The PPE Economics Blog

Don’t Let Death be a Monkey Wrench

2012-11-19T08:24:00.001-08:00

Levitt and Dubner highlighted a really interesting aspect of medical treatment, the fact that prescribing anything, whether it has been proven to be effective or not, acts as a powerful incentive. In their discussion of ontology treatment, L & D made it clear that the successes of chemotherapy are marginal at best – in one large study, only 63% of cancer patients survived, but chemotherapy contributed less than 2% of this success (I’m curious as to what factors were found to account for the much more impressive 61%). Despite this weak evidence in the efficacy of cancer treatment, such practices consumer a huge portion of the health-bill. Why? L & D respond that incentives such as high salaries of oncologists, and the average gain in two-months to live motivate doctors to prescribe these expensive treatments. However, they also point out a third reason, which I find to be the most compelling. They write that doctors find it difficult to tell patients that there’s nothing they can do – that modern medicine has no answer for them and they must face death without any tools with which to fight. I highlight this reason not only to defend the morality of doctors, but because I believe it reveals an important factor coming from the demand side of the health market. If cancer treatment is as ineffective as L & D suggest, even if doctor’s prescribe it, why would anyone do it? Consumers, (in this case patients), are not stupid; when they are diagnosed with a disease, they have the capability of looking up survival rates, treatment success, etc. Thus, it seems like cancer victims should opt-out of chemotherapy treatments much more frequently. While 30 % already do this, 70% do not. Their reason for suffering through the painful side-effects associated with such treatments must be hope – while chemo will probably fail in lengthening their life span, they understandably cling to the small hope that they will be the anomaly, and doctors are willing to oblige.

This trend to delaying the reality of death is also illustrated in ER visits in last weeks of life. A study conducted by UCSF and Harvard colleagues found that over 50% of older adults who had died had visited the ER during their last month of life (this number rises to 75 % when extending the time constraint to 6 months). Furthermore, more than 75% of these people were admitted, and 68 % died there. These statistics highlight that people frequently use hospitals for comfort, which is a wildly ineffective allocation of resources. ER’s exist to diagnose and treat, whereas hospices are much more suitable to the type of care these elderly patients seek. These ill-advises visits may help explain why a quarter or more of Medicaid spending occurs in the last six months of life. In sum, similar to the chemotherapy battle, we as a society are guilty at throwing money at unfixable conditions in an effort to avoid accepting death – this fear acts a monkey wrench in the machine, preventing it from making optimal allocation decisions. This trend is extremely difficult (for those of you who disagree, I would say you probably haven’t faced this type of decision), but still clearly merits change from both the demand (the patient-side), and the hospital side, who are all too willing to appease fears and admit incurable patients.

Source:

http://newoldage.blogs.nytimes.com/2012/06/05/at-the-end-a-rush-to-the-e-r/

Lack-o-riginality

2012-11-19T01:43:00.001-08:00

Super Freakonomics was clearly designed for the populace. While the bloggers below me raise valid points about Levitt's assumptions, transparency of methodology, and thoroughness (which I share), what I also noticed was how little of the book was original research.

Translation: why can't I google "examples of confounding variables" and publish the next installment in the "freako" series?

Chapter 1: Prostitution data is from Columbia's Sudhir Venkatesh.

Chapter 2: Data on life expectancy by month is from Douglas Almond and Bhashkar Mazumder, who also proposed the Ramadan solution; data on athletes' birthdates comes from Florida State Professor Anders Ericsson; terrorist education data borrowed from Alan Krueger; the ER data was compiled by Craig Feied.

Chapter 3: Altruism research was conducted by economist Gary Becker; results from the Ultimatum simulations were conducted by "a group of preeminent scholars" and published in Foundations of Human Sociality.

Chapter 4: The proposition of the seat belt came in the 1950s from Robert McNamara; modern crash data comes from the Fatality Analysis Reporting System (FARS) (Levitt only summarizes the newer data to update McNamara's previous finding).

Chapter 5: The data linking locally grown food consumption and greenhouse-gases comes from Carnegie Mellon Professors Weber and Matthew; the idea that carbon dioxide is not a greenhouse gas comes from Nathan Myhrvold, the former CTO of Microsoft.

I could go on for each chapter, but the point is clear.

It seems a lot of the original contribution from Levitt is just insufficiently justified assumptions, as mentioned by the bloggers before me. Levitt's value-add (if you can call it that) seems to be statements like "let's say it takes an average of one minute to remove and replace your shoes...so...the tax is the time equivalent of 14 lives per year." (93)

I know for a fact Subin, Jen, Sarah and I can walk you through those sort of assumption-to-conclusion progressions -- we practiced consulting case interviews for hours on end over the summer.

It just seemed odd to me that such a popular book would only require skills most undergraduates already have. Paper A says X, but Paper B says X is wrong because of Y. Too large a portion of Super Freakonomics followed this format, a point with which the New Republic concurs.

To be fair, Levitt brilliantly synthesizes and presents the data cited in his book - and he certainly makes appropriate citations. However, I am a little peeved that Levitt gets another best-seller and furthers his reputation for cutting-edge economics while largely piggybacking off the research of others.

And yes, by 'peeved' I do mean 'jealous'.

In addition, I was very intrigued by the argument about birthdays and professional athletes. It seems that Levitt's thesis still holds up: 2005 data provided by Major League baseball revealed that October birthdays were far and away the most common. Sure enough, the Little League birthday cutoff is still July 31. A study on NHL hockey players revealed a similar trend for January births, since most international cutoffs are December 31.

The performance of these athletes once they reach the professional level, interestingly, has very little correlation with birth month.

Freako-not-eco

2012-11-19T00:36:00.001-08:00

I admit it. I find the Freakonomics book series to be charming, and, damn, if it isn’t entertaining as hell. The economist-meets-journalist pairing of Levitt and Dubner makes for a witty, easy read.

However, I have encountered skepticism about the accuracy of the claims in their works. I first read a criticism of the Freakonomics franchise on the website Arts and Letters Daily. ALDaily aggregates the “best” in long form journalism. (I highly recommend it as a homepage.)

Leave it to a bunch of scholars and long-form nerds to throw down a one-liner like this:

"The Freakonomics formula. Anecdote-rich, contrarian narrative + speculative claims presented as fact = publishing phenomenon..."

There seems to be a bit of truth in this statement. The actual article critiquing Freakonomics and Superfreakonomics, which appeared in the American Scientist magazine this year, is a little less tongue-in-cheek. I revisited the piece this afternoon, and was happy to find it co-authored by Kaiser Fung and Columbia Professor Andrew Gelman. (I used Gelman quite a bit in my thesis.) Gelman and Fung, both statistics professors, acknowledge that it can be difficult to be engaging while teaching statistics, but note that Levitt and Dubner have a habit of making unfounded statements.

Gelman and Fung goes on to critique several of Levitt and Dubner's claims. With regards to Superfreakonomics, Gelman and Fung specifically hit on three areas of the book: the opening anecdote about walking versus driving drunk, the section on predicting terrorists and the final chapter on climate change. You can read their complete case by case critique here.

In the beginning of the article, Gelman notes:

“Levitt is celebrated for usin data and statistics to solve an array of problems not

typically associated with economics” (Gelman).

I find this quote to be particularly interesting because it makes me wonder -- why do we call it "Freakonomics"? Is this truly a book about economics? I do not mean to undermine Levitt's work as an economist, because he is incredibly well-credentialed. But at its roots, isn't this more of a book on statistics than it is on economics? What about psychology? Many of the subjects discussed here were not touched upon in any of the other books we read for this class. I'm certainly not trying to call Professor Blomberg's choices into question, I just find this trend quite interesting. I was assigned Freakonomics for my Econ 50 class.

Gelman and Fung concede that the original book Freakonomics was much more based around "Levitt's own peer-reviewed research." I would definitely agree -- although I appreciate their linkage of street prostitutes and department store Santas.

It’s a fitting that this fall as the last book on our schedule. At the beginning of this course, Heilbroner warned us about these “airport economics” books, which seek to please the reader, rather than to provide a thoughtful discussion of economic research. Unfortunately, I think Levitt and Dubner's work falls into that category. It’s a GOTCHA! kind of economics. Sometimes their claims seem a bit outlandish and ounfounded. If it sounds like the script for a Hollywood movie…well, it is. Check out the trailer:

Privacy Invasion or Practicality - Behavior Prediction and Advertising

2012-11-19T00:15:00.004-08:00

I enjoyed reading Superfreakonomics. Particularly, I found interesting the discussion of “Ian Horsley”’s model for using bank and demographic information to find those customers most likely to be terrorists. The success of this sort of endeavor has many interesting philosophical connotations – if our behavior is so reliable that government agencies or companies with access to sufficient data can readily predict what we will do, free will faces a significant challenge. However, another interesting implication of this form of behavior prediction is in its potential use for ad agencies and companies that want to target consumers.

As the New York Times reported earlier this year, Target had begun to analyze customers’ buying habits with the hope of predicting when female customers were pregnant. The article explains that “new parents are a retailer’s holy grail” because new parents are one of a limited set of groups that are at a point in their lives when they’re willing to change their shopping routines. Thus, new parents would be more easily convinced that Target was the only shop they needed. As Target quickly found, the method of finding new parents was very effective – almost too effective. The company sent ads forbaby supplies to a teenager, provoking an irate response from her father. A few days later, the father called back to apologize and tell the store that they had it right – they knew his daughter was pregnant before he did.

