The Daily Cow

In decentralized markets, public goods are under-provisioned because the private benefit to any individual of pursuing action is lower than its corresponding social benefit. There are instances with inverse dynamics: Companies that extract small fractions of money (substitute for anything valuable, like time) from each individual, which collectively amounts to a large sum when spread over millions of individuals. Subsets of the affected individuals do not have the necessary incentives to fight, and therefore such policies remain.

The world is full of examples of such abuses:

• Agricultural companies with large amounts of clout can lobby Congress to increase import tariffs on sugar or dole out more subsidies. The combined effects of the import tariff and agricultural subsidies make high fructose corn syrup competitive with cane sugar (although it is a less efficient source of sugar). Individuals end up paying a dollar more per box of sugar, which is not a tragedy for any individual. But collectively sugar buyers are paying a significant surplus beyond a competitive equilibrium directly to domestic producers, not to mention through taxes to fund subsidies
• AT&T recently started enforcing its tethering rules with its customers. Unhappy customers are encouraged to "vote with their dollars," but where and how? Competitors are not much better, and the flight of a single customer is not going to make a difference.
• A Congressperson from a certain state obtains funding for a pet project in his home state that will increase welfare by a fifth of the cost of the project (but that's OK for him, because the costs are borne by other states!)

What remedies are there to this problem? For one, the threat of class action lawsuits have some effect on dissuading some, but only in cases of legal wrongs. Even then, the benefit for the plaintiff (and his lawyers) is lower than the costs of the incumbent system.

Other remedies are impractical in our system: The problem is with the nature of politics to favor groups. Asking Senators to stop picking favorites is hard. A solution would require structural changes to our legislative body so that no individual has an incentive to favor his own region at the expense of the nation.

One could presumably require members of Congress to prove that a proposal will cost the country less than it benefits it (taking into account all externalities), but how can we rely on the very members of Congress to honestly assess anothers' proposals on that merit?

What solutions do you have?

It's been a while since my last post here. This semester has kept me fairly busy, with the combination of projects, case competitions, job interviews, among other activities. All of them were fairly routine, except for finding the right full time job. But before we get there, let's step back a bit to get some perspective.

It wasn't always this way. In fact, just before summer I was certain that, after graduation, I would continue my education to get my MS in EECS (through the 5-year program) while simultaneously completing the MoT program. It sounded ambitious, promising and rational, and had the potential to open up a whole world of opportunities. I would get to take many of the graduate level CS courses I could not take in my undergraduate years and I would get to take some MBA courses that typically cost tens of thousands.

In the end, I would come out of school boasting a shiny resume flashing various, diverse skills and experiences, with the breadth necessary to build and cross bridges, and the depth necessary to excel in technology. I would conduct interesting research, spearhead incredible discoveries and spread my name through publications. I would be one step ahead of my peers who came out of college with just a BS, presumably because I would know "more".

My experience this summer shattered those ambitions--in a good way. I had never thought that I would learn so much while working. My project was self-contained, ambitious, required me to explore the whole stack, and potentially very useful. My coworkers (especially my mentor Brian) were very supportive, and I learned a lot from them. It made me think of what it is about school that I do learn from--and I realized that much of my learning happens out of the classroom.

I learn through working on projects (like those from my programming languages course), through tackling difficult problem sets (like those from my randomized algorithms course), and through working with other people (case competitions). But school is structured to be easy and straightforward. There are few opportunities to try something radical, see it fail, backtrack, and try again. You follow a script in school. You write the script out in the world, where I have the same learning opportunities (projects, difficult problems and interaction).

Of course, that begs the question: Why not do research through a PhD program? Why work? I tackled this question early on in college, and decided that I would like to work on projects that have immediate, real-life applications. The social advertising space is still being carved out; so is the space for location based services. In academia time is measured in years. In industry it is measured in months. You can't afford to wait because someone else will have established themselves. The excitement of the industry is fueled by the ticking clock.

So that is the story of why I have decided to forgo more years of school in favor of joining the workforce. Some days I still wonder whether that's the right decision for me--whether I will always be one step behind someone who stayed for his MS, or whether I will always be a step ahead of him.

My next post will focus on my decision regarding where I begin my full time career, including what opportunities I pursued and ultimately why I chose Facebook over the alternative options.

