percentage of working men aged 25 and older in the U.S.

And why is this?

Surprisingly, the economists argue, the most important specific thing seems to be traffic.

And if you do work in these traffic-heavy areas, you are likely to work more hours.  But is it all causal?

With all due respect to The Walker Art Center, if I wanted to be a kept woman I would not start my quest in Minneapolis.  High density, as you find in Manhattan, means lots of fun things to do in your copious free time as a kept woman and also a higher degree of income inequality and thus the hope of snaring a rich man.  There's a reason why they didn't set Sex in the City in Paramus and most of the women there will be working even when the traffic gets worse.

Bryan Caplan on the McCain/Clinton gas tax relief plan

You'll find his contrarian take in The New York Times this morning.  It's a second best, public choice argument: according to Bryan we are usually too nasty to energy companies in bad times, so sending them some excess profits is a bit of needed TLC.  McCain's plan of course is better in his eyes because it doesn't include the punitive windfall profits tax.  And without a gas tax holiday we might be tempted to do something worse.  Excerpt:

...even a “giveaway” to the oil industry sets a positive course for the future. During the last crisis, the industry was a scapegoat for scarcity. Politicians scrambled to stop oil companies from profiting from the crisis, even though temporarily high profits end shortages by giving businesses an incentive to figure out how to increase output.

Stephen Colbert dissents.  And here's Bryan's own summary of Bryan.  I don't know the data on the average rate of tax paid by energy companies, compared to other endeavors, but looking at that would be one place to start.

Fragments of wisdom

Yet economists talk much more about trade than they do about health care policy, because they think they know something about it in a way the laity don’t...don’t let economist’s tendency to overemphasize their areas of expertise distort your view.

I don't agree with every claim in this Krugman piece, least of all his defense of you-know-who, but I think that psychoanalysis of economists is spot on.

Get politically uninvolved!

The great P.J. O'Rourke:

All politics stink. Even democracy stinks. Imagine if our clothes were selected by the majority of shoppers, which would be teenage girls. I'd be standing here with my bellybutton exposed. Imagine deciding the dinner menu by family secret ballot. I've got three kids and three dogs in my family. We'd be eating Froot Loops and rotten meat.

But let me make a distinction between politics and politicians. Some people are under the misapprehension that all politicians stink. Impeach George W. Bush, and everything will be fine. Nab Ted Kennedy on a DUI, and the nation's problems will be solved.

But the problem isn't politicians -- it's politics. Politics won't allow for the truth. And we can't blame the politicians for that. Imagine what even a little truth would sound like on today's campaign trail:

"No, I can't fix public education. The problem isn't the teachers unions or a lack of funding for salaries, vouchers or more computer equipment The problem is your kids!"

Hat tip to Newmark's Door.

Theorems

Hillary Clinton's proposal is particularly stupid, in my humble opinion, because it tries to get the money back from the oil companies with a windfall profits tax. Tax incidence is tax incidence: if the oil companies can make consumers pay most of the excise tax, then probably consumers can stick them with your windfall profits tax too.

I believe that is what they call "true enough."  Here is more.

New issue of Econ Journal Watch

It is here, and I'll cover the contents once I've had a chance to read them.  Here is a symposium on why so few women in economics?

What do I think of the Cowles Commission?

Angry at the Margin asks in the comments:

I'm curious to know what you think of these authors, beyond the fact that they achieved mainstream success, given that the Economics that came out of the Cowles Comission is more or less the exact opposite of the Economics coming out of GMU.

Here goes:

1. Tjalling Koopmans.  He is a father of operations research and certainly worthy of a Nobel Prize, although perhaps in mathematics (if they had one).  His work on optimal routing theory remains central to transportation management and he also laid some foundations for quantum chemistry.  True, he doesn't really appeal to my inner Austrian but he was an awesome intellectual figure and he also helped us win WWII.  We should all bow down and pay homage to Tjalling Koopmans.

2. Kenneth J. Arrow.  His reputation now far surpasses that of Samuelson's and he was more philosophical to boot.  Where to start?   He understood his own impossibility theorem better than did the commentators plus he is the father of modern health care economics and that is maybe 1/10th of his total contribution!  People who know him also claim he is the greatest polymath they ever met.

3. Gerard Debreu.  He is the father of general equilibrium theory and also, as a philosopher of time, the real successor to Proust, as he once explained in an interview.  His extremely minimalistic approach to economics is better when it comes from the star than from the second-tier imitators but of course a real star he was.  I think of him as the father of economic science fiction and no I don't mean that as a snub.

4. James Tobin.  About fifteen years ago I realized he was in fact one of the deepest Keynesian thinkers.  He also proposed the Tobit model and laid the foundations for modern portfolio theory.  He lives in an intellectual world different from my own but he is clearly deserving of his Nobel Prize several times over.

5. Franco Modigliani.  He is one of the guys who could have won more than one Nobel Prize.  That's one for the Modigliani-Miller theorem (the implications of being able to chop up and carve up assets), one for the lifecycle hypothesis, and perhaps even another for his 1944 article on liquidity preference, which showed the concept was probably not enough to drive the Keynesian model except for the unusual case where liquidity preference was infinitely strong.  Sadly this piece remains neglected by modern purveyors of the liquidity trap idea.

6. Herbert Simon.  Bounded rationality and behavioral economics have already taken the profession by storm; his insights on computation, neurology, and artificial intelligence have not yet been incorporated into the mainstream in an effective manner, so his long-run influence will only increase.

7. Lawrence Klein.  I can't say I am a fan of his macro modelling approach, but I'll admit I haven't spent much time with his work.

8. Trygve Haavelmo.  He pioneered how to attack identification problems in econometrics; among other things without him there would be no Steve Levitt and no Freakonomics.  He didn't just get the Nobel Prize because he was a Scandinavian.

9. Harry Markowitz.  The father of modern portfolio theory, enough said. 

Amazing, isn't it?  I still think the profession as a whole overdoes theory (even today) and undervalues breadth and real world experience, but these are nonetheless thinkers to be revered.  Arrow and Simon are, by far, the two who have influenced me the most.  It's also fair to say that GMU economics often extends in other directions, but except perhaps for Herbert Simon these are well-mined thinkers by the rest of the mainstream so not every economist need run in their direction.

