Economics/Finance

Via Robert Farley“Scott Lemieux”:http://lefarkins.blogspot.com/2008/02/economics-writers-should-understand.html, I see that “noted economist”:http://marcambinder.theatlantic.com/archives/2007/08/dont_panic_megan_mcardle_is_he.php Megan McArdle “is arguing”:http://meganmcardle.theatlantic.com/archives/2008/02/tax_me_more_fund_raises_little.php that the fact that Virginians haven’t voluntarily contributed to a fund increasing government revenues implies that people don’t want higher taxes. [click to continue…]

There’s a long-standing urban legend about where you meet an attractive person in a bar, they buy you a drink, and the next thing you know you wake up in a bath of ice with a pain in your lower back and a note telling you to get to a hospital. One of the reasons this story is just a story is that in order to usefully extract someone’s kidney for transplant, a whole lot of stuff has to be organized beforehand, and you need to have a lot of skilled people working together against a hard time constraint — too many, really, to quietly and reliably pull something like this off.

On the other hand:

Mr. Mohammed was the last of about 500 Indians whose kidneys were removed by a team of doctors running an illegal transplant operation, supplying kidneys to rich Indians and foreigners, police officials said. A few hours after his operation last Thursday, the police raided the clinic and moved him to a government hospital. … Many of the donors were day laborers, like Mr. Mohammed, picked up from the streets with the offer of work, driven to a well-equipped private clinic, and duped or forced at gunpoint to undergo operations. Others were bicycle rickshaw drivers and impoverished farmers who were persuaded to sell their organs, which is illegal in India.

Although several kidney rings have been exposed in India in recent years, the police said the scale of this one was unprecedented. Four doctors, five nurses, 20 paramedics, three private hospitals, 10 pathology clinics and five diagnostic centers were involved, Mohinder Lal, the police officer in charge of the investigation, said. “We suspect around 400 or 500 kidney transplants were done by these doctors over the last nine years,” said Mr. Lal, the Gurgaon police commissioner.

I’d be interested to see how many suppliers were straightforwardly lied to about what they were getting into, or otherwise forced to undergo operations, and how many were offered money first (and paid afterwards). Unlike some other documented cases of organ sales, this seems less like an illegal but functioning market and more like a criminal racket founded on fraud.

The news that over a million homes went into foreclosure in the US in 2007, affecting about 1 per cent of all households or around 3 million people, supports the view that foreclosure has taken over from bankruptcy as the primary mode of financial catastrophe.

As with bankruptcy, however, the high frequency of financial distress is partly offset by the fact that US law and standard contractual arrangements are more debtor-friendly than in other countries. Compared to those in other places (at least in Australia) US mortgage contracts have commonly favored borrowers in two important ways. First, they have been fixed rate contracts with no, or limited penalties, for early repayment. That means that borrowers can stick with their fixed rate if market rates rise, but can refinance at lower cost if market rates fall.

Second, most mortgages are non-recourse, meaning that the lender can take the house but cannot recover the debt from the borrowers income or other assets. That means that once the value of the house falls below the amount owing (equity becomes negative) the borrower can walk away from the house and the debt. As Felix Salmon notes, the difficulty of pursuing deficiency payments means that most loans are non-recourse in practice even if the contract says otherwise

In the jargon of financial assets, the standard contract gives borrowers both a put option on the house (the ability to walk away) and a call option on the debt (the ability to pay early). Both of these make the contract more valuable to borrowers and less valuable to lenders. There’s quite a good discussion of all this from Tanta at Calculated Risk, though the author makes heavy weather of the put option and seems to me to be unreasonably exercised about the fact that households are now treating their debts to banks with the same calculating attitude that corporations have long shown to their workers and other creditors, paying them if it is profitable to do so and defaulting otherwise.
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note: I originally wrote this for the Dani Rodrik seminar. As it grew, though, it became apparent that it didn’t really have much to do with “One Economics, Many Recipes” and that it was thus a bit unfair to ask Dani to comment on it. On the other hand, I liked it too much to kill it altogether – dd

“One Economics, Many Recipes” makes a lot of useful and constructive suggestions about how to attack the central problems of economic development. However I don’t think it gives enough emphasis (fundamentally because I don’t think it’s possible to give enough emphasis) to international debt as a constraint on development. Nearly all of the success stories in the book relate to countries which started their periods of development without a large debt burden, and the presence or absence of large net external debt is certainly one characteristic which matches up well to the motivating stylised fact in the book – the distinction between those countries like Argentina which followed all the standard policy recommendations but didn’t develop and those like China which ignored them and did. In this essay, I’ll try and flesh out a few provocative views on the financial aspects of development policy, which in my view are just as important real-world constraints as the institutional real-economy factors that are the main subject matter of the book.