Of course, most customers understandably found that sort of aggressive advertising creepy and intrusive. This “creepy factor” seemed to discourage them from considering Target for their shopping needs somewhat. In response, Target scaled back their advertising efforts and instead sent more subtle advertisements to the pregnant women – interspersing baby items with regular items, for example, rather than sending them a book of coupons for baby formula only. Interestingly, this case seems to suggest that some of the fears about targeted advertising are self-regulating – if people feel like an advertiser is extending into their life too much or being too forward, they will respond negatively, which will force the advertiser to change their approach. (That said, in this case, this incentive only changes how the advertiser or company appears to the customer, and not how much information the company gathers. Conceivably, though, in other circumstances the incentive could be structured such that less information would be necessary for the more subtle approach, and thus less information would be gathered.)

It’s interesting to see this sort of method play out (perhaps less successfully) in other circumstances. Facebook ads are, theoretically, a great opportunity for targeted advertising – the host company already holds a wealth of information about the audience for ads. Yet Facebook does not seem to have taken full advantage of its advertising potential, or at least does not use its data nearly as well as Target. Too often it posts random but specific or worse, contradicting ads – on many occasions I have had an ad for a Jewish dating site, an atheist organization, and literal Bible belts – with Bible quotes on them. (My religion was set to Pastafarianism at this point, for the record.) Yet Facebook manages to demonstrate some of the potential benefits of targeted advertising for customers as well as companies – when the ads actually match the customers’ interests, like about tickets for his or her favorite band on sale, it provides potentially valuable information that overall increases utility for the customer. Understandably, our gut reaction to companies gathering private information about us (though obviously if we post it on the internet it’s not quite so private) might be concern about our privacy, risks of identity theft, and so on. Yet it seems that, given enough safeguards to protect information and a sufficiently subtle approach, targeted advertising could serve as a very useful tool for facilitating business between companies and customers that might not otherwise meet.

Of course, I’ll still find it a bit creepy every time Facebook perfectly anticipates my Domino’s craving with a well placed ad. But if I get $5 off and a yummy pizza, who cares?

A Closer Look at Cable Television

2012-11-18T23:53:00.002-08:00

I found SuperFreakonomics to be super interesting and entertaining. I was, however, frustrated at the lack of detail and methodology in the book. I know that this book is aimed for pop audiences and so this it to be expected, but I wanted to look every article up as I went. Since there were dozens of articles used as the basis of this book, I just chose one: The Power of Cable TV: Cable Television and Women's Status in India. Specifically, Levitt and Dobner's discussion of this issue stood out to me because there seem to be so many other correlates of access to cable television that and discrepancies in villages over time that I was not sure that this was feasible to prove.

There were several things, before checking the article, that I wanted to make sure were controlled for: (1) income of the village, (2) closeness to urban center, (3) prevalence of other types of media (satellite television, internet usage).

Income was somewhat controlled for. In one of the two states used in the article, income was available and tested. It was found that income correlated with getting access to cable. Thus, it could be that as rural Indian families get more money, their attitudes towards women change AND they get cable access.

Furthermore, access to cable was also associated with the timing of receiving access to cable. Since villages closer to towns were more likely to get cable, they are more likely to be modern anyways. Worldwide this seems to be the trend; there is a great dichotomy on social issues between rural and urban areas in the US.

This article does not control for access to other types of media. It could be possible that one town never gets access to cable because a competitor, satellite for example, got there first. This is not mentioned in the paper.

Furthermore, the results on women's status and cable were not as consistent as they were portrayed to be in the book. In fact, those with cable access thought it was acceptable for a husband to beat his wife in more situations than those who never had cable. While getting cable access decreased the acceptance of abuse, there was a significantly larger differential between before and after cable and those who never got cable and those who did. This signals that there may be significant, unmeasured differences between the villages in question.

For the data on pregnancy, the results were even more volatile. The discrepancy between years for the non-cable villages was much greater than the downward trend in the villages with access. This signals that this paper may have been damaged by an insignificant sample size - approximately 180 villages.

In summary, the book was entertaining, but each point would have to be examined individually for this to be credible. For one, cable access is not a panacea for gender disparities.

Superfreakonomics- Heating up the global warming debate

2012-11-18T22:09:00.002-08:00

Superfreakonomics- Heating up the global warming debate

Superfreakonomics was a very interesting read. Building on the Freakonomics formula of “this is why the conventional/intuitive view on _____ topic is wrong and here is the data to back up what we view as the correct understanding of _____ phenomenon,” Superfreakonomics continues to look at data in very interesting ways. The most interesting part of these books for me was the ability to use clever naturalistic experiments to examine interesting causal links.

When Superfreakonomics came out it caused a bit of ruckus. When rereading the book, I focused a bit more heavily on the sections that I had read some criticisms about. For instance, Ezra Klein challenges the drunk driving anecdote: arguing that one of the key assumptions in Levitt/Dubner’s calculation “If we assume that 1 out of every 140 of those miles are walked drunk -- the same proportion of miles that are driven drunk” is completely unjustifiable. Ezra goes on to point a number of reasons this statistic might be skewed (more people substitute away from driving drunk towards walking drunk, the sort of miles traveled (rural/urban), and a host of others http://voices.washingtonpost.com/ezra-klein/2009/10/the_shoddy_statistics_of_super.html). While perhaps a justifiable claim, I found this line of criticism a useful reminder not to necessarily be swept up in a statistical story just because it was interesting, but to remember to look closely at both implicit and explicit assumptions in the model. Superfreakonomics is very good at telling interesting stories with data, but it is easy to get swept up and forget to challenge what might be implausible assumptions.

Unsurprisingly, a possibly skewed or misleading assumption in drunk driving was not what caught the media’s attentions. Rather, the passage on global warming raised quite the stir amongst environmental economists and a few global warming advocates. The case Dubner and Levitt seem to be making in the broad sense is that is difficult, if not impossible for a large spectrum of people to change their behaviors with little or no incentives to do so. This is consistent with their broad message, and does a good job of illustrating why the current incentive structure regarding the environment seems suboptimal. Where the critics seem to have taken issue with the work comes through in a few important ways. First, and perhaps most importantly, seems to be a general challenge to the way the facts are presented. While many of them are factually correct, taken together these facts present a misleading picture. For instance, the following sentence received a great deal of criticism: “When Al Gore urges the citizenry to sacrifice... the agnostics grumble that human activity accounts for just 2 percent of global carbon-dioxide emissions, with the remainder generated by natural processes like plant decay...” DeLong and other critics point out that this fact is misleading for a number of reasons. First it underplays the importance of human impact on global warming (http://delong.typepad.com/sdj/2009/10/yet-more-superfreakonomics-blogging-yes-i-know-i-know.html). How the critics would like that sentence to read places more accurate emphasis on human impact: “Of course the agnostics are misleadiing you: the right way to think about it is that already 1/3 of the CO2 molecules in the atmosphere are the products of human actiivity, and the fraction and amount are growing very rapidly indeed…”

Other criticisms focus on misrepresenting scientific studies. Not being an environmental scientist, it is rather difficult to critically say whether these studies were presented fairly. Some certainly seem to claim otherwise: http://thinkprogress.org/climate/2009/10/12/204787/superfreakonomics-errors-levitt-caldeira-myhrvold/ and http://krugman.blogs.nytimes.com/2009/10/17/superfreakonomics-on-climate-part-1/. While, from what I have read many of the general criticisms are a bit overblown and really fall into the category above of being factually correct but at times a little misleading: http://www.freakonomics.com/2009/10/18/global-warming-in-superfreakonomics-the-anatomy-of-a-smear/.

Another area of criticism is drawn around first the criticism of solar panels and the inaccurately rosy picture of geo-engineering. First the solar panels. Superfreakonomics notes that the color of the solar panel makes a difference. For the same reason painting all the roofs white helps to lower the temperature, placing black solar panels all over the place would have the opposite impact. Most of the critics seem to note this as a rather minor impact, and argue that solar power won’t solve the energy crisis for a host of other reasons (http://delong.typepad.com/sdj/2009/10/hoisted-from-comments-nicholas-weaver-on-solar-vs-nuclear-myhrvold-dubner-and-levitt.html). One commentator compared saying the color of solar panels causes global warming in the same way photons from stadium lights cause a curve ball. While it seems solar power is slightly better than the book would have you believe, geo-engineering seems to be a bit worse. There seem to be a host of potential problems with geo-engineering, the least of which being its untested, unknown nature.

The economist criticizes the work by saying: “it contains little in the way of economics, other than a brief discussion of externalities and the observation that the hose system would be much cheaper than building an entirely new low-carbon energy infrastructure for the world.” This quote does a pretty good job of summarizing by feelings on this particular chapter of the book. The economics is generally pretty good; I agree with their thoughts on incentives and the difficulties surrounding policy solutions. I think their focus on one particular plan rather than a market structure aimed at fixing some of the underlying incentives is a bit weak.