Economic update

On Intrade.com, the probability of a formal recession (two successive quarters of negative growth) in 2008 has fallen from the 70 percent range to the 30 percent range.

Some time ago I had proposed "the N word" economic indicator, namely that things would be really bad if lots of people were talking about the idea of nationalizing the banks.  That hasn't happened and indeed the people who predicted widespread solvency problems seem to have been wrong.

Paul Krugman has had numerous good posts on the Ted spread as an indicator of ongoing problems in financial markets.  I'll say this: during the Great Depression no one had to cite a spread to convince anyone that things were going very badly. 

Economic knowledge is always subject to revision, but so far the evidence points in the direction of a mild recession, in the informal sense, and that The Great Moderation is still with us.

Do local currencies do any good?

You know, like BerkShares, the local "currency" in Massachusetts.  Tim Harford is skeptical:

True, community currencies may very gently encourage trade with locals rather than strangers. But the gains from more trade with locals are more than offset by the losses from less trade with strangers.

See the full post for much more.  I am more positively inclined than is Tim.  First, local currencies blossom when the nominal money supply is too low and wages and prices are sticky downwards.  A boost in the real money supply is needed and the private sector will do it -- albeit at high transactions costs -- even if the government will not.  That's why so many of these local currencies blossomed in the 1930s but then disappeared.  They did good but then they were stamped out or ceased to be necessary.

Second, private currencies can serve as a form of price discrimination.  By accepting private currency from your local customers, and indeed only your local customers, you can charge them a lower net price and without being very public about it.  That's useful if the local economy is in the dumps.  Note that as the local community recovers, this motive for the local currency goes away as well.  It also implies that local currencies will be most popular with merchants who hold excess inventory and have some market power.

Collier on the Food Crisis

Paul Collier's The Bottom Billion was my pick for best economics book last year (not written by a dear friend), it was smart, hard-hitting and unconventional.  Collier hasn't lost his touch as a great comment, more like an op-ed, on the food crisis over at Martin Wolf's Economic Forum illustrates.

The remedy to high food prices is to increase food supply, something that is entirely feasible. The most realistic way to raise global supply is to replicate the Brazilian model of large, technologically sophisticated agro-companies supplying for the world market.... There are still many areas of the world that have good land which could be used far more productively if it was properly managed by large companies...

Unfortunately, large-scale commercial agriculture is unromantic. We laud the production style of the peasant: environmentally sustainable and human in scale. In respect of manufacturing and services we grew out of this fantasy years ago, but in agriculture it continues to contaminate our policies. In Europe and Japan huge public resources have been devoted to propping up small farms. The best that can be said for these policies is that we can afford them. In Africa, which cannot afford them, development agencies have oriented their entire efforts on agricultural development to peasant style production. As a result, Africa has less large-scale commercial agriculture than it had fifty years ago. Unfortunately, peasant farming is generally not well-suited to innovation and investment: the result has been that African agriculture has fallen further and further behind the advancing productivity frontier of the globalized commercial model.

Read the whole thing.  Many more oxen are gored.

An interesting view on bank regulation

It starts with this:

...there are few crises I have known from the inside that would not have happened if only there was more disclosure. People knew that sub-prime was a poor risk – it is called sub-prime, after all.

Then it moves here:

The alternative model rests on three pillars. The first recognises that the biggest source of market and systemic failure is the economic cycle and so regulation cannot be blind and deaf to the cycle – it must put it close to the centre. Charles Goodhart and I have proposed contra-cyclical charges – capital charges that rise as the market price of risk falls as measured by financial market prices – and a good starting point for implementation of such charges is the Spanish system of dynamic provisioning (Goodhart and Persaud 2008).

The second pillar focuses regulation on systemically important distinctions, such as maturity mismatches and leverage, and not on out-dated distinctions between banks and non-banks. Institutions without leverage or mismatch should be lightly regulated – if at all – and in particular would not be required to adhere to short term rules such as mark-to-market accounting or market-price risk sensitivity that contribute to market dislocation. Bankers will argue against this, saying that it creates an unlevel playing field, but financial markets are based on diversity, not homogeneity. Incentivising long-term investors to behave long-term will mean that there will be more buyers when banks are forced to sell.

The third pillar is requiring banks to pay an insurance premium to tax payers against the risk that the tax payer will be required to bail them out. If such a market could be created, it would not only incentivise good banking and push the focus of regulation away from process to outcomes, but it would provide an incentive for banks to be less systemic. Today, banks have an incentive to be more systemic as a bail out is then guaranteed. The right response to Citibank’s routine failure to anticipate its credit risks is not for it to keep on getting bigger so that it can remain too big to fail, but for it to whither away under rising insurance premiums paid to tax payers.

Carbon tax splat

A few of you asked me for more commentary on this linked article.  Will is on board but I think it is provocative but unconvincing.  Here are a few points: oddly, the author doesn't mention the strongest argument against such a tax, namely that the Chinese and others may not follow suit.  I don't worry much about one-time compliance costs if energy improvements bring a sounder long-run state of affairs; admittedly a big if.  The side deals from a tax will be bad and I expect an inefficient version of whatever happens; that said this does not disfavor reform vs. the status quo since the status quo has very bad side deals too; whether those side deals get worse, or by how much, depends on how the counterfactual is specified.  Under some scenarios the side deals in fact get better.  Uncertainty alone does not favor inaction, rather it favors action as a kind of insurance policy against very bad outcomes.  And uncertainty about long chains of causation most definitely does not, per se, favor reliance on market prices, rather it favors agnosticism about market vs. government.  Waiting does seem very costly to me; read Six Degrees.  I am far from convinced that the Nordhaus model is the best way to think about the costs of warming.  The author of the post is at his best when arguing: "a tax is unlikely to work," at his weakest when arguing "this means the best course of action is no tax at all."

