The Malthusian Regime

I am late to a debate going on between Bryan Caplan and Greg Clark over the Malthusian Regime. Bryan essentially takes the stance that decreases in population should not be seen as key in raising the standard of living. Presumably because of increasing returns to scale in the production of technology.

However, it seems straight forward to me that that increasing returns in one factor of production are temporarily outweighed by decreasing returns in another. Overtime as technology accumulates the overall functional form moves from decreasing to increasing returns. That shift represents the transition from the malthusian regime to the modern epoch.

Below is a simple numerical example of this type of thing. Income is a constant returns to scale function in technology(we are thinking of ever more advanced capital), labor, and land.

Technology does not depreciate and its accumulation rate is increasing in the total population level. The population grows a steady 2%. Land is fixed.

At first income per capita is decreasing because land is fixed. However, eventually enough technology accumulates that its increasing returns production dominates the fixed quantity of land.

One has to remember, however, that population effects the growth rate of technology, not its level and that the underlying capital accumulation is driven by income, perhaps even income per capita if you consider minimum consumption constraints.

Therefore, it is possible that far from delaying the industrial revolution the black death brought on the industrial revolution by increasing per capita income at a high level of technology.

Basically what helps in this model is to build up a big population to increase the technology level and then to wipe a bunch of them out to increase income per capita. The historically unusual combination of technology and wealth will rocket you forward.

How Good was the Sep NFP Release

On the one hand July was revised up 25K, August up 93K and Sept came in at 110K for a total of 228K more jobs than we would have thought the day before. On the other hand the March 2007 Benchmark revision slashed 257K jobs - leaving the overall level of jobs 17K less than we would have thought.

On net it is roughly a wash.

However, I would suggest that the sizable downward benchmark revision is not the best sign. The BLS methodology produces considerable inertia in the estimates. The birth death model creates or destroys jobs based on how well the monthly data performed in relation the benchmark last time around.

The upshot is that the NFP report will tend to miss turning points. Indeed, if the turning points are close together in time the the methodology should significatly amplify the peaks and troughs.

If the benchmark March 2007 was already revising jobs downward then that implies to me that the turning point was likely sometime before that. Thus all of our estimates until the new benchmarking comes into effect will be overshoots.

Moreover, there is reason to think the economy has weakened since
March 2007 and that our overshoots are actually accelerating. It will be interesting to see how the unemployment rate fairs by the beginning of 2008.

Dead Wrong

Both September NFP and the August revision were well off my predictions. The overall benchmark adjustments were in line. That is, job growth was significantly weaker this year than reported. As a result the BLS data is now roughly in line with ADP.

My confidence in a Oct rate cut has dropped significantly. More later.

NFP to be lower than Expected - BLS is playing catch-up

My non-model guess is 50K new jobs created.

See Calculated Risk on a good chart showing BLS vs ADP estimates of private employment. The ADP report shows less volitionality and there is reason to believe that BLS has overshot the peak. To date BLS is reporting 200K more private jobs than ADP. I expect that the BLS report will be playing catch up in the coming months.

Whose Afriad of the Falling Dollar

There is plenty of hang wringing over what a weaker dollar portends for the US. Will it impoverish us? Reduce us to third-world status? End the US growth machine.

I am perhaps alone in thinking its one of the best things that could happen to the US. The big problem for America going forward is not growth. Its not entitlement spending. As much as I bemoan it, its not even directly our poor K12 educational system.

Its that an America with a strong university system, a strong financial infrastructure and a strong dollar has little use for strong backs. In the long run that's a good thing, but in the long run we are all dead.

Today, its a heartbreaker.

Its heartbreaking to see Americans who just don't have the financial or intellectual capital to compete in modern America fall behind.

Its also scary.

Its scary to see protectionist sentiment rise and the spectre of class warfare haunt Capitol Hill.

A falling dollar could change that. It could make American industry competitive. It will unwind the growing current account deficit - a process that while not without pain is also not without merit. It would not be such a bad thing for those of us who have done well to cut back in favor of gains among the working class.

And, it would be a great thing for that to happen through natural market mechanisms than government regulation or ill fated attempts at moral suasion.

Payroll Tax Hike

Greg discusses Obama and Clinton's proposal to eliminate the cap on Payroll taxes.