For a quick summary of the debate and some of the sources please see:

http://economistsview.typepad.com/economistsview/2009/10/superfreakonomics-on-climate.html

To be or not to be....a Prostitute or a Wife?

2012-11-18T13:11:00.001-08:00

In the first chapter of Superfreakonomics, Levitt and Dubner provide a cost-benefit analysis of the choice to be a street-level or a high class prostitute in Chicago. What really interested me about this chapter is the last few pages – about Levitt and Dubner’s description of Allie, a ‘high-class’ prostitute in Chicago who spent her nights being wined, dined, and pampered by wealthy businessmen. Allie makes an important observation about herself in her interview with Levitt and Dubner - she could be the younger, more sexually adventurous “ideal wife: beautiful, attentive, smart, laughing at your jokes and satisfying your lust”(53). This, coupled with Levitt and Dubner’s point that prostitutes have a harder time finding a husband than a non-prostitute, made me wonder whether or not is was economically better for a woman to be a prostitute or a wife, as well as why men choose to get married rather than continually engaging with prostitutes (or doing both). In order to discuss this question, we first have to assume that selecting a mate itself is a market, and that marriages only occur if it is profitable for both parties involved.

Because marriage can be an important (and sometimes only) source of income for women, prostitutes themselves face an opportunity cost when deciding to pursue this career. Prostitutes are paid so much higher than women who work in other fields, or women who are wives, because they need to be compensated them for the marriage-market earnings they gave up when they decided to be a prostitute.

Because prostitutes are undesirable as wives, buyers must pay a sort of ‘no-husband’ tax that a man normally pays if he is married. Moreover, the opportunity cost for becoming a wife in comparison to a prostitute is all the lower because wives can easily divorce and become a prostitute if married life is not suiting them. However, while they are more limited in the above respect, prostitutes only provide (and are paid for) one specific service by men. Wives, on the other had, deliver a variety of services – they cook, clean, and provide sex. A study conducted by Lena Edlund and Evelyn Korn compares the two different careers and determines the cost-benefit analysis of each. Assuming that both wives and prostitutes are sellers of the same product (and thus are interchangeable), this study determines that wives can offer more than a prostitute at a lower cost. While prostitutes can only offer non-reproductive sex, wives can offer their husbands both non-productive and reproductive sex (ie children), and they offer it at a lower cost (ie, husbands do not have to pay for sex, and, more often than not, wives provide other services like cooking and cleaning, that prostitutes do not). However, although wives are a low-cost alternative to prostitutes (ie you get more bang for your buck – yes, pun intended), there is an opportunity cost to becoming/engaging with a wife – it is a much longer contract than if becoming/engaging with a prostitute. Men and women who engage in marriage have much different and greater responsibilities to each other than a man and a prostitute would. Also, because marriage is a longer contract, we must also take into account that wives age, and because men cannot buy services from multiple wives like they can prostitutes, aging does impose an additional externality on the buyer. This makes wives not have the same guarantee for your money as with a prostitute. This lack of guarantee could be the reason for why married men decide to engage with prostitutes as well as their wives. Moreover, some economists consider wives to be superior to prostitutes because the consumption of the wife increases as income rises – like fine wine. This basically means that the wealthier you are, the more likely you are to consume champagne (wife) than beer (prostitute). Essentially, from a male perspective, the greater your income, the more benefit you will receive from choosing to marry a woman instead of engaging with a prostitute every evening.

There are other ways for women to get income besides simply being a prostitute or a wife. However, as Levitt and Dubner show through this first chapter, the prostitutes of Chicago (whether high-class or street-level), often make more money than they would working in a job in another field. Moreover, based on the anecdotal evidence provided through Allie’s story of being a high-class prostitute, women who are prostitutes have much more flexible schedules, and work about half as many hours as women making a comparable wage, making it seem like being a prostitute is a more economically desirable career than working in a different field.

Marshmallows and Budget Deficits

2012-11-14T15:20:00.000-08:00

One of the most interesting parts of Boomerang was Lewis's discussion of Americans' inability to self-regulate, and our insistence on sacrificing our long-term self interest for short-term rewards. As Lewis puts it, "the boom in trading activity in individual stock portfolios; the spread of legalized gambling; the rise of drug and alcohol addiction; it is all of one piece." I agree. In fact, I would also add obesity and the federal budget deficit to that list. Both are symptoms of Americans' inability to make short-term sacrifices for long-term gains. If we have truly lost this ability, it bodes ill for some of the greatest challenges we face.

Economics has a term for the phenomenon we see in so many areas of American life: the "time inconsistency problem." A decision-maker's preferences change over time, in such a way that a preference at one point in time is inconsistent with a preference at another point in time. So, for example, there is my today self, who wants to eat the chocolat cake, my next Friday self, which will regret the weight the chocolate cake has caused me to put on. The inconsistency occurs because the preferences of these "two selves" are not aligned with each other.

I would argue that part of the reason our budget debt woes are so difficult to solve politically is because politicians are forced to grapple with the time inconsistency problem on a national scale -- to at once satisfy two Americas. Today's America does not want to raise taxes or reduce spending; it would hurt he economy, we say, or just unduly harm our national security, health, or our less fortunate citizens. The America of 2020, however, desperately wants a solution the debt, which has to include tax increases, spending cuts, or both. A similar "two Americas" analysis can be applied to our failure to tackle climate change, to conserve energy, and to address many other societal challenges.

There was a famous psychology experiment on delayed gratification, called the Stanford marshmallow experiment, conducted in 1972 by psychologist Walter Mischel. A marshmallow was offered to each child. If the child could resist eating the marshmallow, he was promised two instead of one. The scientists analyzed how long each child resisted the temptation of eating the marshmallow, and whether or not doing so was correlated with future success. In a follow-up study, researchers found that preschool children who delayed gratification longer in the self-imposed delay paradigm, were described more than 10 years later by their parents as adolescents who were significantly more competent. A second follow-up study, in 1990, showed that the ability to delay gratification also correlated with higher SAT scores

One way of viewing America's problems of political will is that we as a nation are failing the marshmallow experiment -- big time. We have been eating the marshmallows in front of us for the last ten years. Arguably, the baby-boomer generation has been doing so for their entire lives. Now we must decide whether we will keep eating marshmallows, or whether we will finally face our challenges, swallow the tough medicine, and thereby secure a brighter future.

Greece vs. Argentina

2012-11-12T23:27:00.001-08:00

Sorry for the late post, guys. I got back from a five-day Model UN conference late last night and my post for this morning looked just about the same as Jeff's. I would add the below graph, which illustrates my/Jeff's point that Italian and Spanish debt grew in the private sector over the course of 2000-2010. Government debt during the last decade held about constant for both nations. So the problem was not the government issuing more debt than its country could produce in GDP - it was simply individuals consuming beyond their means (or so the data suggests).

Not so in Greece. As of February 10, 2012, Greek public debt as % of GDP was 166%. Even before the debts tied to IMF bailouts, Greek debt approximately equaled GDP as early as 2005. The government truly did borrow huge sums despite the tax collection issues that Lewis implies are as Greek as big fat weddings.

But since Jeff already talked about different debt patterns, I re-blogged tonight about what we talked about in class today: Greece vs. Argentina. Krugman detailed the Argentina bailout, Lewis the Greek bailout. Some data:

What the data shows is that both Greece and Argentina faced massive recessions, but that Greece's ouput data appears much rosier (relatively speaking of course). GDP decline in Greece in 2012 was only half of Argentina's. Slowing in industrial production was almost 50% worse in Argentina than in Greece, as was the contraction in retail sales.

Where Greece clearly suffers is in capital markets. The public debt statistic sticks out like a sore thumb that is indebted to an even sorer thumb.

Inevitable, right? Just part of the leverage trend of the 2000s, right? As the debt crisis argument goes, someone had to suffer for us to recognize our dire international financial straits, right?

But maybe it did not have to be so. The IMF published in 2003 what it titled "Lessons of the Crisis in Argentina." In a report that Timothy Geithner (former US Secretary of the Treasury) himself approved, the IMF noted about Argentina: "When the economy slid into recession, the Fund faced a somewhat different and more serious dilemma. In hindsight, the most viable option would appear to have been an early debt restructuring involving a significant present value reduction, combined with the abandonment of the currency board."

Now we have moved onto Ben's blog post. Of course, the Greek exit is scary. The short-run consequences include possible recession and widespread profit loss due to the default. In other words, the fears Ben cites are the very "present value reductions" that the IMF say clouded the judgements of policymakers regarding Argentina. Yet here we are in Greece in 2012 possibly making an identical mistake.

The reason for the poor policy, the report continued to say, was that "the authorities were unwilling even to consider the possibility of an exit: neither the government nor the public were prepared to take such a drastic course until it was forced upon them."

And right on point, Greek Prime Minister Antonis Samaras pronounced last week, "We must save the country from catastrophe. If we fail to stay in the Euro, nothing will make sense."