The bottom line is that the whole thing is likely to end very badly for at least one billion of the world's people, no matter what we do within the feasible set.  In the meantime we can tell them they ought to get richer, and of course they should, but that's hardly a solution either.

Markets in everything, Thorstein Veblen edition

A watch that doesn't tell time.  Oh, it costs $300,000.  And:

He added that anyone can buy a watch that tells time — only a truly discerning customer can buy one that doesn’t.

And here’s the best part: The watch sold out within 48 hours of its launch.

I thank Darren Klein for the pointer.

Addendum: I am reminded of Borges on Veblen: "When, many years ago, I happened to read this book, I thought it was a satire.  I later learned it was the first work of an illustrious sociologist."

Exporting Electrons

Everyone knows that Caterpillar is an exporter.  But last week Google reported record profits and Google stock rose nearly twenty percent.  Why were profits up?  Google's foreign revenues shot head of its U.S. revenues because of a weaker dollar.  Google is an exporter.  Who knew?  And what does Google export?  Patterns of electrons.

Thanks to David Levy for discussion.

Limited Liability

I will pinch hit for Tyler on a few questions of interest to readers beginning with, "What's up with limited liability corporations?"  A common libertarian argument is that groups do not possess rights beyond those of individuals.  If it is wrong for A, B and C to steal from D then it is wrong for A, B and C to call themselves a government and tax D. Similarly, we might ask if A, B and C must pay for any injuries that they negligently cause D then how can they justly combine together to form a corporation and limit their liability?  For this reason a consistent libertarian like Murray Rothbard rejects limited liability in tort as illegitimate.  (Critics of limited liability from the left, however, do not seem to carry their argument over to taxation.)

Do note that limited liability in tort is the crux.  Limited liability of shareholders to creditors is innocuous because this is just a matter of contract and regardless of the default law can be modified.

The economic argument against limited liability (JSTOR) is that it socializes risk.  But many people on both the right and the left think that limited liability is the acme of capitalism (see the extension for some quotes) without which capital markets would fall apart - thus at least some people think limited liability is important and necessary.

Empirical research, however, indicates that limited liability is just not that big a deal.  British firms had unlimited liability until 1855, California firms had unlimited liability until 1931, banks had double liability until the 1930s and American Express had unlimited liability until 1965.  None of this seemed to matter very much.

One reason why unlimited liability may not matter very much is that most of the time capital more than covers tort risk so unlimited liability is usually moot.  Insurance requirements, Basel-like capital requirements and other such laws cover externality problems when this is not the case.  Most of the time we are not on the bubble where tort does pay and even on the bubble managers can be found criminally liable for truly egregious torts.

Even in an enhanced tort risk environment unlimited liability may not be worth the candle because it can be gamed - assets can be shuffled around to judgment proof investors, and firms can decentralize.

Unlimited liability also raises transaction costs.  In a joint and several regime, for example, Bill Gates would be liable for all tort expenditures simply by owning one share of a corporation - that makes Bill Gates less likely to invest and more concerned with who else owns shares in the corporation.  And which shareholders should pay, the ones who own the stock when the tort claim is brought or the ones who owned the shares when the tort happened?  These problems can be solved but is it worth the hassle?

In my view, the bottom line is that limited liability lowers transaction costs and has few negative effects in part because torts usually do not bankrupt firms and other institutions (such as insurance) substitute for unlimited liability and in part because the advantages of unlimited liability would mostly be gamed away in anycase.

Addendum: Bainbridge has more.

“The limited liability corporation is the greatest single discovery of modern times. Even steam and electricity are less important than the limited liability company”.

Professor Butler President of Columbia University, 1911.

"This limited liability corporation is the bedrock of the market economy…And what do we, the citizenry, get in return for this generous public grant of limited liability? Originally, we told the corporation what to do. You are to deliver the goods and then go out of business. And then let humans live our lives. But corporations gained power, broke through democratic controls, and now roam around the world inflicting unspeakable damage on the earth."

Russell Mokhiber and Robert Weissman, Mother Jones 1999

Markets in everything, China fact of the day edition

Police in southern China have discovered a factory manufacturing Free Tibet flags, media reports say. The factory in Guangdong had been completing overseas orders for the flag of the Tibetan government-in-exile.

Here is the link, hat tip to Christopher Hayes.

Collected advice for young economists

Lots of links, mostly excellent.  The Lucas research memoir was new to me.

Hat tip is to Craig Newmark.

Peter Thiel on the Great Bubble

One would not have thought it possible for the internet bubble of the late 1990s, the greatest boom in the history of the world, to be replaced within five years by a real estate bubble of even greater magnitude and worse stupidity. Under more normal circumstances, one would not have thought that the same mistake could happen twice in the lifetimes of the people involved...

The most straightforward explanation begins with the view that all of these bubbles are not truly separate, but instead represent different facets of a single Great Boom of unprecedented size and duration. As with the earlier bubbles of the modern age, the Great Boom has been based on a similar story of globalization, told and retold in different ways — and so we have seen a rotating series of local booms and bubbles as investors price a globally unified world through the prism of different markets.

Nevertheless, this Great Boom is also very different from all previous bubbles. This time around, globalization either will succeed and humanity will achieve a degree of freedom and prosperity that can scarcely be imagined, or globalization will fail and capitalism or even humanity itself may come to an end. The real alternative to good globalization is world war. And because of the nature of today ’s technology, such a war would be apocalyptic in the twenty-first century. Because there is not much time left, the Great Boom, taken as a whole, either is not a bubble at all, or it is the final and greatest bubble in history.

This also means that catastrophic risk has never been higher and the peso problem -- changing small probabilities of total collapse -- is screwing around with asset prices to an unprecedented degree.  Here is the full essay, which also has much of value on China, among other topics.  If nothing else, remember this:

...there is no good scenario for the world in which China fails.

And this:

...a long “China” position is not a forecast that financial globalization will succeed, but rather a bet that its internal contradictions will persist.

The hat tip is from wunderkind Ben Casnocha.

Markets in everything: reverse prostitution edition

Thousands of people in Africa will be paid to avoid unsafe sex, under a groundbreaking World Bank-backed experiment aimed at halting the spread of Aids.