Of the many ways to raise substantial revenue I view this as among the best. My hunch is that hiking the payroll tax will have limited negative effects for several reasons

1) Upper income wages are mostly economic rent. Individuals who make more than 90K a year are primarily living off of the fact that they are significantly more talented than lower income people and have a preference for high productivity jobs¹. These factors are largely fixed by a combination of genetics and culture and unlikely to be influenced by marginal tax rates.

2) The possibility for tax avoidance or evasion is lower with payroll taxes than the income tax. There are few exemption and no deductions making tax avoidance really difficult with the payroll tax. Moreover, a business would have to be complicit to engage in tax evasion. Both of these factors make the payroll tax more efficient.

3) The payroll tax treats workers in the same household independently. Payroll tax exemptions for one spouse don't affect the payroll tax owed by the other spouse. For example, raising the husbands payroll tax makes the wife more likely to work, not less. The income tax probably does the opposite in high income families.

4) People hate the payroll tax. Karl's Law states that given equal size tax bases the economic destructiveness of a tax is inversely proportional to how much people hate it. That is, people hate taxes that they can't wiggle their way out of. Those are precisely the most efficient taxes.



I chose teaching and practicing economics over teaching and practicing painting not because the significant pay differential but because I prefer interpreting abstract art rather than creating it.

Sticky Price, Sticky Homeowners or Sticky Mortgages

Ed Leamer says that Housing IS the Business cycle. As I mentioned before I was struck by the comment in paper, the name and author of which escapes me, that "contracts could be indexed for inflation for instance mortgages could have variable rates"

After all, most mortgages didn't have variables rates and at the time and most people considered variable rate imprudent. I think most people still consider a One Year ARM imprudent and thats really what the author was getting at. So if housing IS the business cycle then perhaps, housing contracts or more specifically mortgage loans ARE the source of the monetary lever.

Now how does this account for the passage by Hume often quoted by Mankiw that increases in the supply of money first quick the work of every man and only later lead to a general increase in prices. The implication of that passage is that the effects of the money supply on the economy have operated the same way for at least four hundred years. Was mortgage stickiness a problem in 18th century England? Perhaps, there were other important nominal contract, bonds or agreements.


Now suppose that the source of the business cycle is owner occupied housing and long term mortgage loans (think of it as time-to-build communities). Then one question is why the devil is it such a bad idea to get variable rate loans? The empirical evidence suggests that is. I know that despite going way out on a limb and leveraging myself to high heaven, I have avoided them. Yet, I am not sure why. It has something to do with not being able to predict my expenses but why should that matter this much? Is it some form of extreme loss aversion? Is it as simple as neighbor capital? The longer I live somewhere the more painful it is for me to liquidate my holdings. I don't know.

Smart is as Smart Prefers

Picking up on another Cowen post I am sticking a flag in the sand and declaring my hypothesis that the genetic component of intelligence is preference. That is, smart people are people who like intellectually stimulating experiences. My guess is that they are more sensitive to the pleasure chemical released when successfully solving a hard problem. Thus they solve more hard problems.

In the process they build thinking strategies and increase neural efficiency. The result is that they are much better at performing mental tasks.

Ala Judith Harris I take the position of zero direct enzymatic influence. That is, there is no enzyme (remember gene's operate through enzymes) that produces more efficient mental processing without a change in environmental stimulus.

For those who have trouble seeing how this might work consider this: Obesity has a strong genetic component. Obesity like IQ has been rising over time. However, does anyone believe that obesity is not completely determined by your food consumption and exercise patterns? Genes can modify that function, in particular they can modify your equilibrium levels of food consumption but they cannot act outside of the environmental regime.

Four Biases

Bryan Caplan talks about four potential biases in popular thinking about economics. He has written a book on the subject that I embarrassingly have not read. However, I have read journal articles and blog posts by Bryan, so I think I have the gist of his point.

However, I am begining to wonder whether or not the "baises" are simply misstatements of real economic problems.

Anti-Foreign Bias: This is the easiest to see. Economists are found of equating differences between countries to differences between households, towns or states. However, the immediate problem is that nearly everyone would choose some Kaldor-Hicks inferior position if it shifted the distribution of goods towards a member of their household. Many people would even sacrifice their own consumption to increase that of household members. Put simply, the closer you are to someone geographically the more likely you are to be an input to their utility function.