Sources:
http://www.marketwatch.com/story/greek-prime-minister-warns-of-euro-exit-2012-11-04
http://www.bbc.co.uk/news/business-16290598
http://blogs.reuters.com/scott-barber/2012/02/10/breaking-point-greece-vs-argentina/

Sharks or Marks: How Michael Lewis Unfairly Characterizes Winners and Losers

2012-11-12T11:28:00.001-08:00

The book “The Big Short”, by Michael Lewis, tells the story of a market full of fools, and the story of a handful of lucid investors who made a killing off of the ignorance of many. In his recent book “Boomerang” Lewis describes several European countries whose cultural misconceptions led themselves to disaster. These stories are riveting and his writing is superb. Yet, the main characters in all of Lewis’ books are flat; yet, in reality, there is often more to the stories that Lewis tells than what he writes in his novels. “Boomerang” is different from previous books because the characters in the book are whole societies. This is distinct from his previous books because it is much easier to tell stories about flat individuals rather than flat societies. Because of “Boomerang,” a collection of financial meltdown centered vignettes about California, Iceland, Ireland, Germany and Greece, I will never be able to think about Germans without remembering their national obsession with feces. It seemed that the book bordered on crude racial profiling rather than strict economic facts at various points.

For example, in “Boomerang”, Lewis claims that Germans live within their means and refuse to play the overleveraging game that has crushed so many individuals and economies. However, in “The Big Short” Lewis argues that Germany was ultimately the country who made the credit default swap gamble possible: “When Morgan Stanley devised extremely complicated credit default swaps so they were all but certain to fail, so that their own proprietary traders could bet against them, the buyer was German. When Goldman Sachs helped the New York hedge fund manager John Paulson design a bond to bet against — a bond that Paulson hoped would fail — the buyer on the other side was a German bank.”

And speaking of John Paulson, though his investments went well during the subprime mortgage crisis, during 2011 his two largest funds, Paulson Advantage and Advantage Plus, lost 36 percent and 52 percent that year. This red streak has continued into 2012: Advantage and Advantage Plus were down 6.3 percent and 9.3 percent as of the end of May. Paulson makes the following excuse: “If you’re going to come in and then leave, come in and leave, I don’t think you’ll reap the benefits of investing with us,” Paulson says. “Investors that do the best, and have done the best, are those that stay and compound at above-average rates over the long term.”

If I can find any shortcoming in Lewis’s writing it’s the flat, binary nature of his characters. According to Lewis everyone is either a shark or a mark, a savant or an idiot. Yet the sucker of his 2010 book, Germany, has become the savior of his 2011 book. And the biggest winner of “The Big Short” has become a loser in the past two years. In any case, the book was a great read, albeit a simplified version of the truth. Even though Lewis is a great writer, at the end of the day, he is still a journalist.

Above: John Paulson

Sources:
http://www.forbes.com/sites/kylesmith/2011/09/28/book-review-boomerang-by-michael-lewis/
http://www.foreignaffairs.com/articles/137193/michael-lewis/boomerang-travels-in-the-new-third-world
http://en.wikipedia.org/wiki/John_Paulson
http://www.businessweek.com/articles/2012-06-28/john-paulsons-very-bad-year#p6
http://dealbreaker.com/2012/09/peyton-manning-isnt-the-only-legend-in-the-middle-of-a-return-to-glory/john-paulson1/
http://en.wikipedia.org/wiki/Michael_Lewis

Different Debt for Different Folks

2012-11-12T06:40:00.002-08:00

Lewis’ snapshots of each country focus largely on a ‘national character’ that flavors the effects of the economic crisis in different countries around the world. His broad thesis is that bankers of all backgrounds and races gained exposure to the dangerously-easy and tempting opportunities afforded by American financial ingenuity (obscure financing tools created by investment bankers at the biggest, baddest Wall Street banks). Everyone was drinking the artificially sugary Koolaid, and for different cultural reasons as well. The promise of risk-free investments and credit that were ‘too good to be true’ turned out to play into the vices of everyone from the centuriey-old Icelandic fisherman to the spendthrift Greeks to the rigorously rule-based Germans.

I found this attempt to tether economic outcomes to national character interesting, and did a bit of hunting for further macro data to support the conclusion that governments are, after all, simply extensions of the people and their devious (or responsible) money habits.

We see that rich Anglo-Saxons countries have racked up the title for most personally indebted nations, perhaps due to their desire to own homes and cars and everything else expensive there is. This affinity for debt is matched by high levels of government debt as well. Developing countries have remarkably lower rates of household debt, while our European friends straddle these debt extremes.

Household debt is not be conflated with fiscal irresponsibility; highly leveraged households, like firms and governments, are in good financial standing so long as they can comfortably pay back the debt with future revenue streams. However, these Western countries have not always stood at such precariously indebted heights, from the first quarter of 2004 to the first quarter of 2009, private-sector non-financial debt rose by an average of 43% of GDP in the western countries listed above, excluding Germany of course. The US, naturally, led the way as can be seen in the graph below, in which the green line is household debt and the red line is government debt, both indexed to population (blue line).

1952-2012: U.S. Government Debt vs. Household Debt

The private sector has now begun to deleverage, and we have seen the spread the debt to public balance sheets. Bail-outs, stimulus, and reduced tax revenue from recessions have made government debt ratios look rather scary of late. However, this movement of debt from private to public hands is a somewhat more sustainable and stabilizing trend. While governments can deal with high levels of debt through eventual taxation and growth, households do not have the same flexibility. Britain, for example, has maintained high levels of debt (exceeding 100% GDP) for 81 of the last 170 years.

While Greece and other Euro zone countries steadily increased household debt preceding the financial crisis, we can see below that Germany was not having any of it. While Germany's banks might have been duped, its households held fast to their principles and did not rack up debt like families across the Euro zone. Increases in household debt can entail high gains for domestic demand while they last, but often result in severe losses and debt recessions when this growth takes a turn, this helps explain why most countries on the graph below are in struggling, while Germany is doing just fine. The very high levels of debt in Spain and Ireland are largely explainable by their housing bubbles.

Household debt-to-GDP ratio (%)

Real Estate Bubbles - advice to avoid bobbling

2012-11-12T00:45:00.000-08:00

In Michael Lewis’ discussion of Ireland’s financial crash, he highlights the crucial role that real estate played in the fall. The assumption that housing prices would continue to rise encouraged people to take out mortgages that were well beyond the real price of their house. However, the issue of determining real estate’s “true” price can be extremely complex. Is it merely the price that someone will pay for it? Or pay for one like it? This, obviously, is an unhelpful answer as people frequently overvalue the price of real estate, in either in their rush to earn the symbolic title of landowner or with an improper surge of animal spirits (read overconfidence in the market). Lewis instead suggests an alternative indicator – the rent levels of comparable housing. He writes that when the price of renting a house grows disproportionally less than the price of buying the house, the real estate market is undergoing a price bubble and will eventually come crashing down.

To test this hypothesis, let us analyze the recent real estate history of Marin County. Prior to the 2007 crash, housing prices in Marin had been rising steadily and quickly. The incredible returns on real estate persuaded many to invest heavily in its housing market, which resulted in huge losses for many of these risk takers. However, if they had been familiar with Lewis’ law regarding housing and rental costs, perhaps the fall in home ownership prices could have been anticipated. First lets look at the rise in the cost of house rentals in the early 2000s. A study by the Marin Affordability Housing Inventory showed that rent prices increased significantly in the decade prior to the crash – from 2000 to 2006, the median rental price rose 26%. However, during this same time period, household ownership prices rose much more rapidly – between 1999 to 2006, the median value of homes increased 75%. Just as Lewis predicted, this difference in price growth indicated a housing bubble, and in 2008 the “pop” was extreme. The median price would fall by around $200,000.

The large divergence between the growth rate in rent prices and the growth rate in housing did indeed predict a housing price bubble and subsequent crash. While the Marin market is beginning to recover, real estate investors would be wise to heed Lewis’ law describing the relation between rent and housing prices and behave cautiously when housing prices grow much more quickly rental prices.

The Scariest State

2012-11-11T23:05:00.002-08:00

In the last chapter of his story on global fiscal recklessness, Michael Lewis makes a very compelling argument that the financial problems of California (and more broadly the United States) are in fact symptoms of a much more serious and scary disease: the American culture itself. We, as Americans, succumb to the desire to overindulge and reap rewards in the short run, sacrificing long-term interest. Lewis points to the idea that as long as this culture is in place, out financial problems will persist. Since Lewis highlighted California’s Public Employee pension woes in this chapter, I decided to take a closer look at the state of pensions in California to see whether this mindset is beginning to change. California is spending $6.6 billion this year on retirement benefits, up from $2.7 billion a decade ago. The tab will continue to increase as the state amortizes its $225 billion unfunded liability. On top of this, pension and retiree health benefits consume more than a third of many local government budgets, forcing cuts in services and public safety, and in some cases bankruptcy (as in the case of Vallejo). The below graph shows this rapid increase in the costs associated with California’s Public Employee Pension.

By comparing the yellow and black lines on this below graph (Average Pension Payment and Average California Income, respectively), we can likewise ascertain the drastic amount that pension payments have jumped in the last two decades.