The $1.8m trial – to be launched this year – will counsel 3,000 men and women aged 15-30 in southern rural Tanzania over three years, paying them on condition that periodic laboratory test results prove they have not contracted sexually transmitted infections.

The proposed payments of $45 equate to a quarter of annual income for some participants.

Here is the full story.  It is a joint private sector, public sector initiative, in case you were wondering.  I thank Johannes for the pointer.

How good would the abolition of zoning in New York City be?

Yes, I am opposed to many forms of zoning.  Without zoning our cities would be denser, more eco-friendly, cheaper to live in, more able to produce economies of agglomeration, and more immigrants would benefit from American prosperity.  Matt Yglesias periodically has good posts on this topic. 

More specifically, Manhattan would look more like Sao Paulo, with a true forest of skyscrapers instead of the current puny and indeed embarrassing line-up.  Many of these towers would be residential, as they are in Sao Paulo.  Many problems of cities, including congestion, would of course become worse.  Overall I see the gain as real but a small one, at least relative to gdp.

A key question is what zoning means.  Let's say you wanted to set up a shack on the sidewalk and live in it; should that be allowed?  How about a modest apartment building but without a water connection?  Should Manhattan really become like Sao Paulo?  Only in extreme cases would I wish to waive such infrastructure requirements for the housing stock.  And if you agree with me on that one, then you don't want to get rid of most zoning either.

Fried Rice

Dani Rodrik offers some criticisms of my piece on free trade in rice:

Cowen argues that freer trade in food commodities such as rice would boost global supplies and help reduce prices.  He is probably right about the first, but not about the second.

Angus offers some good responses plus see the comments section on my blog and his.  I'm with the guy who wrote: "I read the piece, Cowen never commits the fallacy."  Adam Smith weighs in too.

I'll put the rest under the fold...

The main point of my piece is that inter- and intra-national restrictions on trade in rice are bad, not that free trade reduces the price of rice for everyone.  Consider a simple analogy: if the quality of Interstate 95 declined, the price of barbecue in North Carolina might fall, namely because people like me wouldn't drive to go eat there.  Yet few people would argue that a nation can do better feeding itself by lowering the quality of its roads or for that matter littering its harbor with dangerous rocks or for that matter imposing export restrictions.  It doesn't knock down the trade argument, as an empirical claim, to cite the existence of pecuniary externalities.

Maybe Rodrik has in mind the commonly-heard argument that eliminating the agricultural subsidies of rich countries would produce vast benefits for poor countries.  I've criticized that claim myself; my column is careful to argue that the poor countries are the worst protectionists, often internally as well as externally.

Here is a related part of Rodrik's critique:

Freer trade would reduce prices of food (relative to other prices) only in countries that are food importers.  Food exporters would experience a rise in the relative price of food, and there is simply no way of escaping that reality.

The great strength of Rodrik's work is how much he stresses the context-dependent nature of economic arguments and how "one size fits all" is often an oversimplification.  So beware when anyone writes "there is simply no way of escaping that reality."  Increasing returns are one way of escaping that reality.  Would the price of cars be lower in Japan today, if the Japanese had placed heavy export restrictions on Toyota autos?  Probably not.  (Constant returns, by the way, are another means of escaping from that reality.)  Now rice production may or may not be subject to increasing returns, but surely rice trade is a positive-sum game and also has broadly pro-egalitarian effects.

Trade really is an issue where a) economists have something to say and b) human lives are on the line.  If Rodrik wishes to argue, "Indonesia should ban the export of rice," then by all means he should just come right out and say so.  Let's have that debate.  But if not, I wonder if he could see his way toward using his considerable influence and writing eight simple words:

"The world should have free trade in rice."

Markets in Everything: Want Ads for Hit Men

One of Mexico's biggest drug cartels has launched a brazen recruiting campaign, putting up fliers and banners promising good pay, free cars and better food to army soldiers who join the cartel's elite band of hit men.

From USA Today.  Hat tip to Peter Gordon.

Freer trade could fill the world's rice bowl

Here is my latest New York Times column.  Here is the conclusion:

Lately, it’s become fashionable to assert that, in this time of financial market turmoil, the market-oriented teachings of Milton Friedman belong more to the past than to the future. The sadder truth is that when it comes to food production — arguably the most important of all human activities — Mr. Friedman’s free-trade ideas still haven’t seen the light of day.

Here is the most interesting paragraph:

The reality is that many of today’s commodity shortages, including that for oil, occur because ever more production and trade take place in relatively inefficient and inflexible countries. We’re accustomed to the response times of Silicon Valley, but when it comes to commodities production, many of the relevant institutions abroad have only one foot in the modern age. In other words, the world’s commodities table is very far from flat.

Here is the most tragic part of the piece:

Poor rice yields are not the major problem. The United Nations Food and Agriculture Organization estimates that global rice production increased by 1 percent last year and says that it is expected to increase 1.8 percent this year. That’s not impressive, but it shouldn’t cause starvation.

The more telling figure is that over the next year, international trade in rice is expected to decline more than 3 percent, when it should be expanding. The decline is attributable mainly to recent restrictions on rice exports in rice-producing countries like India, Indonesia, Vietnam, China, Cambodia and Egypt. 

Addendum: Also from today's NYT, read this supporting article, which covers grain in Argentina.  And from Duke, here is a related piece on Africa.

Trade and inequality, revisited -- Rooftops edition

Another way of investigating the relationship between inequality and trade with poor countries implies that China may actually help the poor, suggests new work from University of Chicago economists Christian Broda and John Romalis.

Instead of focusing purely on what's produced outside of the country, Broda and Romalis turn their attention to an interesting but obvious relationship between imports and consumption within our border: The goods exported by poorer countries are typically consumed by lower-income Americans. Our typical methods of quantifying inequality, however, don't take this into account.

At the same time, inflation in the price of these goods has fallen behind inflation in services, which make up a greater portion of what wealthier people buy. Taken together, these trends imply that official measures may be overstating the rise in inequality.