There is reason for advanced economies to have entitlements. However, the size of those entitlements should not rise out of the potential for the current generation to pay them. Unfortunately, that's exactly what will happen in the near future--starting now. Medicare, social security (etc) are starting to become underfunded, and by 2020 will consume our entire government (100% of tax revenues at current rates). In fact, that day of reckoning may arrive faster with medical and health care costs skyrocketing.

The solution for a predictable entitlement-to-revenue ratio is to define retirement age dynamically--as the age such that the labor participation rate is constant (Something like 60%). By adjusting retirement age to keep the participation rate constant, and by capping per-capita payment growth to either the inflation rate or the fraction of per-capita GDP, the outflows for children (i.e. education) and retired people (social security) will be predictably constant. No more will the cost of entitlements spiral out of control.

As the general population ages, and as life expectancy rises, this will allow the more prosperous generation to work longer and be retired earlier (as a fraction of life span). It is not fair to pass the burden of your longer retirement onto your descendants; if you're retired for longer, you must work for longer (in aggregate).

Without some quick action, as Thomas Friedman said today in the NYT, what is happening in Greece and London is just a harbinger for what will happen in the United States as our demographics change to reflect an increasingly older population.

The run-up in commodity prices prior to the onset of the current recession was strongly driven by the quick appreciation of the Yuan during that time. The 21% appreciation in the Yuan effectively made commodities--oil, metals, the basic needs of an exploding industrial economy--relatively cheaper for China. That in conjunction with rising incomes caused one of the most dramatic climb in demand for those commodities.

During the recession, that climb paused as China paused its currency's appreciation and the global financial crisis sapped demand. However, as the world emerges from the current recession, demand will roar back to its previous levels. As a consequence, commodity prices will resume their rapid ascent.

In response to the resumption in growth globally, China will allow its currency to appreciate again, further pushing up demand, and hence prices, for commodities. It is clear that demand for ever-scarcer resources will not cease rising. Sharp rises in commodity prices will only push up the price level in industrial economies, especially those that have generously minted money to cope with the recession. Lower-income workers, especially those that depend on commodity-intensive industries (construction, energy, transportation, etc) will be hit the hardest by the double-whammy of the rise in costs of business, and the subsequent erosion of their purchasing power.

But the rise in commodity prices--like the sharp rise in the price of oil in early 2008--is not the only force pushing inflation. A rise in the cost of imports, which (again) the lower-income workers depend on, will lower the effective living standards. Not only will imports from China be more expensive, but also those from Malaysia, India, even goods produced domestically. China's neighbors will undoubtedly let their currencies follow the Yuan as their fears of loss of competitiveness to China are mitigated. American producers, realizing that competition is less intense (higher import costs), will certainly raise prices to exploit the opportunity.

Clearly, America's susceptibility to forces outside of its control demonstrate its loss of competitiveness. Potential consequences of changes in foreign demand for commodities and changes in exchange rates highlight its willful dependence on volatile inputs. America needs to demonstrate it has the political will to cope with the changing world.

Otherwise, rapid inflation is imminent. The trillions of dollars printed during the recession won't help.

Here is an excerpt from a superb article by Paul Krugman, highlighting the hypocrisy and misinformation of the critics:

What you hear from conservative opponents of a climate-change policy, however, is that any attempt to limit emissions would be economically devastating. The Heritage Foundation, for one, responded to Budget Office estimates on Waxman-Markey with a broadside titled, “C.B.O. Grossly Underestimates Costs of Cap and Trade.” The real effects, the foundation said, would be ruinous for families and job creation.

This reaction — this extreme pessimism about the economy’s ability to live with cap and trade — is very much at odds with typical conservative rhetoric. After all, modern conservatives express a deep, almost mystical confidence in the effectiveness of market incentives — Ronald Reagan liked to talk about the “magic of the marketplace.” They believe that the capitalist system can deal with all kinds of limitations, that technology, say, can easily overcome any constraints on growth posed by limited reserves of oil or other natural resources. And yet now they submit that this same private sector is utterly incapable of coping with a limit on overall emissions, even though such a cap would, from the private sector’s point of view, operate very much like a limited supply of a resource, like land. Why don’t they believe that the dynamism of capitalism will spur it to find ways to make do in a world of reduced carbon emissions? Why do they think the marketplace loses its magic as soon as market incentives are invoked in favor of conservation?

