Cardiff de Alejo Garcia

New podcast at FT Alphaville

Please have a look at a podcast we launched over on FT Alphaville a couple of weeks ago.  Hosted by yours truly, it's a long interview about the Chinese economic model with Peking University finance professor (and indie record-label owner) Michael Pettis.

A response from Charles Karelis

My thanks to Professor Charles Karelis, author of The Persistence of Poverty, for his excellent comment beneath my recent guest post at Psychology Today's Headcase blog.  I'm reprinting the comment below, but first a recap and some additional thoughts.

My post focused on a 2008 study that Dan Ariely linked to a few weeks ago, and which found that premature deaths in the US are increasingly the result of bad personal decisions (rather than causes such as accidents or genetic diseases).

After explaining the study, I mentioned that some of these decisions are made disproportionately by people in poverty.  This is where Karelis's book comes into play, as its main thesis is about how the decisions faced by the poor are different in nature than those faced by everybody else.  I summarized his idea as follows:

If you have so many burdens in your life at the same time—joblessness, obesity, crime—then eliminating just one of them makes a difference so negligible that you'll simply choose not to address any of them.

As Mike Konczal explained in a great post last year, Karelis posits that solving the first of many problems brings very little satisfaction, or "utility" in economic speak.  The problems that remain are so many, varied, and painful that someone in poverty will hardly notice.  But if the first problem does get solved, then solving each additional problem would bring increasing satisfaction, as the issues become fewer and more manageable.  This is an idea that reverses the traditional economic utility function, which predicts diminishing returns for additional goods.  But the point is that because solving the first problem brings such little satisfaction to someone in poverty, it won't be worth the effort to get started.  "Hence the persistence of poverty," Konczal writes.  (That's an extremely simplistic overview, so do read Konczal's full post for more depth, or better yet buy the book.)

Anyways, the book generated additional discussion within the blogosphere (see also Tyler Cowen in 2007), with mostly favorable reviews.  But some reviewers noted that although the book's ideas were intriguing, they hadn't been tested and consequently there didn't seem to be much evidence for them.

In my post at Psychology Today, I wondered why it hadn't been investigated.  Despite the discussion of utility, along with Vaughan Bell I understood Karelis's theory to be as much about psychology as about economics.  And I closed my post by suggesting that if social scientists were going to design new experiments and conduct new research about personal decision-making (as Ariely recommends), they should keep Karelis's theory in mind.  In other words, this seems like a situation where it's not necessarily appropriate to isolate psychological influences from socioeconomic ones, as they might interact with each other in complicated ways.

Karelis writes below that the rationalist paradigm of economics needn't be discarded for his critique of the utility function to hold, and he also responds to the notion that his theory is unproven.  I thank him again for the comment and reproduce it here in full:

From the author of the Persistence of Poverty, cited in these posts. My book doesn't link the life-shortening decisions discussed by Ariely (smoking, overeating) to the utility function I hypothesized. That extrapolation seems to have been made first by Ezra Klein in his Washington Post blog, and it was carried further by Mr. Coates in his Atlantic blog and by Andrew Sullivan in his blog. But though I didn't make it in my book, I find the extrapolation very plausible. After all, it takes discipline to resist many of these life-shortening activities. They're like work, or maybe you could even say they're a kind of work. So--on the rationalist paradigm of human behavior, which has been too much disparaged by behavioral economics, in my opinion-- the prudent decision will be taken if and only if the accompanying rewards are perceived as being greater than the effort required. What my hypothesis adds here is that for poor people, whose plates are heaped high with troubles--the felt relief brought about in the short run by losing a few pounds or breathing easier as you climb upstairs will be hardly noticeable. What's one or two fewer troubles on a plate heaped high with them? So we need not embrace the (in any case distasteful) hypothesis that poor people suffer from limited time horizons in order to explain the failure to resist these life-shortening temptations.

As for the question whether my book is "empirically confirmed," I would respectfully contend that my critics have a paradigm of "the empirical" that over-relies on laboratory evidence and under-weighs the question of which among competing theories offers the simplest explanation of undisputed facts about human behavior, such as the greater obesity, alcohol consumption, and smoking among the poor; and I'd add that positivist economics has a double-standard when it comes to introspective evidence. The conventional wisdom about the utility function rests on little else besides introspection. Take down your intro econ text and look if you doubt it.