Looking at trade data between 1994 and 2005, Broda and Romalis construct inflation rates for different income groups and find that rates for the richest outpaced rates for the poorest by about 4 percent over the period. Since income inequality between the top and bottom 10 percent of earners grew by about 6 percent, the different inflation rates among income groups wipes out about two-thirds of the rise in inequality.

The emphasis in that last sentence is mine.  It continues:

China's role in this new way of analyzing inequality is large, accounting for about 50 percent of the total reduction.

And scream this part from the rooftops too [how do you scream a parenthesis?]:

(A very interesting aside. Broda and Romalis also find that the poor are more likely than the rich to buy newer goods. Because of the lag in how quickly the CPI tracks new products, the researchers argue that once this "new goods bias" which serves to keep official inflation rates higher than they actually are since newer goods are typically cheaper, is factored out, inequality between the rich and the poor between 1994 and 2005 may not have changed at all.)

Here is the link.  Again, here is the Broda and Romalis paper.  If this holds up it is big, big news and we must revise many claims that have been made about inequality, trade, and China.

Is Richard Posner right about air travel and its problems?

Who better to ask than Air Genius Gary Leff:?

...the usually sober, sometimes brilliant, and certainly prolific judge and scholar offers up an unusually misguided rant on why he believes “airline service is so bad” over at the Becker-Posner Blog...

Here is Posner's charge, which I might add calls for air travel reregulation.  Read Gary's whole response.  I don't, as they say, have a horse in this race (noting that Gary and I work together at GMU).  What I do know points to two major problems: badly run airports (rather than air travel deregulation per se) and too many flights clustered at peak hours.  That puts me closer to Gary's analysis than Posner's.  Congestion pricing and true markets for all airport services would solve many of the problems, in my view.

Europe fact of the day

Ahem:

At a time when the world’s top climate experts agree that carbon emissions must be rapidly reduced to hold down global warming, Italy’s major electricity producer, Enel, is converting its massive power plant here from oil to coal, generally the dirtiest fuel on earth.

Over the next five years, Italy will increase its reliance on coal to 33 percent from 14 percent. Power generated by Enel from coal will rise to 50 percent.

And Italy is not alone in its return to coal. Driven by rising demand, record high oil and natural gas prices, concerns over energy security and an aversion to nuclear energy, European countries are expected to put into operation about 50 coal-fired plants over the next five years, plants that will be in use for the next five decades.

Here is the full story.

Non-mainstream schools of thought

A loyal MR reader requests coverage:

On mainstream versus "fringier" economic schools of thought (and schools themselves too if you like); and on different schools of thought generally, and your take on them; where economic theory is at present.

Here is me on Sraffa and the neo-Ricardians and also post-Keynesians and the Cambridge capital debates.  The Austrians I cover all the time.  Here is my post on what is new and essential in economics.  Overall I don't believe in schools of thought for modern economics.  Think of the notion of a school of thought as a brand.  The whole point of the internet is to break down branding into the evaluation smaller units, including individuals and their very particular ideas, even doing cite counts paper by paper.  Why move toward more macro branding in that kind of environment?  You can think of trustworthy bloggers as another means of branding and also as substitutes for schools of thought.

Today I see neuroeconomics and personality psychology as two frontiers, plus economic history, but I wouldn't call any of those schools of thought, nor should they be.

Hendrik Houthakker dies at 83

Here is the Post obituary.  Here is Houthakker at scholar.google.com, most of all on consumer behavior and conditions under which revealed preference is a coherent theory of individual behavior.  Here is another obituary; not only did he serve on the CEA twice but he was selected by the Pope as Knight Commander with Star in the Papal Equestrian Order of St. Gregory the Great.

Demand Response

A large share of the special green issue of the NYTimes Magazine was closely tied to economics.  I find this encouraging.  Here is one interesting bit:

...demand response has become one of the most powerful green techniques for protecting the nation’s overtaxed power grids. When a blackout looms, utilities call a small coterie of demand-response firms. These firms prearrange for major users of electricity — factories, shopping malls, skyscrapers — to shut down all nonessential electricity in exchange for payments, often totaling tens of thousands of dollars each year. It’s expensive, but far less so than a blackout that cascades across the country....ConsumerPowerline controls 300 huge buildings in New York alone, where hastily brokered turnoffs by Macy’s and major hotels prevented the spread of a 2006 blackout in Queens — a blackout that lasted for more than a week — into Manhattan.

More on energy pessimism

Paul Krugman writes:

You might say that this is my answer to those who cheerfully assert that human ingenuity and technological progress will solve all our problems. For the last 35 years, progress on energy technologies has consistently fallen below expectations.

It's worth noting that if we had to build today's energy infrastructure working under the current regulatory and NIMBY burden, it probably could not be done.  So it shouldn't be surprising that building a new energy infrastructure is proving so hard.  There's a reason why many of us think deregulation is a big issue and it's not because we want to see people poisoned by Chinese botchagaloop.

What will happen with commodity prices?

Megan McArdle gives one bottom line, referring to Paul Krugman's somewhat pessimistic column.  I would say that China has been massively productive but not so much in producing commodities.  That means the demand for commodities has gone up much more rapidly than the supply.  You could imagine an alternative universe in which China grew by figuring out ways to produce oil, copper, and rice much more cheaply.  Of course that's not what happened and it is relatively easy to see why not.  Following some good policy changes, Chinese growth has been driven by a massive rural to urban migration and yes we are talking about hundreds of millions of people.  It's plastic basketballs that have become cheaper, not the products of farms.

The mere addition of labor inputs to urban areas doesn't, in the short run, help you produce commodities more cheaply.  Think of the Solow model where K and L have gone up lots but the rate of generating new ideas is only slightly higher.

When all those new Chinese engineers and scientists are at the peak of their creative powers, this relationship will reverse itself and commodities prices will plunge.  But it's quicker to produce another toy than to bring about a new Green Revolution, so in the meantime commodity prices are very high.  I give the current price trend another ten or fifteen years or so to run.  Eventually high commodity prices will seem permanent and then the bottom will drop out.