In addition there are local economies of scale. Otherwise no one would be paying Manhattan rent. It benefits you to live near other successful people. Moreover, since this is the case it is reasonable to conclude that foreigners will attempt to collude against you so that there locality will grow at the expense of yours. Fighting over attracting residents is typically a zero sum game. Even more so if we are trying to attract the most genetically gifted residents.

Anti-Market BiasI think this is probably an expression of concern over asymmetrical information and cognition costs in general. People are afraid of being screwed in the market, and they should be. Not understanding how the market works causes lots of problems for people. Economists are not afraid because they have lots of information. It seems rational to be more concerned about asymmetric information problems when your information set is quite small.

Make Work Bias I won't go into detail but if you talk to people about this carefully it usually comes out that they are concerned about the growth of the money supply in response to economic shocks. They don't realize this is their concern but it is really what they are talking about. And they are right, if the money supply isn't managed there can be increases in unemployment from demand and productivity shocks.

Pessimistic Bias I think this is a symptom of rate of time preference inconsistency. Perhaps hyperbolic discounting. Most people's live are getting worse in that their opportunity cone, opportunity set over time, is shrinking because of consistently bad choices. Bad in the sense that people wish that they had not made them.

Yes, their opportunity set grows over time but at time T it is smaller than than it would have seemed looking into the future from T-1.

Modeling the Internal Princple-Agent problem

Tyler Cowen asks why "Call me naive but . . . " works better than "I am not naive." After all both are intended as signals that the person is not naive. This works because it takes advantage of the fact that a person is not a unitary entity.

Most of the time we can act as if people have a single well defined objective function. Indeed, much of the time we can act as if households have a single well defined objective function.

However, there are times when this model breaks down. Households disagree internally and people have personal internal conflict.

For the sake of this model lets say there are two entities within each person. A purely internal manager and a communications agent.

The communication agent wants to be trusted. The internal manager wants to feel self confident. If the internal manager is indeed naive, then he will become upset at the communication agent's statement "Maybe I am naive" and potentially shut him down.

The communication agent will have to deal with balancing the threat of being shut down with his desire to be trusted. Making the statement "Maybe I am naive" signals to other agents that the threat of being shut down is low and therefore the internal manager is probably not naive.

I believe nternal principle-agent problems are part of why deceit is more difficult and less common than traditional models might suggest.

Hawk No More

I tend to agree with KNZN's assertion that what is need is fast decisive action by the FED. Even as late as this spring I was a hawk, calling for increases in the funds rate by 25 -50 basis points. Now I am reversing course, looking for a 50 basis point cut now and a bias towards at least 25 more basis points if the September employment data is as bad as I expect.

Isn't this the kind of schizophrenic action that bankers are supposed to avoid?

The traditional approach says yes, but I am coming to believe that slow steady tightening with a tendency towards over-tightening and then dramatic easing might be the way to go.

Why?

Because the response pattern from monetary policy is humped shaped. We get real effects first, inflationary effects later. Moreover, the damage from recession is that people lose their jobs and can't pay their bill immediately. The damage from inflation occurs because the long term trend of prices becomes less certain.


Pumping loads liquidity into the economy as it tilts into recession has the potential to stop what is happening now and prevent the acute crises that comes from joblessness. On the contrary controlling the evolution of prices should be a much more gradual process that convinces financial entities that, whatever happens today, the value of long money is protected.

From a slightly nerdier prospective, the suboptimality of a recession occurs because liquidity constrains the equation of marginal cost and benefit. The suboptimality of inflation occurs because uncertainty drives a wedge between marginal cost and benefit. Setting the modal response towards over tightening combined with spikes of easing provides slack when constraints bind while keeping expected values in the target range.

Why NFP is even worse than it seems

You probably know the BLS job creation estimate was negative for the first time in four years. In my on going debate* with Barry I maintain that there is nothing fishy about the way the BLS uses its Birth Death model. The error comes from the fact that the Births and Deaths are estimated by looking at how the model performed last year. When times are changing fast the BLS model is likely to miss that. It under estimated the strength of the labor market when job creation turned around in late 2002 and it is overestimating job creation now.