Actually, just as I don’t think it’s sensible to carry out international comparisons of crime rates without taking demographics and urbanisation into account, I don’t think that any kind of comparative analysis of developing economies can be carried out at all without conditioning on the debt burden. It’s that important. When you have a situation in which a country’s capital account is dominated by contractual flows payable in foreign exchange, that is far and away the most important fact about that country’s economy. This is because as long as the debt service constraint is binding (and I discuss what happens when it isn’t, below), then unless the country is receiving massive net transfers from abroad, the entire economic development program is going to end up being twisted toward a capital account constraint which almost certainly has nothing to do with a sensible locally-based development plan of the kind that Dani advocates.
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The decision of the US Federal Reserve to cut interest rates by 0.75 per cent is as clear a sign of panic on the part of the monetary authorities as we’ve seen since the 1987 stock market crash. It’s not entirely coincidental that it followed a dreadful week on Wall Street, and a couple of awful days on world stock markets while the US was closed for the long weekend.

Still, stock markets have fluctuated quite a bit in the last 20 years without producing this kind of reaction. The really alarming events have been happening in bond markets and, in retrospect, the most alarming happened just over a month ago.*

That’s when Standard and Poors cut the credit rating of ACA Financial Guaranty Corp from A (strong investment grade) to CCC (just about the worst kind of junk) in one move. This event showed the weakness of two of the most important defences against the kind of credit derivative meltdown that market bears have been worrying about for years.

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The “BBC reports”:http://news.bbc.co.uk/1/hi/health/7186007.stm that a change may be in the offing in Britain’s policies on cadaveric organ donation:

Gordon Brown says he wants a national debate on whether to change the system of organ donation. He believes thousands of lives would be saved if everyone was automatically placed on the donor register. It would mean that, unless people opted out of the register or family members objected, hospitals would be allowed to use their organs for transplants. But some critics say the state should not automatically decide what happens to people’s bodies after they die. Currently there are more than 8,000 people waiting for organ transplants in the UK – a figure which rises by about 8% a year. Writing in the Sunday Telegraph newspaper, the prime minister said a system of “presumed consent” could make a huge difference. … The system already operates in several other European countries and has boosted the number of organs available for transplant.

My view is that Gordon Brown is wrong, but not for the reasons you might think.

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The Economist Blog joins in the handwringing over the Theil piece that Henry linked to the other day.

bq. I often fantasise about how much nicer the world might be if more people grasped a few rudimentary principles about they workings of the social world. So I took this Foreign Policy article by Stefan Theil on the sorry state of economics education in Germany and France pretty hard. I desperately hope it’s not really this bad … Why does this matter? Because ideas matter … We rightly deplore the politicisation of the curriculum when it comes to “intelligent design” crackpottery. We should deplore politicised psuedoscience all the more when it so directly threatens the material well-being of a country’s people. If this is all as Mr Theil says it is, then the Germans and French really ought to be ashamed by the failure of their educational system to teach anything remotely approximating decent social science.

Given the sorry state of their economics, it’s amazing the French even manage to have an economy at all. And presumably it is by sheer chance that products of their disastrous education system often end up tenured in leading American economics departments, and write textbooks used to teach economics to Americans. I’m reminded of the concluding paragraph of this JPE paper by La Porta et al, which asked whether the relatively weaker protections of investors and creditors in civil-law countries like France, as opposed to the stronger protections in places like the U.S., had adverse consequences for corporate governance and economic growth. And, indeed, they found some of the predicted effects. On the other hand:

bq. Taken together, this evidence describes a link from the legal system to economic development. It is important to remember, however, that while the shortcomings of investor protection described in this paper appear to have adverse consequences for financial development and growth, they are unlikely to be an insurmountable bottleneck. France and Belgium, after all, are both very rich countries.

A dollar is not very much money. A billion dollars is a lot of money. Twenty billion dollars is an awful lot of money.

For most people reading this (though not for Bill Gates or for the billion or so people living on a US dollar a day or less), these statements should seem pretty obvious.

But all of these can be (and have been used as) different ways of measuring the same thing. If every Australian receives, or pays, a dollar a week, the total amount is very close to a billion dollars a year. And if you have a cash flow of a billion dollars a year, and your interest rate is 5 per cent, the present value of that cash flow (the amount of extra wealth you would need to generate the flow) is twenty billion dollars.

It’s easy to stretch this gap even further. A dollar a week is about fourteen cents a day. And, if we looked at the US (about 300 million people), or the entire developed world (around a billion people, depending on your definition), the total would be that much larger. Fourteen cents a day for everyone in the developed world has a present value of one trillion dollars.

The fact that the same flow of money can be presented in such radically different ways, and that each of them is appropriate in certain contexts, is one reason public policy debates get confused.