Clearly, conservatives abandon all faith in the ability of markets to cope with climate-change policy because they don’t want government intervention. Their stated pessimism about the cost of climate policy is essentially a political ploy rather than a reasoned economic judgment. The giveaway is the strong tendency of conservative opponents of cap and trade to argue in bad faith. That Heritage Foundation broadside accuses the Congressional Budget Office of making elementary logical errors, but if you actually read the office’s report, it’s clear that the foundation is willfully misreading it. Conservative politicians have been even more shameless. The National Republican Congressional Committee, for example, issued multiple press releases specifically citing a study from M.I.T. as the basis for a claim that cap and trade would cost $3,100 per household, despite repeated attempts by the study’s authors to get out the word that the actual number was only about a quarter as much.

A number of people and groups (President Obama, then members of Congress, and now the World Bank) have pressured the People's Bank to let the exchange rate move relative to the dollar, some more angry than others. If they had any knowledge of Chinese culture and history, they would realize that these calls are counterproductive.

The bankers in China realize that the exchange rate needs to change by the end of this year. However, they continue to assert that they will keep the Yuan-to-Dollar rate stable for four reasons, some more public than others:

1. They want to keep away speculators. If they gave any signal that their exchange-rate policy were to change, immediately a lot of hot money will begin flowing in, pushing the exchange rate further, and causing the central bank to lose some control over the exchange rate. By signaling that they're keeping the exchange rate fixed (and by reaffirming that statement in the face of strong opposition to make it believable), foreign investors have less incentives to flood the Chinese market. Here, they have a conundrum--a weak and gradual revaluation will invite speculators, and an one-time revaluation will strongly hit domestic producers (especially those that export), giving them no time to adjust.
2. They are running huge deficits with manufacturing countries like Germany and Japan. This is a sign that it's the US's fault for not producing goods or services that China demands, as opposed to Germany and Japan. The US simply does not export goods or services that appeal to Chinese businesses and consumers, and it isn't up to China to remedy that.
3. They don't want their dollar-denominated assets to depreciate (too fast). They have the largest foreign currency reserves, a large portion in dollar assets like Treasury bills. If they let the dollar depreciate against the Yuan, they will have to take the world's biggest capital loss. In fact, due to the Yuan's 18% appreciation from 2006-8, at redemption value (in Yuan), their two-trillion-dollar investments in the US have lost 18% of their value (~400b dollars, or 3T Yuan). They don't like how the US Treasury invited them to buy the US bonds, then turned around and instructed them to revalue their currency.
4. But as a matter of policy (with the goal of stabilizing the economy), the exchange rate will have to change. Yet, the push by western legislators will be anything but productive. China doesn't like reacting to foreign demands; it makes it look weak, appeasing, and reminds it of its history of submission to western powers in the past two centuries (Recall the Opium wars--Buy our opium! You wont? OK, we'll beat you to submission). China has iterated many times: "We will not bow our heads to foreign powers." It will not act in a way to give that impression. Reacting now to foreign pressure to revalue the currency will be exactly that sort. The most productive pressure will thus be private meetings wherein economics experts convince China that a stronger currency will be good for them in the long run.

China has let its currency appreciate in the past--starting the summer of 2006--as a part of its economic policy. The goal was to stifle the growth of asset bubbles and inflation. However, when the inflationary pressure disappeared in the summer of 2008, they stopped the appreciation. Instead, they turned to fiscal policy (a package whose total is a whopping 15% of their GDP) to support the world economy.

Now that the global financial crisis is over, and inflation is rising again, China will let its currency rise this year, but not as a result of foreign pressure. The best action for China is to assure President Obama privately that the Yuan will start appreciating before summer, at 5% a year for at least four years, but not because of foreign pressure. In the mean time, China should slowly unwind its positions in dollar assets before they depreciate any further--enough to get out of major positions, but not quickly enough to startle the markets.

In the long run, an appreciation of 20% in the Yuan-to-Dollar exchange rate will have negligible effects on the Yuan with respect to other currencies. China will move up the terms-of-trade scale, and other currencies (Japanese Yen and the Euro) will continue to be strong because of Japan and Germany. The Dollar's decline is only a sign of America's loss of competitiveness.