Over the past year, California Governor Jerry Brown pushed forward pension reform legislation that contains a cap on benefits for future hires of public safety officers at $132,000, a later retirement age to 57 for public safety officers, a rolled-back pension formula and higher contributions from some state employees. The fact that a pension plan of any shape or form is passing in California forces us to ask the question of whether this pension reform plan indicate a change in the California culture? The answer to this question is … maybe. While these reforms push California in the right direction, they do not push California far enough. The roughly $50 billion in anticipated savings won’t take place for another 20 or 30 years, as most reforms affect future employees. Critics of Brown’s pension plan highlight that comprehensive pension reform has to do more to address current employee benefits. This fact in itself indicates that the current ‘mindset’ of legislators is still very much focused on ensuring that their own indulgence is satisfied; the present generation gets to spend while the next generation is forced to sacrifice. This in itself embodies Lewis’s assertion that the importance of long term interests pales in comparison to the allure of short-term reward. Moreover, this reform plan will not impact the pension benefits of the majority of CalPers (one of California’s largest funds) members (i.e. it will not reduce California’s pension bill either).

While the evidence strongly points to the fact that Lewis is indeed correct in saying that pension problems are one of many resulting symptoms from the American cultural disease, the fact that other states like Rhode Island, New Jersey, Wisconsin, and Illinois are pushing through pension reform while California still lags behind indicates that either this ‘disease’ is not as pervasive throughout the United States as Lewis assumes, or that Californians are more indulgent than most.

"A Collection of Regional Economies"

2012-11-11T21:47:00.002-08:00

I thought Lewis’ last chapter and particularly his discussion on the Whitney controversy was particularly interesting (though like many of you I enjoyed his anecdotes and storytelling as well). Unlike Caroline and Shane, however, I do not know very much about California’s politics. Rather, Whitney’s discussion of the emergence of “regional strength and weaknesses” and view of “the U.S. national economy as a collection of regional economies” resonated with my personal experience (Lewis 177, 175). I am not certain the extent to which people move explicitly because of financial stability (though it isn’t difficult to imagine); however, there is definitely plenty anecdotal evidence of individuals who move between towns or states to avoid high taxes as well as to access economic opportunity. Being from New England, I know plenty of people from Vermont and Massachusetts who cross over into New Hampshire to do tax-free shopping (indeed, New Hampshire has capitalized on their sales tax free status as they have NH State Liquor Stores on either side of the highway when you enter and leave the state). Similarly, there are many people who move out of New England to southern states with lower tax rates (or, like Texas, with no income tax whatsoever), as well as for job opportunities. Regional “strengths and weaknesses” in terms of offering more preferable tax policies or opportunities thus seem to exist.

Within Connecticut itself, in my experience it seems like there is a divergence among towns such that the towns with lower tax rates tend to attract those who are able to move, which are usually wealthier individuals. Towns with lower tax rates also seem to have higher median home values – it’s difficult to say whether the competition for lower tax rates would cause home values to rise or if the higher home values allow for a lower tax rate to maintain the same amount of revenue, but the correlation seems to exist. Thus, those who are wealthier and own nicer homes live in towns with lower tax rates, but because of the relationship between tax rates and property prices, they may be able to get the same level (or better) of municipal services . Imaginably, such towns will have a relatively easier time balancing their budget and will be at a much lower risk for a debt or budget crisis.

I wanted to see what the data says about my experience and to see if there is any sort of divergence among towns based on income or wealth, so I did a few quick and dirty regressions (data source: CT census data available through the Hartford Courant here). As the dependent variable, I used the mill rate (town property tax on real estate, the main, if not only, source of tax revenue for most towns in CT). I ran four different linear regressions, the first with all independent variables I gathered data for (average income, percent of family households with children, percent of residents over 65, percent of residents foreign born, percent of residents that were white, and median home value of homes where the owner lived in it). Interestingly, only the percent with children (positive correlation), percent white (negative correlation), and median home value (negative correlation) were statistically significant at the 5% level (all of them were significant at 1% as well; no variables were significant at 10%). A regression with only those three variables confirmed those results. I also regressed those three variables and average income as well as percent children, median home value, and average income, but in neither case was average income statistically significant at even the 10% level.

These results are interesting because they suggest that, although there is a negative correlation between median home value and tax rates, there is not a correlation – or at least no linear relationship – between income and tax rates. (I attempted to run a regression including average income squared, but there did not seem to be a quadratic relationship either – neither average income nor average income squared was statistically significant at even 10%). Of course, income and wealth are different, as are income and home ownership – many seniors on fixed incomes, for example, own homes of high values, and many people, including well off young professionals, rent. Conceivably if we had a better measure of personal wealth, especially pertaining to homeowners specifically, that might show different results. Nonetheless, it does not seem like those with higher incomes – without taking into account home ownership status (a huge deficiency of this analysis) - automatically gravitate towards towns with lower property taxes.

Nonetheless, the negative correlation between home values and property tax rates seems to suggest that there may be a “divergence” among towns, in that those that are poorer and have less valuable homes tend to have higher taxes, which they may require simply to operate. When taxes are already high, they may be harder to raise (as Lewis’ analysis in the book suggests – people seem very loathe to tax increases, even if they’re not Greek) and thus “poorer” towns (defined by real estate values) might have greater difficulty balancing their budgets. If there is enough of a divergence between property values, poorer towns might not even be able to keep up with richer towns no matter how high their property taxes are. Thus, in terms of fiscal stability, there may be some degree to which towns with higher property values are more “stable” than others (& potentially able to provide more services for the given tax rate), though obviously this theory could use much better and more in depth data and analysis.

Lewis Should've Interviewed Prof. Miller!

2012-11-11T20:00:00.000-08:00

Boomerang was a fun read and I liked the way Lewis linked each economy’s woes to cultural factors in a concrete way (too often do people chalk things up to “cultural factors” without actually describing what those factors are and how they cause the effect in question). In the chapter on California, I thought Mark Paul’s quote was especially sharp: “What the polls show is that people want services and not to pay for them.” Lewis goes on to describe how this sentiment manifests itself in the state’s politics, but I think he missed an important piece of that conversation: ballot measures.

CMC’s own Ken Miller gave a briefing on California politics a couple of weeks ago, and a lot of what he had to say about ballot initiatives in California is supportive of Lewis’s thesis. Here’s the video (the discussion of ballot measures starts around 15:00): http://vimeo.com/52641324

Miller points out that, of states that allow ballot measures, California is far and away “the most aggressive in its use of the initiative process, both in terms of absolute numbers of initiatives, and in terms of consequences of these measures.” For example, almost 30% of all 2012 ballot initiatives in the nation were on the California ballot. While direct democracy might be philosophically admirable, it lacks is fiscal accountability. Individual citizens can’t hold one another responsible for the states budget, and so it is easy to get into financial trouble. Only three times in history have Californians directly voted to raise taxes, and two of those were cigarette taxes (the third was on incomes over $1 million). Raising taxes is always a political challenge, and usually only gets done when politicians are backed into a corner. Sidestepping the representative legislative process also sidesteps forcing anyone into such an unpleasant compromise, and makes raising taxes in a serious way nearly impossible.

On the other side of the balance sheet, Californians have voted many times to increase services or cut taxes. Miller lists five relatively major tax cuts that came through ballot measures off the top of his head, and there are certainly others. Proposition 13, in particular, placed stringent restrictions on property taxation, and is often cited as a leading cause of California’s repeating budget deficits. Of course, increased spending on state services has also ballooned the deficit, but that only reinforces the claim that Californians want it all, and they want it for free.

Update: Both proposals to raise taxes on California’s ballot failed to pass last week. Big surprise.

Much Ado About California Cities

2012-11-11T18:36:00.002-08:00

"So what's the scariest state?" I asked her.

She only had to think for about two seconds.

"California." (pg 178).

I really enjoyed Lewis' final chapter on the state of California.

This summer, I followed California politics closely for my internship, and I wrote a tutorial paper on San Bernardino's municipal bankruptcy. As many of you may know, three California cities declared bankruptcy this summer: (in chronological order) Stockton, Mammoth Lakes, and San Bernardino. The above passage comes from the final chapter of Boomerang, when Lewis is interviewing analyst Meredith Whitney about her controversial comments on 60 Minutes. Whitney predicted the collapse of municipal bonds because, as Lewis reports “states had the ability to push their problems down to counties and cities” (173). During her interview, filmed in December of 2010, Whitney estimated there would be 50 to 100 municipal bankruptcies (173).

About four pages into the final chapter, I had to flip back to the title page to figure out when Boomerang was published. I was pleased, or at least interested, to see it was in 2011, prior to the series of bankruptcies this summer. Impressively, Whitney was calling California about two years in advance.

With the three municipal bankruptcies in 2012, the state of California cities has become on the rage, especially in the press. Here are a few pieces in the last six months on exactly what Lewis is talking about:

· “Not California’s last bankrupt city” – New York Post, June 27

· “California bankruptcies are only the beginning” – CNN, July 12

· “Bankruptcy in California Isn’t Seen as a Trend” – New York Times, July 12

· “Three California Cities Bankrupt: ‘This Is The Tip of the Iceberg, Says Fmr. Statesman” – Yahoo! Finance, July 13

· “Moody’s: More Calif. Cities could go bankrupt” – CBS Money Watch, August 17

· “California Muni Bankruptcies a Growing ‘Disease,’ Kotok Says” – Bloomberg, October 3

As evidenced by the above headlines, there is still considerable debate about whether or not this is an ongoing trend.

Reuters reported in August of 2011 that there have only been 624 municipal bankruptcies since 1937. So Whitney’s prediction that there would be ’50 to 100’ within a couple years is a bit extreme.