We've never had a rapid and successful migration of hundreds of millions before, ever.

Answering your questions

Who knows, maybe I'll try to get to them all.  Here's the first:

What impact will algorithmic game theory have on economics?

I'd start by asking: will game theory pure and simple have (further) impact on economics?  And I'd say basically "no."  The common concepts and tricks of game theory are invaluable but we already have those and I don't see any more coming down the pike.  Algorithmic game theory will address problems internal to game theory and within that context it will flourish.  Finding equilibria, and discriminating among multiple equilibria, are otherwise very difficult problems and AGT is a natural way to crack those nuts.  So AGT will have continued practical applications in computer science and problems of engineering.  But it won't much affect how most economists think about the world or do their research.

As for NBA analysis, I'll just say that a) Boston is still an odds-on favorite, b) No one ever really told us what happened to Andrew Bynum, and c) Even though Phoenix probably won't make it, the Shaq trade was very clearly a good idea and all you doubters should offer up mea culpas.

Non-profit prediction markets

At Bet2give, an online electronic prediction market, anyone can “bet” real money on the outcome of these events but with a twist – the “winnings” go to a charity of the person’s choice.

Here is the full article, and here is Bet2give.com.  One of the "problems" with prediction markets is that they are zero-sum investments and traders cannot on average hope to come out ahead.  So why trade?  If only people really "in the know" trade liquidity will be low.  If too many "betting for fun" fools trade, the prices don't mean that much.  You might get the right mix of informed and uninformed but who knows?  So the idea of doing these in charitable form might make some sense.

Sentences of wisdom

What’s missing is a recognition of how mysterious the secret of economic growth remains, despite all the energy that economists have poured into solving it.

That's James Surowiecki, reviewing Ha-Joon Chang's Bad Samaritans and writing on free trade; the piece is interesting throughout.  The pointer is from Ben Casnocha.

Climate solutions and carbon dividends

Peter Barnes, Climate Solutions: A Citizen's Guide is the full title.  This simple book is written in the form of punchlines and cartoons but it's still one of the more insightful treatments of the topic.  He is skeptical of a carbon tax:

A carbon tax will never be high enough to do the job.

A low carbon tax would create the illusion of action without changing business as usual.

His alternative proposal has four steps:

1. Carbon cap is gradually lowered 80% by 2050.

2. Carbon permits are auctioned.

3. Clean energy becomes competitive.

4. You get an equal share in the form of permit income.

The "carbon dividends" of course are intended to make the tax politically palatable.  Naturally I am worried by the idea of revenue addiction, not to mention the general practice of redistributing income from business to citizens simply because it is popular to do so.  It might feel pretty good at first but we don't want to encourage Chavez-like behavior on the part of our government.

A broader question is whether the carbon dividends in fact make the citizenry better off.  First there is the question of the incidence of the initial carbon tax, which of course falls on individuals one way or another.  Second, does just sending people money, collectively, make the populace better off?  Aggregate demand effects aside, will the fiscal stimulus make the citizenry as a whole better off?  No.  Will printing up more money and sending it to everyone, even if that is popular, make people better off?  No.

(As an aside, does the Humean quantity theory experiment redistribute wealth from corporations -- which don't sleep on pillows and thus cannot wake up in the morning to "more money" -- to individuals, who do sleep on pillows?  Or is the corporate veil fully pierced?  Just wondering...)

I fear versions of this idea whose (possible) popularity rests on tricking voters.  Being pro-science also means being pro-economic science. 

The general point remains that most discussions of global warming focus on prices and technologies alone, without incorporating realistic models of politics.  By the way, if you think John McCain is a straight talker, try this for yikes. 

Sunspots forever

David Cass, formerly an economist at the University of Pennsylvania, has passed away.  His contributions were notable:

He made singular contributions to economic theory, including the introduction of the "Cass-Koopmans" growth model, the discovery of the "Cass" criterion for Pareto efficiency in overlapping generations models. With Karl Shell, he discovered the importance of extrinsic uncertainty (sunspots) in economic dynamics.  His work with many coauthors on incomplete financial markets was extremely influential.

The main idea of sunspots models is that when multiple equilibria are present, expectations can determine which equilibrium comes to pass.  This is a twist on rational expectations; under RE people expect the true model but Cass showed that what is the true model will depend on what people expect.  If I recall correctly, Cass also helped figure out when problems with infinities will render growth models incoherent or invalid.  Cass's version of "high theory" is exactly what is out of fashion today but in the 1980s it was the rage.  I believe some of his work will return in importance.  Here is Cass on scholar.google.com.

Thanks to Chester Norman for the pointer.

Good paper titles

"Do Funds-of-Funds Deserve Their Fees-on-Fees? "

The answer, of course, is yes.

The Mobi

The Mobi is Germany's mobility bonus, funding that covers moving, relocation and retraining costs for unemployed Germans seeking work anywhere in the world.

Plagued by high unemployment due to the turmoil of re-unification and rigid labour laws, Germany has been helping its skilled and less-skilled jobless workers match up with foreign employers searching for manpower.

The country has also been offering financial support to cover moving and transportation costs for the hordes of unemployed Germans in search of jobs across the European Union, and even as far away as Australia and Canada.

The mobility bonus strikes me as a move of desperation. The Germans have created a bloated welfare state and now they are paying people to get off the welfare rolls and get out.  I wonder what Rawls would have said?

Even now, I see an opportunity for America:

Give me your tired, your poor,
Your huddled masses yearning to breathe free,
The wretched refuse of your teeming shore.
Send these, the homeless, tempest-tost to me,
I lift my lamp beside the golden door!

Financial Compensation for Organ Donors is Working

Only one country in the world has eliminated the shortage of transplant kidneys.  Only one country in the world has legalized financial payments to kidney donors.  That country is Iran.

In an important report, transplant surgeon nephrologist Benjamin Hippen argues that the Iranian system has saved thousands of lives and it should be used if not as model then to inform America's efforts to eliminate its deadly shortage.