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A terrific paper by Matthew Smith, Michael McPherson and Sandy Baum called “Financial Independence and Age: Distributive Justice in the Case of Adult Education” (pdf) is at the Equality Exchange. Currently, American colleges consider students over the age of 24 to be financially independent of their parents for financial aid purposes, and the paper argues that this rule has regressive consequences, showing that it unfairly favours students in advantaged circumstances. They argue for replacing the ‘age condition” with a ‘minimum income’ condition. It’s a great model of applied philosophy, demonstrating complete command of the (labyrinthine) institutional details in the US context (well, with these authors anything less would be disappointing) and making a compelling normative case for a modest, but valuable, reform.

A lot of discussion of climate change is based on the implicit or explicit premise that, since we use energy in everything we do, and most energy is derived from carbon-based fuels, large reductions in CO2 emissions will require radical changes in the way we live. Some people welcome this prospect, but most do not.

Having looked at this problem in various different ways, I’m convinced that this premise is wrong, and that quite modest changes, many of which would follow more or less directly from the imposition of a suitable cost on CO2 emissions, could achieve large reductions in emissions. I’ve argued this at the macro level, based on demand elasticity estimates, and also at the micro level in terms of road transport. I thought it might be a good idea to attempt more micro estimates and, as I was visiting Cairns last week[1], my thoughts naturally turned to long-distance tourism.

So, this is hoped to be the first in a series where I consider the question: Could we reduce emissions in a given sector of the economy by 75 per cent in a way that wouldn’t substantially change the services delivered by that sector?

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A rich post over at Scatterplot.

bq. I spent a lot of those years exhausted and angry. We continued to have only part-time child care. Some nights I put the children to bed crying because I knew they were better off crying alone in bed than interacting with an angry sleep-deprived mother. I was furious that I had to make constrained choices and could not have the life I wanted. When he was home, my spouse was “superdad,” who did a lot of the work and played a lot with the children, so there was a big hole when he was gone. He was aware of how much he did when he was around, but not of what it was like when he was not around. I wanted him to confront the consequences of the work-home choice he was making and feel just as bad as I did. In retrospect, I probably should have used more paid child care and household help, as the children would probably have been better off with a saner mother, but I did not want to concede defeat to the constraints in my life. I preferred feeling angry to adjusting.

I haven’t said “Read the whole thing” in a while. This one’s worth it.

Dennis Perrin, who I’ve just realised is the same bloke as the Dennis Perrin I used to have really nasty flamewars with on a mailing list five years ago, has a post up which, among other things, mentions a bumper sticker he recently saw which read:

“As Hillary, Nancy and Jennifer Rise In Stature, They Give New Meaning To The Phrase Ho Ho Ho!”

Well it got me thinking. Quite a number of points, below. I tried, but failed, to keep the footnotes under control this time.
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Here’s some information for fans of “the capability approach”:http://www.capabilityapproach.com/Briefings.php: the “Dutch Environmental Assessment Agency”:http://www.mnp.nl/en/index.html released “a report”:http://www.mnp.nl/en/publications/2007/Sustainablequalityoflife.html that I co-wrote on how to conceptualise the quality of life for national policy purposes in affluent countries – we argue for a capability metric and are rather critical of the happiness metrics. I should add, though, that the proof is in the eating of the pudding, and we don’t have any funding to collect the necessary data that a capabilities-based index of the quality of life would require; our work remains at the conceptual level only. It may well turn out that we would need a very long questionnaire in order to collect all data, which in turn might jeopardize the viability of a capability-index of quality of life (since the non-response-rate would be higher). And there are more problems to solve before we would arrive at a capability index, certainly one as (relatively) easy to measure as either GDP per capita or happiness indicators. Anyway, if anyone has more money and more time and thinks this is a fun project to pursue, let me know what comes out of it.

The NY Times has an interesting piece on statistical studies of the deterrent effect (if any) of the death penalty. For those who want to get straight into fact-free debate, the bottom line is that the evidence is too weak to allow a firm conclusion one way or the other. What’s interesting to me, though is the way in which debates within different disciplines proceed, and the lags in transmission between them. Here I think the NYT story, while excellent in many respects, is quite misleading, presenting a story of deterrence-hypothesis economists facing off against legal critics.

That was pretty much the way things stood in the 1970s, after the publication of Isaac Ehrlich’s study in the American Economic Review claiming that one execution deterred 7 or 8 homicides. Ehrlich used multiple regression analysis (quite difficult and computationally demanding in those days, and correspondingly highly regarded) in an attempt to control for other factors affecting homicide rates and isolate the effect of the death penalty.

Over the next decade, economists learned a lot about the limitations of regression analysis. With limited amounts of data, it’s impossible to avoid mining the data for patterns which are then used to fit the model. And if you try enough specifications on weak data, you can get just about any result you want. A classic exposition of this point was Ed Leamer’s 1983 article “Let’s take the con out of econometrics” which pointed out the fragility of regression analysis on time-series data and picked, as an example, the deterrent effect of the death penalty.
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