The currency problem is not one where the People's Bank has good options. Either way, it will lead to a massive capital loss; and it will have to balance employment and inflation (and pissing off trading partners), yet ward off speculators. Hopefully western legislators' lack of understanding of China does not lead to a trade war--that would benefit nobody.

In the previous article, I briefly laid out the case for a jobless recovery in the short run. However, despite the immediate pain, it has positive long-term consequences.

• The federal government has more time to fix the entitlements issue with regards to the boomers. Their accumulated skills and experience are necessary in the workplace, and with last year's market decline, they have a stronger incentive to work--and pay taxes--than retire--and draw entitlement funds.
• Greater investment in capital will allow us to achieve the same level of production using fewer people, or equivalently, more production using the same number of people.
• The above, combined with our lessened propensity to consume, will help lower (or perhaps altogether eliminate) the trade imbalance (net exports)
• The savings rate going back to a more normal level will help investments in future growth

Perhaps the US will be in a less unsustainable path of unbridled consumption after this transformation.

There are three key reasons why this recovery will be fairly jobless in the short run:

• Aggregate demand is below the normal level because of increased propensity to save and the permanent rise in energy costs (Oil likely won't return to pre-Katrina levels)
• The workforce is above the normal level because of the recently-devastated retirement accounts of the boomers; they have to work a few more years to compensate for the lost retirement value
• Companies are increasingly turning towards technology and automation as the way to increase margins and profits. Capital investment is long-lasting and should provide them with increased capacity (at any given labor employment level).

The increased capacity due to both a larger workforce and capital expenditures, combined with lower aggregate demand for the final products will lead to a near-term squeeze on employment and wages. For the inflation hawks, this means wage-pressure inflation still has a long way to go before becoming an issue.

Before we worry about how many people go to bed hungry in the world, we must tackle an even more damaging yet easy-to-fix problem--how many people are simply malnourished.

It costs less than a dollar to fortify an entire ton of rice with essential nutrients like calcium, many metals (like iron), and vitamins, whether by genetically engineering them to be more nutritious or by artificially mixing them in. Yet, for that dollar, it produces at least a ten-fold (estimated 17x) return within that year in terms of boosted productivity--not to mention the higher standard of living, better health, and clearer mind. The social dividend from this minor investment will be on a scale magnitudes more significant than the global iodizing of salt.

So why don't developing nations invest in such a project? It has three options:

1. Pay for it: Distribute fortification materials to farmers, or expand the ambitions of agriculture research labs, and distribute engineered seeds. For the few hundreds of millions of dollars spent annually, more than that will be earned back in increased productivity (captured in taxes), better health (captured in lower health costs and higher happiness), and political points (for the democracies). This is the preferred option
2. Force it: By law, all rice has to be fortified. This has enforcement issues. Since farmers aren't paid to do it, they have no incentive to pay to do it themselves.
3. Hope for external help: This isn't exactly a complete option--but hope for help from an agency like the IMF or WFP--and simply deal with enforcement

Each idea has issues with centralization, because farmers aren't as concentrated as salt-producers, but if implemented correctly, will provide tangible returns ad infinitum. So why not give it a try?

Let's start with China and India.

The popular attack of government-backed enterprises is that it encourages inefficiency and takes the enterprise's focus off of profit. Is that true?

In the cases where the corporation must have other social agenda (promoting social welfare as a general goal), government backing definitely encourages that. Now, they have a large financier for any social task that is conducive to the government's goals, whatever they may be (Think: Samsung and Korea).

In other cases, is that attack true? Think back to the bailout days when banks left and right got money (but with strings) from the treasury. In response, the companies clamored to climb back to profitability in order to pay back the treasury and drop any suggestions that they were acting against the interests of the taxpayer.

And just now, after GM is 60% nationalized (Yup, we own 60% of GM now), it announces that it "cannot afford business as usual," implying that it could prior to nationalization.

Clearly, it is not always the case that having government backing for some enterprises or industries is the worse way of organizing economic activity, and in many cases it is the better way--for industries that have significant national impact or cannot sustain themselves.

Samsung could not have achieved a fifth of Korea's entire GDP and a third of its trade volume without the backing of the South Korean government. Given the facts, America should reexamine its fears of national industries, say, starting with health, insurance, and energy.