In the Iranian system organs are not bought and sold at the bazaar.  Instead a non-profit, volunteer-run Dialysis and Transplant Patients Association (DATPA) mediates between recipients and donors.  Recipients who cannot be assigned a kidney from a deceased donor and who cannot find a related living donor may apply to the DATPA.  The DATPA identifies a possible donor from a pool of people who have applied to the DATPA to be donors.  Donors are medically evaluated by transplant physicians, who have no connection to the DATPA, in just the same way as are non-financially compensated donors.

The government pays donors $1,200 plus limited health insurance coverage.  In addition, charitable organizations also provide renumeration to impoverished donors.  Thus demonstrating that Iran has something to teach the world about charity as well as about markets.  Will wonders never cease?  Recipients may also contribute to donor remuneration.

Hippen reports that the system works well, although better follow-up of donors would be an improvement.  He concludes with a call to legalize financial compensation in the United States.

The economics of the male pill

Might there soon be a pill for men?  Standard theories of tax incidence (borrowing from the Coase theorem) say that if so, it shouldn't much affect the quantity of intercourse.  Either the gains from trade are there or they are not.  The initial burden of taking the pill might change the distribution of those gains across the sexes, but at the end of the night the final result should still be the same.

Only not!

If you are a man who can credibly signal he is taking such a pill, it is like paying the woman for that final result you so desired.  The woman no longer has to perform the costly pill-taking action herself.  And indeed the typical equilibrium is in fact that the man does the paying.  But with the male pill you are paying her in a way that will flatter her, not insult her.  Nice, eh?

The funny thing is, I don't expect the male pill to be popular at all.  The key question is to figure out which assumption of the basic model is not satisfied.

One possibility is that women will infer that a man taking the pill is essentially paying other women for sex and she values him less highly.

Another possibility has to do with credibility combined with lags.  If it's focal for the woman to be taking the pill, the woman is in any case taking her pill in advance.  The male pill would have impact, at the margin, only on women who weren't really planning on having sex at all.  And what kind of man spends his energy targeting such women?  Yes, some men indeed do target such women, but then we're back to the male pill not really being so popular.

A third possibility is that women in any case want the man to use a condom, if only to prevent STDs.  If the man is on the pill, it is harder to make that request without insulting him and thus a woman doesn't want her new paramour to be on the male pill.

Addendum: Megan McArdle adds a fourth explanation.

Simple sense about discount rates

Geoffrey Heal writes:

Sterner and Persson...talk about the effect of changes in relative prices rather than consumption of produced and environmental goods, but the point is the same.  If we consume both produced goods and the services of the environment...then we can expect that with climate change environmental services will become scarce relative to produced goods and therefore their price will rise relative to that of produced goods.  Consequently, the present value of an increment of environmental services may be rising over time, and the consumption discount rate on environmental services may thus be negative...This could be the case even with a positive pure rate of time preference...

Here is the paper.  Here is an ungated version.  In the interests of fairness to both sides of this debate, I should note that while I believe the costs of climate change are higher than most people think, I also believe that the costs of fixing the problem are higher than people think.

Why are there so few eligible bachelors?

...game theory predicts, and empirical studies of auctions bear out, that auctions will often be won by "weak" bidders, who know that they can be outbid and so bid more aggressively, while the "strong" bidders will hold out for a really great deal. You can find a technical discussion of this here. (Be warned: "Bidding Behavior in Asymmetric Auctions" is not for everyone, and I certainly won't claim to have a handle on all the math.) But you can also see how this works intuitively if you just consider that with a lot at stake in getting it right in one shot, it's the women who are confident that they are holding a strong hand who are likely to hold out and wait for the perfect prospect.

This is how you come to the Eligible-Bachelor Paradox, which is no longer so paradoxical. The pool of appealing men shrinks as many are married off and taken out of the game, leaving a disproportionate number of men who are notably imperfect (perhaps they are short, socially awkward, underemployed). And at the same time, you get a pool of women weighted toward the attractive, desirable "strong bidders."

Where have all the most appealing men gone? Married young, most of them—and sometimes to women whose most salient characteristic was not their beauty, or passion, or intellect, but their decisiveness.

Here is the full argument.  I don't, however, quite buy this as the explanation of the phenomenon.  I view the real world auction as being held -- at least if you wish -- continuously rather than at discrete times.  So the "strong bidding women" can always cave and settle for a "lesser man" after an optimal amount of waiting, yet many don't.  The distinction between period-by-period happiness and overall lifetime happiness also shapes the market.  As smart single women mature, their lives get better and better.  "Settling" becomes psychologically harder, even if it would make some of the "settlers" happy in the longer run.  So settling doesn't happen; decisiveness become harder to conjure up at the same time that its long-run value is increasing, or in other words behavioral economics is very much at work here.

Incentives are everywhere

The introduction of automated cameras that ticket people who run a red light has given some cities a "clever" idea - let's reduce the yellow-light period and increase ticket revenue.  Here's one example from Dallas. 

An investigation by KDFW-TV, a local TV station, found that of the ten cameras that issued the greatest number of tickets in the city, seven were located at intersections where the yellow duration is shorter than the bare minimum recommended by the Texas Department of Transportation (TxDOT).

The city’s second highest revenue producing camera, for example, was located at the intersection of Greenville Avenue and Mockingbird Lane. It issued 9407 tickets worth $705,525 between January 1 and August 31, 2007. At the intersections on Greenville Avenue leading up to the camera intersection, however, yellows are at least 3.5 or 4.0 seconds in duration, but the ticket-producing intersection’s yellow stands at just 3.15 seconds. That is 0.35 seconds shorter than TxDOT’s recommended bare minimum.

More examples here and a hat tip to J-Walk Blog.

Sebastian Mallaby on hedge funds

The most striking fact about the ongoing financial mayhem is that it is concentrated not in lightly regulated hedge funds but in more heavily regulated commercial and investment banks. It is banks that created subprime mortgage securities. It is banks that mispriced them. And it is banks that filled their own coffers with this toxic paper, losing hundreds of billions of dollars. A somewhat breathless March 31 Financial Times article proclaimed the closing of the worst month for hedge funds since the collapse of the infamous Long Term Capital Management in 1998. But the average fund tracked by the Chicago-based firm Hedge Fund Research declined by a mere 2.4 percent in March, bringing the cumulative fall for the first quarter of 2008 to 2.7 percent. By contrast, the bank-heavy financial services component of the S&P 500 fell 12.3 percent in the first quarter.