Minimum wage and employer behavior

In the course of a long, thoughtful post on the complications involved in dealing with unemployment, Felix Salmon writes:

But if workers at places like Wal-Mart start being paid a decent living wage, that is surely a significant improvement on where we are now. And if we raise the minimum wage to a point where employees are less likely to quit and more likely to learn reasonably high-level skills, that will help get us to Richard Florida’s promised land. Without unions and minimum-wage laws, corporations compete on who can pay the least. With them, they compete on who has the best employees and they invest significantly in those employees. Which is exactly what we want, especially since raising the minimum wage is unlikely in and of itself to increase unemployment visibly.

A respectful quibble.  How do we know that with a higher minimum wage, employers will "compete on who has the best employees" and "invest significantly in those employees"?

It seems just as possible that employers would react by doing one of the following, or some combination thereof:

• Hiring fewer workers and asking existing workers to do more (a tactic employers are more likely to get away with in an environment of sustained unemployment)

• Investing more in capital (whose price relative to labor obviously declines as the minimum wage increases) to help the company do the same work with fewer people

• Simply continuing to compete on price, even if the prices will be higher across the board as the increased minimum wage affects all employers in the same industry

These probably read like libertarian talking points.  But my impression it that the issue of the minimum wage's impact on employment and wages is more sharply debated by economists than was implied in Salmon's post, though it's likely that the kinds of changes typically proposed by legislators are small enough to have only have a marginal effect. 

Regardless, I've never seen the argument that employers react to higher minimum wages by increasing their investment in human capital.  I'm not saying Salmon is wrong about any of this, but I'm genuinely curious to know what the evidence is for it.

UPDATE: Thanks to Felix for responding here.

Kling, Reinhart, and capital inflows

What follows is long and consists entirely of finance geekery, so it goes beneath the fold. 

Robert Shapiro on immigration reform

Ryan Avent interviews interviews Robert Shapiro, author of a recent paper on immigration's impact on American wages, and writes:

I particularly appreciated the point that undocumented workers will find it risky to move around the country. Their geographic mobility is therefore limited, which means that costs are concentrated locally. At the same time, upward mobility is curtailed since some opportunities are too risky to pursue, which increases the time illegal immigrants spend in poverty.

As I posted earlier, the ability of illegal immigrants to move easily from where jobs are scarce to where jobs are abundant is a boon not only to them but to the US economy.

Shapiro also has interesting things to say about about immigration and entrepreneurship, the composition of where immigrants are coming from, and about the family values of illegal immigrants.  The whole interview is just ten minutes.  Check it out:

 

Sovereign wealth funds and technology transfer

John Kemp of Reuters posted a concise, helpful overview of the issues facing sovereign wealth funds last week, writing:

There is no evidence SWFs have wielded their non-traditional assets for political or military purposes, or to achieve technology transfer, according to the IMF. But the fact that they might do so in future has made investments by funds with a “sovereign” label much more controversial than those by institutions which are notionally private.

This is one of the topics covered in The End of Influence: What Happens When Other Countries Have the Money, the excellent recent book by economists Stephen Cohen and Brad DeLong.  The authors aren't much worried about governments using these funds to advance military aims, but they do think attempts to transfer technology and innovation are a possibility.  What exactly does this mean?  Here's a relevant passage in the book:

In the real world, scale and especially technological knowledge were key causes of wealth—and the acquisition of your technological knowledge by others might well diminish your terms of trade and standard of living.  Recall that at least half of American economic growth comes from technological and organizational progress in the form of innovation.  These gains from better knowledge of technology and organization are not all seized by those who pioneer the innovations that turn out to be most useful, but rather spill over into the broader economy usually quite nearby.

It is here that sovereign wealth funds may threaten to become a serpent in the garden.  Governments would pursue objectives—for technology transfer, for strategic political advantage, for the redistribution of rents, for the differential acquisition of markets—that would lead them to different decisions that would have been made by profit-oriented market agents. ...

Here is another:

And what will happen when governments with ownership stakes in [foreign] firms think that it would be nice if they would tune things so that the spillovers happen not where the operations are currently located, but rather where the government would prefer the spillovers to be?  And this growth can be shifted.  Money helps.  It can try to shift many things, including the generators of yet more  money.  It can take totally new technologies out of the start-up companies that create them and attempt to shift them back home for next stage development into yet newer products and processes.  Some such efforts will succeed.  Most will probably fail.  But when they fail, they will still have inflicted damage on the innovating economy. 

Of course, it's possible that nothing like this will come to pass, or perhaps it will but not on such a scale that we'll notice.  Maybe sovereign wealth funds will simply continue to invest passively and look for good investment opportunities.

The only additional point I'll make is that there's nothing especially pernicious about a country that uses its money to buy foreign companies seeking to capture for itself any new innovations—even if most such attempts are bad ideas and likely to fail.  Americans would probably treat such efforts with suspicion of evil motives, but in reality it's exactly what you'd expect from an investor who just wants to get maximum value out of its investment.