As I thought the June / July numbers wererevised downward. I wouldn't be surprised if July was revised downward again and if the August estimate dipped even further in coming months.

Upshot no conspiracy, no willful misreporting, but a very week labor market.



*Debate in the sense that Barry graciously takes time off from being a super blogger-pundit to answer my objections.

What's So Special about U6

Barry Ritholtz repeats the popular line that "real unemployment" is much higher than headline unemployment.

U6 is indeed higher than U3. The problem is that value in unemployment stats comes from comparing different points in time and throughout time U6 has always been higher than U3.

When one says, if the "real unemployment rate" was 4.6 the labor market would be tight, you are using your familiarity with U3 to call 4.6 a tight market. Even in the heyday of the late 90s U6 was above 7%. If U6 was 4.6 today the FED would be talking about moving the funds rate upwards 50+ basis points per meeting.

The BLS has data on U6 going back to 1994. The gap between U6 and U3 is procyclical and as one might expect lower now than the average of the last 12 years and only slightly above the roaring 90s.

US Leads

In a new productivity study (still searching for the study itself) reported by MSNBC and the Associated Press.

The US comes out on top in total production per worker and second in hourly productivity. Norway edges us in part because of oil revenues.

I have long been concerned about productivity statistics. Typically my attitude towards statistics is that they are ultimately just the mathematical product of several measurements and should be treated as such, no more, no less.

However, productivity is a bit different. It is the closest a statistic comes to answering our most important question: How effective is an economy in allowing people to achieve the most goals in our fundamentally limited time on earth.

Production per hour is important because hours are the stuff of life. The fewer we have to spend toiling to survive the more we have to devote to whatever makes surviving worthwhile.

So what about hourly productivity. Well one problem is that it doesn't count people who want to work but can't find a job. In particular we could raise our productivity just by forcing less productive workers out of the market. This theoretical possibility wouldn't be important if it weren't for the fact some popular policies do exactly that.

Expanding unions and raising the minimum wage can both raise hourly productivity, but they do so by forcing out the weaker members of the workforce. This doesn't seem like the type of activity we want to capture.

Yet, simply averaging in the unemployed isn't right either. After all, they are likely unemployed because they are less productive. Simply slotting them into the denominator would suggest that they are just as productive as the average working member of society.

So at this point I am at loss for the "right" statistic on such an important matter.

The Diversity Paradox?

An Article in the Boston Globe highlights Robert Putnam’s research on diversity. The take home message is that diversity seems to lower social capital, yet increase creativity and possibly economic growth. This is labeled a diversity paradox.

However, it seems to me that there is no paradox at all, at least with respect to creativity. Diversity increases creativity because it lowers social capital.


A sketch of a model:

There are two levels of social goods: global and local.

Finding a cure for cancer is a global social good; building a children's center is a local social good.

People are compensated for the production of social goods through status.

Each ethnicity has a different preference ordering over local social goods.

In a mulit-ethnic community there are fewer people who prefer any one social good. Therefore, the status return is lower to producing local socials goods. The status return to global social goods is constant everywhere.

When communities become more diverse people substitute the production of local social goods for global social goods.

That is, it is more difficult to become famous and loved by all for being a civic leader so I tend to invest more time in becoming famous and loved by all through some national level accomplishment.

This might suggest that diversity itself is a public good but I am not sure. That is, it could be that homogenous communities are piggy-backing off of the global social goods produced by diverse communities.

Hat-tip Mankiw

Losses II

Losses 0.9 Beta.

Something like this is probably going out.