Hedge funds, for the most part, have weathered the storm remarkably well.

Here is more, interesting throughout and in my view largely correct.  See also related remarks by Megan McArdle.

Assorted Links

• Keith Chen (of monkey sex fame) says cognitive dissonance may be an artifact of an unappreciated Monty Hall problem.

• Brad DeLong is an "optimist" on housing.  Even if wrong this puts him in good company.

• The economics of Barack Obama Senior is upsetting some people.

More on Bartels

I'm a little surprised that the Bartels result is receiving so much attention because the result, in slightly different form, has long been known to political economists under the rubric of partisan business cycle theory.  In a nutshell, the theory of partisan business cycles says that Democrats care more about reducing unemployment, Republicans care more about reducing inflation.  Wage growth is set according to expected inflation in advance of an election.  Since which party will win the election is unknown wages growth is set according to a mean of the Democrat (high) and Republican (low) expected inflation rates.  If Democrats are elected they inflate and real wages fall creating a boom.  If Republicans are elected they reduce inflation and real wages rise creating a bust.  Notice that in PBC theory neither party creates a boom or bust it's uncertainty which drives the result - if the winning party were known there would be neither boom nor bust.

Ok, there's plenty to question about the theory but let's look at the data.

Notice that in the second year of just about every Democratic Presidency there is a boom.  Interestingly, the boom is biggest for Truman whose reelection was highly uncertain (remember Dewey wins!) thus expected inflation would have been low and the boom big.  Similarly the boom is smallest (relative to the surrounding years) for Clinton II a relatively certain reelection.

Now look at Republicans in just about every second year of a Republican Presidency there is a bust.  The one major exception being Reagan II where uncertainty about the outcome was low.

It's pretty clear that this result can explain Bartels's result which is exactly Tyler's point in his post.   It's equally clear that when we consider Presidents there aren't many data points.  (PBC does appear to hold somewhat in other countries).

Notice that the reason for the result, according to PBC, is sticky wages and the business cycle and not some nefarious story about taxes, oligarchies and political conspiracies.

World Wide Losses are the Best Losses

From the frozen lands of Norway's Arctic Circle to the hot sands of the Middle East and the booming metropolis of Shanghai the losses from America's subprime crisis are popping up around the world like angry whac-a-moles.  The losses are large and appear larger by being found in the most unexpected of places.  Today the focus is on these world-wide losses but I think future historians will focus on how the crisis demonstrated to everyone the power of integrated capital markets to diversify risk. 

The losses, of course, are regrettable and the desire to find and apportion blame for the crisis among investors, home buyers, mortgage brokers, credit analysts and regulators is understandable.  We should and will learn lessons.  And yet, despite problems with transparency one of those lessons ought to be that the crisis would have been worse if the losses had been more concentrated.

From this perspective, world-wide losses are perhaps the best losses of all.

The erotics of investing

When young men were shown erotic pictures, they were more likely to make a larger financial gamble than if they were shown a picture of something scary, such as a snake, or something neutral, such as a stapler, university researchers reported.

The arousing pictures lit up the same part of the brain that lights up when financial risks are taken.

...The study conforms with recent research that indicates men shown a pornographic movie were more likely to make riskier sexual decisions. Another suggests straight men think less about their financial future after being shown pictures of pretty women.

Here is more.  One question -- and perhaps a more direct test of the hypothesis -- is whether traders in more sexually integrated firms do in fact behave differently.  Or how about companies located next to modeling agencies?  I suspect in real social settings the effect washes out, for reasons identified by Freud (among others) some time ago.  The more literally minded among us might also question whether a stapler is in fact a neutral image.  It isn't for me.

Why economics was late in starting

I've already posed the question, I'd like to add two points.  First, sustained economic growth in the Western world starts in 17th century England, as shown by Greg Clark.  Interest in economic reasoning then comes rapidly, first from the mercantilists, then in Adam Smith and some earlier free trade thinkers, such as Dudley North and Nicholas Barbon.

Second, the idea of "private vices, publick virtues" was central for eighteenth century economic thought and for social science more generally.  This came from Bernard Mandeville (drawing upon the French Jansenists) in 1720.  It's no accident that Mandeville lived in the Dutch Republic, which had very little censorship.  No, I am not a Straussian but the merits of that viewpoint are often overlooked.

The School of Salamanca had an excellent marginal utility theory in 17th century Spain, the framework simply did not go anywhere.  For that matter we can look later and see that Samuel Bailey, Mountifort Longfield (1834), and others had critical components of Marshall.  But no one really cared because they could not yet see how important those contributions would turn out to be.  This is a central theme in why the growth of economic thought took so long.

It also suggests that today we might have some very important ideas amongst us, we simply cannot yet see how fruitful they will be.  Their own proponents may not even know it.

Capital requirements smackdown watch

Eric Falkenstein writes:

How much capital for derivatives? Good question. Should it be weighted by risk? If so, how does one measure risk? Considering that risk is a function of the collateral, which comes in many different flavors (traded debt, pools of mortgages, pools of bank lines), and then are structured very differently, with differing levels of subordination, differing rules for the waterfalls of cashflows depending on various metrics of collateral quality. It's a mess.

...You may think this is no different than regular lending, but you would be wrong. For example, lets say you have two swaps, but they both offset each other almost exactly for interest rate risk, but as they have different counterparties, they have differing credit risk. How about swaps from the same counterparty, but differing interest rate exposures, partially netted. How much should capital be netted? And if the US banks have capital requirements greater than economically necessary, how many seconds before all swaps would move offshore?

I take him to be saying that financial institutions can never be transparent in their risk-taking, or at least not in the sense that can be made accountable to a regulator.  Read the whole thing.  Read also Doug Colkitt's comment