Still, Whitney stood by her comments. The following clip provides an update on the "Whitney debate":

California cities are definitely the cities to watch in the next six months. Whether or not we will see 100 cities default is a larger question, but there's at least something to Whitney's point.

Pension Negotiations and Accountability

2012-11-11T17:14:00.004-08:00

While I agree with Entertainment Weekly that Boomerang would not be the first book I would recommend on the financial crisis, I found Lewis to be an excellent story-teller, bringing together many plot narratives into a cohesive piece, with a lot of interesting facts along the way. While ultimately the reader is forced to take Lewis's stories as the right ones, at the very least he brings a social environment perspective into the discussion. From my experience, his description of Greek life and culture was definitely too simple, and used selective narratives to draw a much harsher stereotype of the Greeks than they deserve -- but simplicity is essential to story-telling, I suppose.

I was also very interested by his discussion of the emerging social trends in the United States, that we will most likely be forced to painfully confront in the (perhaps not so far) future. In particular, I thought that Lewis aggregated the issue of budgeting, even on the municipal level, too far. It is not that challenging to believe that people everywhere, not just California, like services and don't like paying for them; isn't that really just a factions problem, a la Federalist No. 10? A very important function of government is to help us non-angels actually coordinate how we will spend (and tax) our money (the exact function which fell apart in Greece under the corrupt members of government).

More problematic, however, is the lack of accountability both in and out of the government, and this is the element which Lewis rolls all together into "too fat to fly." For example, the pension negotiators for the police and fire departments in many (now broke, or close) cities were in fact acting AGAINST the longer-run best interests of those they represent -- when San Bernardino recently declared its bankruptcy, it's by-far largest segment of debt was for pension and retirement plans, and the sums to actually be paid post-bankruptcy were decided by the courts. Had the representatives for the government employees negotiated for sustainable policies (and encouraged good budgeting practices, or even asked for evidence that these were sustainable), rather than just pushing for the best deal they could get at the time, many of these cities may have avoided crisis, and the recipients of the pension plans would actually be getting more than they are now. I believe this is quite similar to the issue of bank CEOs in the recent financial crisis - apart from the culture of risk-taking and the lack of some important regulations, the lack of long-term accountability on a firm-specific level added up to a significant issue in the market.

In short, the problem is not just a lack of match-up between willingness to receive services and willingness to pay for them. These economic crisis rarely pay off for anyone (except, apparently, Kyle Bass) - on a more specific level than just the entirely societal, many organizations and institutions are acting in non-rational ways. More accountability and encouraging responsibility for long-term interests, on every level, will be essential moving forward, helps markets and governments to function much better, and is also probably much less difficult to institute than getting us to stop paying attention to our lizard brains.

“Grexit” from Bad to Worse: What Would a Greek Exit Look Like?

2012-11-11T15:37:00.003-08:00

One Sentence Abstract: Cultural and institutional factors make convergence and Euro resolution difficult, but the costs and risks of a periphery exit are also very difficult to face.

Lewis did an excellent job describing the national character and institutions of financial crises and nations through both anecdotal vignettes and sociological observations. What jumped out at me throughout the book, was the enormous cultural difference of each nation, especially Germany and Greece. If this is the case for just two of the Eurozone countries, it seemed likely, and somewhat disheartening, for Eurozone economic convergence. This led me to reflect on an event over the late summer, the Greek elections and subsequent Greek exit concerns. During this period, there was a sharp worry that Greece would exit the Eurozone.

Default and exit was, in a very real sense, very close to being embedded in the Greek culture as the population squirmed under heavily persistent austerity measures and abysmal growth. The differences between Eurozone natures had the potential to cause enormous economic turmoil. The threat of Greek exit has subsided since its pre-election peak, the worry persists as the crisis has been given a central bank “band-aid” but no fundamental fix. This raises the important question, “what would a Greek Euro exit look like?” I quickly discovered that the answer to this question is enormously complex and uncertain, but likely results can be painted in broad strokes, into two potential exit scenarios: managed and disorderly.

First the orderly. What one might expect under an orderly Greek exit from the Eurozone is to start with a revocation of bailout terms. What this means is that the Greek government refuses to enact the required austerity reforms imposed by the IMF and required from ESM/EFSF. However, under a managed scenario, the parting of the Greeks from the Euro is at least partially mutual. This is important for a number of reasons, and allows the Euro government to help both limit damage in Greece, but also limit the contagion impact of a country leaving the Euro. This type of exit would likely be accompanied by support for financial institutions with exposure to Greece (may of the European FI’s have already limited their direct exposure to a Greek exit, but remain exposed in terms of secondary effects). We might expect to see a firewall for the remaining IIPS, with the ECB and other international monetary funds acting to ensure financial stability by injecting liquidity. A managed exit would require a plan to be put together in secret, and implemented along with severe capital restrictions. To illustrate why, imagine you are a Greek citizen who becomes aware that all of your assets will be redenominated in new-Drachma next week. This new currency will immediately inflate and become worth less and thus your net wealth will take a large hit.

Would it make any sense to hold your assets in Greece and allow this to happen? No. This illustrates the danger of capital flight should this plan become known before capital movement restrictions are put into place. Should this downside realize, we would see something more akin to the disorderly resolution mentioned below.

Applying some numbers to this scenario, we see something along the lines of the following PwC projections for Greece (assuming fiscal reform post exit, a very optimistic assumption, I believe its more likely for less growth in the 5 year period, especially given the subsequent Eurozone slowdown after this report was published):

Similarly for the Eurozone:

A Greek exit has negative growth impact, especially in the short term, and especially for Greece. It would also likely lose access to capital markets and thus still be dependent on the IMF.

The Greek economy does not make up a large percentage of the Eurozone, in fact it is only about 2% of the total:

Given the small size of the Greek economy, a large portion of the worry of a Greek exit its impact given the interconnection between Greece and the rest of the periphery as well as connections to the Eurozone core. Without the policies aimed at dampening the contagion impact of a country exiting the Eurozone, a Greek exit would be much more damaging. We would expect a large, negative world impact from a disorderly exit. A disorderly exit increases the risk of other periphery nations exiting. At the very least, the borrowing costs for these nations would dramatically increase alongside weak growth. Even without going very far into the weeds of how these policies would be enacted, it becomes apparent how difficult and fraught with downside risk a Grexit would be.

After reading Boomerangand exploring what a broken-up Eurozone would look like I am left with two important impressions. First, the culture of the more productive, creditor Eurozone nations is significantly different from the debtor, Sunbelt nations (as represented by Greece). It seems unlikely, given the history and long-term trends of the cultures and institutions in both areas that the sort of economic and institutional convergence that would be required to fix the Euro will occur. Similarly, the political problems creating a fiscal union to match the existing monetary union are very difficult to overcome. However, the alternative in which the Euro is dissolved is extremely untenable. Like it or not the Euro has significantly tied these countries together, and breaking it up would be extremely painful, not only for the countries directly involved in the break-up, but also profound world-wide recession. Understanding the divergence in institutional and cultural characteristics of these nations along with the costs of splitting-up, illustrates just how difficult this situation is to resolve.

Boom Boom Boom Boom?

2012-11-11T01:20:00.000-08:00

Boomerang was definitely one of my favorite reads of all semester! Lewis does a great job of mixing cultural and political stories intertwined with economic analyses of the various global financial crises. Although I would be keeping up with the Euro crisis and what is happening in Greece, I never got a full explanation of the country's issues before they joined the Euro in 2001 all the way to now, which provides a very holistic and yet simple overview of the country's state. Aside from all the differences and culturally outrageous stories Lewis sprinkles throughout, there are definitely running themes throughout all of these chapters though: first of all, financial disasters don't happen overnight, but rather from lack of long-run oversight and neglect of impending warning signs. Secondly, there are dangerous consequences of paying for the present with the future, of which California is the last and most relevant example in the book.

The Germany section was one of the more interesting ones (aside from his argument that Germans are obsessed with defecation in one form or another). He points out that one reason the euro was created was to ensure a newly unified Germany would be fully integrated into the rest of Europe to counteract any dominant power they might gain again. He also points out the irony of Germany emerging as an influential figure not militarily, but economically. It is in its position of economic power today because of their austerity measures, many of which are relevant to the growth vs. austerity debate. Unlike the US and other European countries, Germany did not enjoy a debt-driven real estate boom before the crisis, which resulted in slower growth. In the absence of a real estate bubble, though Germany's economy was still affected by two main channels: finance and export. Lewis mentions in his book that numerous German banks were overexposed to the toxic assets being sold in the US and Ireland. The book cites almost $200 billion in losses (which means even more was simply invested), and it is visually depicted in this OECD graph:

The second, and more important, channel was trade. The export industry suffered both from lost sales in volume as well as a financing crisis because customers interested in buying goods lacked the necessary capital since the shortage of bank lending. Even though GDP declined significantly after 2008, Germany's unemployment rate remained almost unaffected at a 0.3% decline and has actually been decreasing.