Regardless, there's probably not much we can do about this.  As Cohen and DeLong explain, for the government to vet every foreign investment in an American company would be an inappropriate reaction.  Our government just isn't very well suited for that kind of role and would be as likely to filter out the kinds of benign investments we should encourage as anything that would threaten our prosperity.

Taleb, debt, young people, and entrepreneurship

We currently learn in business schools to engage in borrowing (by the same professors who teach the Gaussian bell curve, that Great Intellectual Fraud, among other pseudosciences), against all historical traditions, when all Mediterranean cultures developed through time a dogma against debt. Felix qui nihil debet goes the Roman proverb: “Happy is he who owes nothing.” Grandmothers who survived the Great Depression would have advised the exact opposite of debt: redundancy; they would urge us to have several years of income in cash before taking any personal risk—exactly my barbell idea of Chapter 11, in which one keeps high cash reserves while taking more aggressive risks but with a small portion of the portfolio. Had banks done that, there would have been no bank crises in history. ...

Debt implies a strong statement about the future, and a high degree of reliance on forecasts. If you borrow a hundred dollars and invest in a project, you still owe a hundred dollars even if you fail in the project (but you do a lot better in the event you succeed). So debt is dangerous if you have some overconfidence about the future and are Black Swan blind, which we all tend to be. And forecasting is harmful since people (especially governments) borrow in response to a forecast (or use the forecast as a cognitive excuse to borrow). My Scandal of Prediction (i.e., bogus predictions that seem to be there to satisfy psychological needs) is compounded by the Scandal of Debt: borrowing makes you more vulnerable to forecast errors.

That's from a new essay in the second edition of Nassim Taleb's The Black Swan. 

Provocative stuff, and Taleb's rationale against debt at the macroeconomic level is interesting.  Globalization---the increased flow of goods, capital, and people across borders---has already levered up the world economy in a sense, by making it vastly more efficient.  But this interconnectedness has also made it highly susceptible to the kinds of acute, negative shocks that would be contained locally in a less connected world.  So, for instance, a sovereign debt crisis in Greece might contribute meaningfully to a double-dip recession in the US (maybe). 

Fine. He takes this a bit too far, but his basic point about the systemic dangers of leverage seems correct---and it's an old lesson we keep forgetting.

But I think Taleb's advice that individuals should have big savings before taking personal risk has to be qualified.  Specifically, young people with an entrepreneurial bent should ignore it completely, as that kind of caution leads to worse outcomes both for them and for society.

Taleb is no fool: he's a proponent of experimentation and entrepreneurship, which is similar to book publishing in that it's impossible (or nearly impossible) to predict either which idea will be a big hit or the extent of its impact.  In other words, the whole point is to make it possible to capitalize on a positive Black Swan.  It's just that Taleb wants this kind of personal risk to be taken with a small part of an individual's portfolio so that he or she is "robust" to failure.  

Unfortunately, this would eliminate most people in their early twenties from the pool of potential entrepreneurs.  These are people who tend to finish college without a whole lot in the bank.  They can't take personal risk with only a small part of their portfolio because they have no portfolio.

But look.  If a bunch of 23-year-olds with few personal assets choose to max out their credit cards while starting a company in their garage, the worst thing that happens if the project fails is they get wiped out and declare bankruptcy.  In the meantime, they've picked up some valuable skills and remain young enough to bounce back from whatever damage was done to their credit rating, reputation, etc..

This kind of risk-taking, even when it involves debt, is good for young people, especially in an ideas-based economy where the commodified jobs of the past are less safe than they used to be.  As Paul Graham, who invests in companies founded by twenty-somethings for a living, writes:

Your early twenties are exactly the time to take insane career risks...it's not necessarily a mistake to try something that has a 90% chance of failing, if you can afford the risk. Failing at 40, when you have a family to support, could be serious. But if you fail at 22, so what? If you try to start a startup right out of college and it tanks, you'll end up at 23 broke and a lot smarter. Which, if you think about it, is roughly what you hope to get from a graduate program.   

More often than not, starting a company means incurring debt.  And a society that fosters this kind of risk-taking, for instance through lenient bankruptcy laws, makes for a more dynamic economy.  Nor does it increase the "fragility" of the young people who borrow the money, as Teleb worries; in many cases, quite the opposite. 

So for these kinds of ventures, I think the primary responsibility to diversify and be cautious belongs to the institutions doing the lending and investing, as they would be wise not to expose too much of their portfolio to any single risky project.  Which is something they already know anyway, or should know.

Some thoughts about private equity in emerging markets

This one's for the finance geeks, so it goes below the fold.

