Paul Krugman has a piece on oil. This is as good a time as any to put up a long post I’ve been working on about oil and whether it’s finally going to run short, points on which I broadly agree with Krugman.
From the category archives:
Economics/Finance
It’s already 1 May in Australia, so I get to make what will no doubt be the first of many posts on the significance of the day.
First, and still the most important in the long historical view is the holiday (a public holiday here in Queensland) celebrating the achievements of the labour movement.
Second, there’s the admission of ten new members to the EU. As far as the historical significance of this event goes, I’m waiting to see whether Turkey is admitted to accession negotiations later in the year.
Thirdly, and of most immediate interest, the anniversary of Bush declaration of victory looks as good a time as any to date what seems increasingly certain to be a defeat [at least for the policies pursued for the past year, and for the objective of a stable, pro-American Iraq]. Of course, this judgement may turn out to be as premature as was Bush’s statement a year ago, but the decline in the US position has been almost as rapid as the collapse of Saddam’s regime, and the events of the last few days have seen the process accelerating.
The Google IPO has now been announced, and there are some more figures to analyze. In addition, I wanted to talk a bit about the option, suggested by one of the commenters on Kevin Drum’s blog of arbitraging by short-selling overpriced dotcoms and buying those with more reasonable valuations. Finally, I wanted to look at what all this means for capital markets and therefore for capitalism.
I thoroughly recommend this article in the New York Times. While I have no particular opinions on the management of the Maine state pension fund (well, if you really needed one, I daresay I could get some for you cheap rate), it’s a nice and clear explanation of an interesting little part of an issue that I’ve always thought the plain man should be more interested in than he in fact is.
I’m working on a piece on the Iowa Electronic Markets in my copious spare time at the moment. Just as a warm-up, here’s a few questions for finance mavens.
1. In the 1996 Presidential vote-share market, after the candidates have been nominated and adopted, what should the sum of the values of the CL|DOLE(Clinton vote share given Dole as opponent) plus V.DOLE (Dole vote share) contracts be?
2. What percentage return would you have made in the 2000 winner-takes-all market by buying the BUSH contract at the point when DEM was at its peak and holding to maturity?
3. You hold a porfolio in the current 2004 Presidential vote-share market long BU|KERR but short BU|CLINT. If George Bush were to announce tomorrow that he had decided to withdraw from the race, what would be your profit or loss?
Answers below the fold. Historical price and prospectus data available on the IEM website.
Back in December I wrote:
“[…] the proposed “Policy Analysis Market” (which claims on its website that it’s going to launch in March; sadly there is no currently existing futures market which allows me to bet that it won’t)
Historical note; it didn’t.
BTW, for those who care about that sort of thing, while we’ve expressed plenty of scepticism over the marginal value of election betting numbers in the past, they are probably no worse than polling numbers and available with greater frequency. Bush is currently more or less holding steady on IEM, but weakening on Tradesports. Note that these two figures are not directly comparable, as the IEM contract is for vote share while the Tradesports one is “winner take all”.
As many bloggers have noted over the years, one of the weaknesses of modern journalism is that in a political campaign journalists feel compelled to try and present an even-handed picture when evaluating the claims made by the leading candidates, even when one side is exaggerating while the other side is simply making things up. This “CNN/Money”:http://money.cnn.com/2004/04/12/news/economy/election_incomes/index.htm?cnn=yes article is a classic of the genre.