Although the German economy was hit harder than people initially expected because of its austerity measures, this only goes to show how interconnected global trade is these days regarding of measures to shield oneself from international domino effects. At the same time, it also goes to show the various impacts of growth vs. austerity. Considering US and Germany's wildly different economic approaches, the data shows that the US has still had faster recovery out of the recession. At the same time, Germany is one of very few economically sustainable countries in its region, which goes to say that the austerity model has worked for them. Based on the examples he cites in the book, Lewis would probably be against over leveraging and growth stimulus measures. And yet the data speaks for itself! This reading has made me only more interested in following the Euro crisis more closely and getting a better opinion on whether Greece is more suited for a growth or austerity approach.

When I Move You Move

2012-11-05T02:48:00.001-08:00

A lot of Krugman's commentary was oddly prophetic; his discussion of the Savings and Loan crisis, of the issues associated with large-scale insurance, and of Japanophobia begged analogy to the financial crisis, AIG bailout, and recent Sinophobia.

But I've already blogged about how well some of these writers predicted future problems. In fact, we all have at least one post to that effect. So I will investigate a Krugman claim I believed no longer holds true.

Krugman questions how global the global market really is. He writes that because "there is so little international 'cross-holding' of stocks, world stock markets do not necessarily move together. This was illustrated spectacularly from 1990 to 1992." (183)

But I interned at an investment firm this past summer and noticed in my first week how global markets frequently moved together. If the S&P was down, you could count on the Nikkei being down before you woke up the next morning like clockwork. But don't just take my word for it. Below is a graph of the S&P 500 index (US), Nikkei Index (Japan), FTSE 100 (Europe), and Hang Seng Index (Hong Kong). Clearly, they move together quite frequently in the modern global economy.

The next question is to evaluate why. Krugman saw no interdependence in the early 1990s because of scant 'cross-holding,' which he defined as "international diversification of portfolios - that is, Americans [as] stockholders of foreign companies, and conversely." (182)

Interestingly, the United States census bureau maintains data on such cross-holding and the trend is as I expected. By the mid 2000s, both the number of international financial transactions and the net purchases of foreign securities in the United States skyrocketed. Unfortunately, the data skips from 1990 to 2000 so it is difficult to isolate the beginning of the trend.

Krugman cites Walter Wriston, former chairman of Citibank, as someone who overreacted to the potential impact of information technology on financial markets. Said Krugman, "much of this is hype." (182) Yet the data does not agree. Reports by economists at HSBC, Cornell, Wells Fargo, and UBS even highlighted correlations in bond and commodity markets across borders since the internet boom of the late 1990s. As the New York Times reported, markets (even more so now in the risk-averse post-2008 era) have "been behaving like synchronized swimmers." (182)

Not quite Krugman's prediction when he published The Age of Diminished Expectations...

Sources:
MarketWatch
US Census Bureau
NYT

The Invisible Children Model, Uganda

2012-11-05T00:44:00.000-08:00

The Invisible Children Model -- Alternative Title: The White Man's Burden Goes Viral

While I was reading Easterly's work, I could not help but think on the Invisible Children organization and the "scandal" that broke in spring 2012. Easterly wrote this book in 2006, before the true hey dey of organization, but I would have been interested to have heard his thoughts on the movement. The 2012 KONY documentary truly could be called the new White Man's Burden.

As many of you may remember, the non-profit organization Invisible Children aims to help protect children from being kidnapped and drafted into the Lord's Resistance Army in Uganda. The organization, which has gotten more than its fair share of press attention, utilizes social media to turn young people into activists.

In their KONY movement, the Invisible Children group tried to mobilize Americans through a 30 minute documentary that implored them to help make war-criminal Joseph Kony "famous" by plastering his name all over the country. The solution was simple -- purchase one of Invisible Children's poster kits and decorate your school in order to "raise awareness" about the issues, and some of the other proceeds would go to the actual project. In the Kony 2012 documentary, several U.S. politicians are featured. "If we take the pressure off, if we're not successful, he is going to be growing his numbers," Senator Jim Inhofe of Oklahoma tells the camera. "People forget and you've got to remind em and it takes numbers to remind em."

When Easterly mentions the Live 8 concert series, I instantly thought of Invisible Children. There are a couple parts of the Kony campaign that relate directly to Easterly's work.

First, the New York Times referred to the movement as a form "slacktivism". That is, the replacing of financial aid with a "like" or "share" on Facebook page. This allows the individual to fulfill his or her need to reach out and help, without requiring any effort.

This was interesting to me in light of Easterly's statement that "The prevalence of ineffective plans is the result of Western assistance happening out of view of the Western public." He also adds, "Fewer ineffective approaches would survive if the results were more visible" (16).With social media, we have the ability to move people with images. Invisible Children was able to show images of young (white) people on the ground in Africa, teary-eyed and many were driven to action.

But to a second point about private non-profits, Easterly does seem correct in that they can have a better feedback look than foreign aid. Only about a third of Invisible Children's budget is spent on working with children:

Of course, these financial charts were not released until a popular uproar but pressure on the organization to release them. In this way, this non-profit had to confess that it wasn't doing as much on the ground as many other organizations. This caused a press fire storm -- with people dropping support for the organization left and right.

I also found the rhetoric around the Kony campaign a bit goofily similar to Easterly's description of colonialism -- namely how benevolence was "a strong staple of propaganda back home to justify the colonies." A major theme of the tear-jerking film is that the American troops deployed in Uganda should stay there, and people should continue to lobby for more foreign aid to Uganda. Ironically, American troops play no role in the actual film, nor does foreign aid. In this respect, Invisible Children is a very interesting organization to say the least. It certainly urges a "Middle Class Burden" to save child soliders in Uganda.

It is also relevant to share this bit of news -- that Ireland and Great Britain have just pulled their foreign aid from Uganda because ten million pounds were redirected into the prime minister's pockets.

http://www.dailymail.co.uk/news/article-2225443/Britain-Ireland-suspend-aid-Uganda-10m-funding-ends-Prime-Ministers-account.html#ixzz2Arob7WaO

Repost of Easterly (Title: So Sen-sible)

2012-11-05T00:02:00.001-08:00

Posted on Easterly too last week. A repost:
I found Easterly's critique of foreign aid to be very persuasive. Almost too persuasive. When he argues that aid programs should be tailored to their targeted societies, should sidestep dealings with corrupt governments, and should heed feedback mechanisms from the local populations, it is difficult to disagree with him.

But surely our aid programs, even if prone to the occasional error, already set out with Easterly's intentions in mind? In other words, don't aid programs already try to incorporate Easterly's suggestions?

Easterly almost agrees. He notes that "the working-level people in aid agencies or nongovernmental organizations (NGOs) are more likely to be Searchers than Planners." (18) This relationship makes sense: the upper-class American is the Planner, wants to combat poverty, donates to the Red Cross worker in the developing world, who determines the best use of that donation.

I repeat: is this not what is already happening?

Easterly says no. He qualifies his praise for the working-level people by observing how "Big Plans foist on these workers...taking money, time, and energy away from the doable actions that workers discover in their searching." (18)

To be honest, I do not really know what Easterly means by this. Is his point that aid programs are so large and bureaucratic that they waste aid dollars? Possibly. Easterly certainly criticizes the bureaucracies in his Tanzanian pothole anecdote. (174-175)

Source: PolitiFact

Data on several NGOs, however, reveal reasonable efficiency levels. As the chart above shows, 92 cents of each Red Cross donation dollar reaches its targeted aid program. The same goes for 83 cents of every UNICEF dollar. While clearly imperfect, the operational efficiency of NGOs likely is not the explanation for the ineffectiveness of foreign aid.

Is his point, then, that the leaders of NGOs, the World Bank, and the IMF are incompetent? Not really.

Easterly concedes that "the IMF and the World Bank do succeed in attracting professionals who are dedicated to the mission of poverty reduction...and employees with strong norms of professional conduct do perform better." (177)

Amartya Sen (remember him?) authored a compelling critique of Easterly that captured many of my reactions. Sen wrote that if delivered in a less-extreme fashion, Easterly's lessons "could have yielded an illuminating critical perspective on how and why things often do go wrong in the efforts to help the world's poor." Yet Sen could not accept "Easterly's overblown conclusions...[because even Easterly] acknowledges the successes of many international aid efforts." (Sen, 172)

Ignore poverty reduction for a moment. International aid performs critical humanitarian functions. A recent study by the Social Science Research Network found that foreign aid played a substantial role in reducing infant mortality rates in Kenya. The Chief Economist of the IMF, whom Easterly cites as a denier of the growth effects of foreign aid, admits aid can be useful to save lives.

Even if one accepts only the premise that aid does good in the humanitarian realm - rejecting the idea that aid fights poverty - he or she still stands with Sen.

And I stand with Sen. Ample evidence, at the very least for humanitarian efforts, demonstrates the benefit and necessity of foreign aid. Yet I still find in The White Man's Burden welcome insights into ways of heightening the impact of foreign aid programs.

--

In all seriousness, I highly recommend reading the Sen critique. I struggled all day to write this blog post because Easterly seems so right and so wrong at the same time - I'd imagine many of you feel this way too. Find the critique here.

Sources:
Politifact
OECD
WHO
IMF
World Bank
Social Sciences Research Network
New York Times
JSTOR

Raghuram Rajan and Arvind Subramanian

Microfinance: Something Sachs and Easterly Can Agree On?