What's Next

The start from what I am working on now




A Contribution to the Theory of IQ and Economic Growth


This paper takes Garett Jones seriously. Forty years after Robert Solow’s classic article suggested that long run growth depends on increases in total factor productivity Jones and Schneider (2006) proclaim:

stylized facts related to IQ and productivity are ready and waiting for the theorist who seeks to explain a large part of the puzzle of cross-country productivity differences. Accordingly, persistent difference in national average IQ—regardless of their source—may play an important role in answering Prescott’s (1998) call for a theory of total factor productivity

In a series of papers Jones, twice with Schneider argues, that

1) IQ is one of, if not the most powerful predictor of economic growth

2) IQ is a proxy for and indeed may be the primary source of otherwise unobserved worker heterogeneity

3) IQ correlates heavily with a tendency towards cooperation

4) The effect of IQ is more powerful at the macroeconomic level than the microeconomic level

5) The effect of IQ on growth rates is persistent and likely associated with higher growth rates rather than higher steady states

6) The importance of IQ on economic growth has been increasing since at least the mid twentieth century

7) At least in a naive sense the growth does not appear to cause changes in IQ

My goal below is to provide a theory consistent with these facts.

Nice work if you can get it . . .

The jobs report disappointed today at 92K vs. a consensus 130K. I believe this number is likely to be revised downward in the coming months because of the birth-death adjustment.

Each month the BLS has to estimate how many jobs were created in new companies and destroyed when old companies went out of business. The way it does this is by looking at how far its count was off a year ago.

That is, if last year the BLS counted 150K new jobs in July but then, after all new companies were firmly established, they went back and counted 170K new jobs they say that the birth-death adjustment needs to be 20K higher. In other words, last time they guessed 20K too few so this time they will add 20K to their baseline guess.

Here is the problem. Last time the housing market was surging and all sorts of upstart companies were coming on to cash in. Fly-by-night organizations that support builders, suppliers, etc.

Clearly those extra jobs aren't being created now and so the BLS is likely to be overly optimistic. By how much, I don't know. If there was a reliable way of fixing this problem then the BLS would use it. However, there is not and so we are left to readjust on our own.

Bottom line . . . job growth is slowing.

UPDATE: Commentors on Ritholz report that the Birth-Death adjustment for July is 26K new jobs. Typically, we find that around 50K are lost from companies' Birth/Death in July as kids get ready to go back to school, housing sales slow, etc. However, this time we got an estimated 26K created from Birth/Death. I strongly expect that to be revised downward.

Fertility and the IQ of Nations

We have long known that economic growth was associated with decreasing family size. It appears the increases in IQ may also be associated with decreases in family size. The myriad of ways in which this trivariate correlation could be explained are tantalizing but for now I will leave you with the data itself.



P.S.

I can't help but mentioned that if low IQ caused larger families then we would expect IQs to decline over time. In fact they have been doing the opposite. What I wouldn't give for good measures of Chinese IQ before the 1-child policy.

Do Smart Guys Tell Better Jokes?

In the wake of the recent blog brouhaha over IQ and the Wealth of Nations I have been thinking about the general connection between intelligence and income.

My interpretation is that many people find it natural to conclude that IQ causes macroeconomic growth because IQ appears to cause microeconomic success. High IQ people are richer people, on average.

While I am sure that many smart people are quick to assert that their intelligence is what got them where they are, are we so sure? Height is correlated with individual success. I willing to bet height is also correlated with economic growth. And, we know that there is a height “Flynn effect.” That is, people have been getting taller over time. Do we think height causes growth?

The height correlation is usually settled by noting that height is a general sign of health and fitness, thus the correlation with macroeconomic growth, and therefore tall people are more likely to be chosen as spouses of successful people. Rich men and women have a greater choice in spouse and they tend to choose taller ones. Therefore, height and the genetic or cultural traits that produce wealth are commingled.

Could the same thing be true with IQ? That is, are smarter people more likely to be chosen as spouses to the rich and powerful? Now one possibility is that intelligence is just out and out attractive. Some people may agree with that conjecture.

Another, however, is that intelligent people are more likely to land a successful spouse because they are more clever at the dating game. My pet theory is that the human brain evolved through sexual selection. It’s just too big and mostly useless to have come about any other way. Looking at the monstrous and dangerous thing sitting a top most people’s shoulders one cannot help but be reminded of the Irish Elk.

It wasn’t so much that we impressed each other with our big brains, but that those brains busied themselves with devious plots to ensnare the objects of our affections. Most of us are aware of the modal thought among men and I would reason a guess that the modal thought among women is the dissection of the thoughts and intentions of men.

It seems possible then that IQ may simply be commingled with the attributes that produce success. My guess is that those attributes have more to do with perspiration than inspiration.