How we spent our money

One last post on The Great Reset, which I recommend.  I've had this in the queue for a while and forgot to publish.  Richard Florida writes:

Over the past half century or so, the amount of money the average American family spends on housing and cars has skyrocketed.  From 1950 to the mid-1980s, the amount allotted for housing and cars doubled from 22 percent to 44 percent of its budget.  (At the same time, the amount of the average American family had to devote to health care rose threefold, from 5.2 percent in the late 1950s to 14.8 percent by the year 2000.)  A generation ago, all of life's basic necessities—housing, transportation, health insurance, education, and taxes—accounted for 54 percent of the average family's income; today, they account for 75 percent of it. ...

Still, with the basics sucking up so much of the family budget, the amount of money Americans spend on electronics, a reasonable proxy for high technology, increased from 1 percent in 1959 to just 1.6 percent by 2000, while the amount they spend on entertainment, a proxy for experiences, actually declined from 5.8 percent in 1950 to 3.9 percent in the year 2000.

It's ridiculous to label that second SUV in the garage a "basic necessity" just because it falls into the category of transportation.  Same thing with that summer home by the lake.  But the point is that although trade and technology made the basic necessities increasingly cheaper, Americans chose to spend a big chunk of their surplus savings on bigger and more expensive versions of those same basic necessities.  That's money that could have been spent more wisely on creative endeavors, entertainment, or even cool gadgets.

This isn't entirely regrettable---there's nothing wrong with having a nicer home, with nicer things inside it.  But we took it too far.  Florida thinks the tech boom of the 90s might have represented a chance for us to move away from this trend.  But the boom went bust, and in the aftermath we went right back to putting our money in housing.  (And actually, a lot of it was borrowed money, so not really ours at all.)

*****

My earlier post on The Great Reset and New York City is here.  An interview with Florida in this week's Newsweek is here.  Florida's blog is here.

Do immigrants compete with Americans for the same jobs?

One of the more intriguing concepts I've come across in the research about immigration and the US economy goes by the unappealing name of "imperfect substitutabity", which was studied by economists Gianmarco IP Ottaviano and Giovanni Peri in this paper. 

Previous studies had assumed that you could "substitute" a US-born worker with a foreign-born worker in the same job if they had similar levels of schooling and work experience.  So a foreigner with, say, a college degree and two years work experience is assumed to be competing for the same jobs as a US-born worker with the same background (as defined by those two metrics).

Ottaviano and Peri claim this isn't true: their research shows that these two workers are likely to choose different fields of work despite their ostensibly similar background. 

In other words, they're not competing—and not only are they not competing, but the ways in which their different jobs complement each other bring real benefits to the economy:

Conceivably native and foreign-born workers should not be much easier to substitute in production than two U.S. born workers with 5 years of experience difference. One reason for this imperfect substitutability is that, for given skills, U.S. and foreign born workers often choose different occupations (see Card 2001 for more detail). This is particularly true for workers with high and low levels of education (rather than with intermediate levels). For instance among the lowly-skilled (HSD), foreign born workers are highly represented in occupations like tailoring (where 54% were foreign born in 2000) and plaster-stucco masoning (where 44% were foreign-born in 2000), while U.S.-born workers are highly represented among, say, crane operators (where less than 1% was foreign-born in 2000) and sewer-pipe cleaners (where less than 1% foreign-born). Since one would be hard pressed to call these services perfectly substitutable, there is no reason to believe that payments for such services should be equalized. A similar argument applies for the highly-skilled (COG). For instance foreign-born workers are highly represented in scientific and technological fields (45% of medical scientists and 33% of computer engineers are foreign-born) while U.S.-born workers are highly represented among lawyers (less than 4% are foreign-born) or museum curators and archivists (less than 3% are foreign-born). Moreover, even within the same profession, often the U.S. and foreign-born provide different services, and hence benefit from complementing each other, regardless of education level. For instance, Chinese and American cooks do not produce similar meals, nor do Italian and American tailors provide identical types of clothes. Similarly, a European-trained physicist (more inclined towards a theoretical approach) is not perfectly substitutable with a U.S.-trained one (more inclined towards an experimental approach), and a French architect will likely create a starkly different building than an American one."

This goes straight to the idea of whether or not immigrants take away jobs that would otherwise belong to Americans.  Ottaviano and Peri clearly think not, and their reasoning makes sense to me. 

That being said, in the interest of fairness I'll also point to this research paper from Harvard's George Borjas, who challenges their claims about imperfect substitutability.  Ottaviano and Peri have been having an ongoing debate over the last half-decade with Borjas about the impact of immigration on the wages of US-born workers.