2012-11-04T23:52:00.005-08:00

In this post, I will explore arguably the biggest new idea in poverty-reduction – microfinance – which has received considerable attention, investment and scrutiny in the past few years as it expands across the globe. I would like to evaluate the impact and overall philosophy of microfinance using Easterly’s straightforward approach. I will discuss how the burgeoning microfinance movement has both searching and planning implications, showing why Easterly’s dualistic view of development programs may be overly simplistic.

In one of his anecdotal snapshots, Easterly seems to endorse the microfinance movement, insofar as it was conceived by Mohammad Yunus in true Searcher fashion. Yunus identified a very specific, homegrown need, and went about formulating a way that local lending markets could fulfill that need. Since this need – financial access to micro-loans to smooth income and consumption - is arguably universal amongst the world’s poor, we have seen somewhat of a microfinance revolution across the world since its humble inception in rural Bangladesh. This expansion beyond its specific context, coupled with some concerns over its measurable impact, would likely cause Easterly to soften his praise.

Microfinance is very much a bottom-up approach that helps poor people help themselves. Shifting the approach from large macro-inputs to a very real, micro level about money (in the form of micro-loans) that can actually be translated into really “outputs” such as education, health, increased income from businesses, etc. It is not a Big Plan instituted across the board with cookie-cutter policies; rather it tends to vary with each context, and it is local individuals taking on the risk. However, as it grows in scale, it is ever in danger of becoming more streamlined, and seen as a necessary part of the overall development package through the belief that access to financial instruments (such as bank-operated savings and loans) is a fundamental need that must be filled in order for people to pull themselves out of poverty.

It has clearly brought about some positive results, particularly the empowering and women and a paradigm-shifting realization that poor people are “bankable” and are not a huge credit risk (they have shown very impressive levels of repayment). However, in order to pass Easterly’s development muster, programs must stand up to rigorous statistical evaluation and be specifically aimed at a need within a small, specific context. A study by Jonathan Morduch, the modern superstar of microfinance impact, of the flagship microfinance programs from the Grameen bank in Bangladesh shows that households with access to micro-loans do not have higher consumption levels than others, and their children are no more likely to be in school. Experiments showed that microcredit only nudged up the rate of new business-formation from 5% of households to 7%. Microloans are most often used for something else, such as financing the purchase of consumer durables or repaying debts to moneylenders. From an anecdotal perspective, I can say that I certainly saw that “dark side” of Microfinance through my fieldwork in Peru, a hot bed for microfinance. These poor, undereducated Peruvians were no better at handling constant, excessive debt than your average American. The proliferation of easy credit to those who are truly under qualified is more dangerous than no credit at all. This is not just a truism for the developing world, look no further than the sup-prime mortgage crisis to see how aggressive banks can prey on those searching for credit that is cheap and seems too good to be true (see link to below to Strangio’s critique of microfinance). I certainly believe that microfinance has created an artificially high demand for credit in poor populations, using promotions and interest rates to lure poor people into dangerous levels of debt.

One might expect, however, that microfinance banks would not have the same profit-motive as the greedy mortgage-banks in America, and this leads us to one of the biggest debates in microfinance today, should MFI’s be profit-seeking or should they operate from donations alone?

Many believe that profit is essential for the sustainability of these institutions. However, there are some very valid concerns over the expansion of the microfinance sector. Easterly might argue that this effort to make a large, formal sector of banks that serve poor customers is too much of a Big Plan based on some vague ideal about the universal access to credit, savings, insurance for all. Certainly, the expansion of these banks to new “unbanked” areas and populations would require a large influx of foreign investment/aid/donations to fund these banks. Bill and Melinda Gates have already given millions to initiatives that support microfinance (I have actually been the beneficiary of some of these funds myself). However, it is important to consider what might happen if they banks expand without the proper government regulations and oversight, particularly given that their customers are particularly vulnerable. If the US has trouble regulating its banks, one could imagine these issues would be even worse in the third world. Also, giving loans to poor people to help them achieve their goals is noble, but the unfortunate reality is that they need the training and education to learn how to pay it back responsibly and there will always be banks looking for an opportunity to take advantage of that need in the market.

Easterly has written a little bit about microfinance, remarking that it tends to be overhyped and that it achieves the best results in 1) small scale application and 2) specific contexts. He is wary of it being converted into a Big Plan with excessive targets and goals that it cannot truly meet. However, it would seem that his love for markets, as ultimate conduits of feedback and coordination, might sway him to support the unleashing of MFI’s so long as their services are ultimately provided positive outcomes for the world’s poor.

Microfinance is one of the few things that Sachs and Easterly agree on, and this is perhaps because both of their approaches have become overly dogmatic. Microfinance has its origins in a grassroots Searching approach, yet is sits precariously on the edge of a mainstream Planning takeover that would greatly spread it to all the unbanked corners of the developing world (as wells as poor areas within developed countries). Therefore, to beast reap the benefits and minimize the costs of microfinance, some important reforms must be put in place before it is unequivocally embraced and codified like the rest of the Millennium Development goals. Based on the debates, we should at minimum assess the following:

1. More rigorous impact evaluations to see what works in different environments.

2. Avoid the pitfalls of Planning approach, such as a target of making every rural village “banked” by a certain year, also be wary of streamlined MFI’s and practices across different countries and regions.

3. Come to consensus on the profit-motive of MFI’s, understand the crucial role of regulations/oversight in the feasibility of this option

Sources:

Murdoch’s Impact Study:

http://www.tnr.com/article/world/98499/microfinance-drive-poverty#

Easterly on Microfinance:

http://online.wsj.com/article/SB10001424052748703956904576287262026843944.html

Strangio on Microfinance Shortcomings:

http://www.tnr.com/article/world/98499/microfinance-drive-poverty#

Easterly and US Foreign Aid

2012-11-04T22:50:00.004-08:00

I thought Easterly’s treatment of corrupt governments in developing nations and how the international community deals with them was interesting and insightful. Particularly, Easterly observes that “Another problem is that foreign aid is used as a political reward to allied governments, no matter how unsavory they are” (Easterly 132). Easterly acknowledges that “strategic geopolitics explains only a small portion of the variation in aid receipts across countries”, but it is still interesting to see just how many countries receive aid from the US and how much they receive (Easterly 133). Foreignassistance.gov, developed by the Department of State and USAID, has this graphic showing aid given based on the country and fiscal year.

http://foreignassistance.gov/CountryIntro.aspx (Unfortunately since it is interactive and not just a jpeg or gif, I can't embed it. Or, at least, I don't know how. Sorry!)

Virtually all of the countries in the developing world, aside from a few notable exceptions (e.g. Iran and Syria), are receiving aid from the US in 2012. It seems that US foreign aid is almost a “given” for any developing country – they can pretty much expect it, which makes it a much weaker potential political tool. Rather, that aid is so ubiquitous makes its revocation a much more powerful statement than anything else. Of course, it is certainly still doubtful if such a revocation would make any major impact – if anything it might signal that other, more impactful policies are or will be implemented against the state, such as the current economic sanctions against Iran. Even so, there might be a political case for reducing overall foreign aid to increase its political power, or at least prohibiting aid to a larger group of corrupt governments.

This website in itself is also interesting as it appears to be a bureaucratic attempt to resolve one of the major issues with bureaucracy – lack of transparency. This website makes at least some attempt to provide data on foreign aid in a clear and comprehensive manner accessible to the average US citizen. Of course, Easterly’s emphasis on making bureaucracies more responsive is in terms of making them more responsive to the poor foreign nationals they are attempting to serve, but it seems that there is some value, even if less value, in making developed countries’ governments’ bureaucracies more transparent, if not more responsive to their populace on the whole. Even misguided “Planners” want their government’s foreign aid to be efficient; if they can have clear and understandable but specific data about a program and how its money is spent, that can provide some gauge on aid’s efficiency. I assume that the public is fairly well-intentioned or, at the least, wants to limit government waste – only proper information and perhaps the ability to make their opinions heard prevent them from making an impact on policy. While a cursory glance of this website does not suggest that it is anywhere near a panacea, I would be interested to see what more efforts towards transparency in developed-world government bureaucracies could do, especially combined with an increased movement within those countries’ populations towards not just awareness of international issues, but also a desire for proper understanding and actually efficient solutions.

Krugman - Sources of Inequality

2012-11-04T21:56:00.000-08:00

So I messed up last time and posted on Easterly. Here is my post on Krugman to make up for it.

I decided to look more into the sources of the rise in inequality Krugman discusses.

Reed and Cancian (2001) find that female earnings became more equal over the 1970s and 1990s, while male earnings became more unequal. These changes in male earnings accounted for a significant portion of the increase in inequality in the US during this period.

Male and Female Earnings Inequality 1970s-1990s

Another interesting finding from the literature was that economic volatility increases inequality. This makes sense if the poor are the ones laid off or forced to sell off resources during business cycles and can never fully recover.

In Aghiom and Williamson (1999), they find that the volatility of real GDP accounts for 22.7 percent of the differences in the level of inequality between countries. This makes an understanding of how to prevent business cycles more significant. Volatility is significantly more explanatory than inflation and growth in per capita income. They do also show, however, that growth in income does lead to more inequality. This shows that everyone does not benefit equally from economic growth.