Forbes is the latest magazine trying to capitalize on the blogging thing by holding a “best blog competition”:http://www.forbes.com/personaltech/2003/04/14/bestblogslander.html across various categories. It’s interesting to note that no less than “53%”:http://forums.prospero.com/n/mb/viewpoll.asp?webtag=fdcbiz&tid=187&lgnF=y&dlink=1&vote=6&submit=%A0Vote+%3E%3E%A0 of voters say that the best blog on the economy is “none of the above” (no other entry gets more than 11%). I imagine that the glaring absence of a certain Berkeley economics professor from the shortlist helps explain this rather peculiar outcome … (via “The Decembrist”:http://markschmitt.typepad.com/decembrist/2004/03/is_this_one_of_.html)
The idea that the war in Iraq is a necessary part of the struggle against terrorism is probably the biggest single factor in the case supporting the war. Both political leaders and pro-war bloggers have made repeated claims that the overthrow of Saddam Hussein constitutes progress in the “War against Terror”. A variety of arguments in support of this view have been proposed, most notably the ‘flypaper’ or ‘bring ’em on’ theory that, by encouraging terrorists to fight in Iraq, the war made the rest of the world a safer place.
The most widely reported opinion poll in Australia is the Newspoll, which provides results for Rupert Murdoch’s News Limited papers (he has about half the Australian market). There was widespread discussion recently about a Newspoll showing that 65 per cent of people thought the war in Iraq had increased the danger of a terrorist attack in Australia[1],
However, the really striking result was ignored. This concerned the proportion of people who accepted the claim, made repeatedly by the government here, that the invasion of Iraq substantially reduced the danger of terrorist attack. Only 1 per cent of respondents said that the invasion had made a terrorist attack “less likely”. The view that the war made an attack “a lot less likely” got an asterisk (less than 0.5 per cent). You can read the details here (PDF file).
Markets versus Politics – The Real Choice: … Too often policy arguments proceed as follows: A) politics “fails” because it does not produce the theoretically optimal result, therefore B) market processes are necessary. But B does not follow from A. The failure of government to produce an optimal result does not ensure that market processes will do a better job. From a social democratic perspective – or any perspective that is inherently suspicious of privatization – the burden should be on those advocating market processes to explain why the marketplace can be expected to produce a better result than the political process. In such an inquiry, the theoretical virtues of a basic equilibrium model of perfect competition are no more relevant than Pigouvian theories of government intervention. Both are blackboard abstractions that often have little bearing on what occurs in the real world. What matters is how privatization — and make no mistake, the subordination of political decisions to the marketplace is always political — is likely to affect the status quo ante, and whether the consequences of such intervention (and the attendant rent-seeking, transaction costs, etc.) constitute an improvement in the real world.
The introduction of market mechanisms into politics may be well intentioned, but that does not make it any more likely to generate positive results. Indeed, insofar as noble intentions leave the likely consequences of such interventions unexamined, such policies may make us all worse off.
(see “here”:http://volokh.com/2004_03_21_volokh_archive.html#108022995813874684 for original).
One of the justifications I make for the time I spend blogging is that it gives me a chance to try out arguments I use in my work. With that in mind, I’d very much appreciate comments on this short summary of the role of ideas and interests in explaining policy outcomes.
Brad de Long correctly summarises the argument of my papers with Simon Grant. If you accept that the equity premium (the large and unexplained difference between the rate of return expected by holders of private equity and the rate of interest on low-risk bonds) is explained in large measure by the fact that capital markets do not do a good job in allocating and spreading risk, the the natural solution to all this is the S-World: Socialism: public ownership of the means of production This is because risk can be more effectively through the tax system, and through governments’ capacity to run deficits during economic downturns than through private capital markets. A very robust implication of the observed equity premium is that a dollar of investment returns received during a recession is worth two dollars during a boom – this provides governments with a huge arbitrage opportunity.
Brad DeLong has had a string of posts referring to the possibility that some or all of the US Social Security fund should be invested in stocks rather than, as at present, in US Treasury bonds, of which the most pertinent is this one. This idea first came up in a major way in Clinton’s 1999 State of the Union speech, and has since had some play on the Republican side, especially now that privatization individual accounts seem to be off the agenda.
The key fact that makes the idea attractive is the equity premium, the fact that, historically the rate of return to investment in stocks has been well above that in bonds. This used to be explained by the fact that stocks were riskier than bonds. But ever since the work of Mehra and Prescott in the 1980s it’s been known that no simple and plausible model of the social cost of risk that would be generated by efficient capital markets can explain more than a small fraction of the observed premium. The immediate response, that of finding more complicated, but still plausible models hasn’t gone very far. The alternative explanation is that capital markets don’t do a very good job of spreading risk. For example it’s very hard to get insurance against recession-induced unemployment or business failure, even though standard models imply that this should be available.
Simon Grant and I have done a fair bit of work on this, with some specific attention to the Social Security issue. In this paper (large PDF file), published in the American Economic Review, we argued that substantial gains could be realized by investing Social Security funds in the stock market. We didn’t put a number on it, but I don’t find Brad’s half-embraced suggestion of $2.4 trillion in present value implausible.
An important point, though, is that investing in stocks will generally not be the best way to go, at least if the amount invested is large. A government agency holding, say 20 per cent of the shares in Ford and General Motors, would seem to have big problems. Leaving aside the specific institutional issues of the US Social Security fund, the obvious implication of the equity premium is that, unless there are large differences in operating efficiency between private and public enterprises, government ownership of large capital-intensive enterprises like utilities will be socially beneficial. The case is strengthened if monopoly or other problems mean that the enterprises have to be tightly regulated in any case. Again, Simon Grant and I have written this up, this time in Economica (PDF version available here)
My post a week or so ago considering (and ultimately rejecting) the hypothesis that the 2004 election might be a good one for the Democrats to lose raised plenty of eyebrows, but the ensuing debate helped to sharpen up my thinking on the underlying issue, that of the unsustainability of current US fiscal policy and the appropriate Democrat response.
In the original post drew the conclusion that the only campaign strategy that would give a Democrat, once elected, any real chance of prevailing over a Republican congress, was that (supported by Dean, Gephardt, Kucinich and Sharpton) of repealing the entire Bush tax cut and starting from scratch. To the extent that primary voters considered this issue, they didn’t see it this way. With the possible exception of Lieberman, Kerry was the candidate most supportive of the tax cuts.
Like Bush, Kerry promises to cut the deficit in half over four years. He proposes to scrap the cuts for those earning more than $200 000, but to expand them for ‘middle-class families’, a group normally taken to include about 95 per cent of the population[1]. When other spending proposals are taken into account, the Tax Policy Center (a joint venture of the Urban Institute and Brookings Institution) estimates that Kerry’s proposals will yield a net increase in the deficit of $165 billion over four years , or $40 billion a year. (Of course, Bush will almost certainly spend more once the unbudgeted costs of higher defense spending and even more tax cuts are factored in). As I show below, this is relative to a baseline of around $550 billion.
I think it’s safe to say this won’t happen. The problem for Kerry, then, is when to discover the deficit. There are three basic options:
fn1. It’s evidence of the startling lopsidedness of the Bush tax cuts, and the explosion of income inequality over the past two decades, that there is, nonetheless, a substantial revenue gain from repealing the cuts for the rich and ultra-rich. About half the benefits of the Bush tax cuts go to those on incomes over $200 000 per year.
Update: Brad de Long points to Kerry’s appointment of Roger Altman as his budget priorities advise as evidence that Kerry will choose Option 1. Kevin Drum is underwhelmed. He supports Option 2 and expects Option 3, or worse.
“Tim Dunlop”:http://www.roadtosurfdom.com/surfdomarchives/002045.php tells us about another signal contribution to the “David Bernstein school”:http://www.matthewyglesias.com/archives/002568.html of revealed preference theory.
bq. It’s hard to take Keith Windschuttle seriously when he says things like this, apparently without irony:
bq. “In other words, since the ’60s the great majority of Aboriginal people have voted with their feet in favour of integration with white Australia.”
bq. Same way I used to vote with my fork and eat my Brussels sprouts when told I couldn’t eat anything else for the night if I didn’t.
(minor corrections and reformatting of original)