Young Economics.

Posts Tagged ‘Economics

Where economics and beer appreciation intersect

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What happens when drunks play the ultimatum game?


Written by Alex

September 19, 2009 at 9:38 am

NBER Treasure Trove

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This post could well be called “The blog is dead!  Long live the blog!” since the blog has not been very active in recent weeks.  Now that we are all settled into our new lives as non-students, though, hopefully the blog will enjoy a renaissance.

The purpose of this post is just to express my satisfaction with the latest NBER announcement I received in my inbox a few days ago.  They really outdid themselves this time.  The set of new working papers includes no less than eight papers with abstracts that were interesting enough to make me click on them.

Obviously I can’t write about all of them, so I will just list them.  I think some of them will be of interest to one or two of our myriad of readers.

Written by Alex

September 15, 2009 at 3:02 pm

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Rational Choice and Addiction

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Here is an interesting interview with psychologist Gene Heyman, who argues that drug addiction is a matter of choice and not of illness.  His reading of the epidemiological literature on addiction suggests that there is a lot of economics underlying the issue.

I began looking at the epidemiological data. . . .  A huge percentage of people who had at some point met the criteria for lifetime substance dependence no longer did so by the time they were in their 30s. It varied from 60 to 80 per cent.

. . .

It’s this problem we have with the idea that individuals can voluntarily do themselves harm. It just doesn’t make sense to us. Why wouldn’t you stop?

. . .

60 to 70 per cent of the time, [addicts who end up in rehab clinics and get studied] have additional psychiatric disorders. And those disorders interfere with their capacity to engage in activities that would compete with the drugs—jobs, family, other activities. So the people the clinicians see, and the people the researchers study, are those who keep using drugs and don’t stop right into their 40s. That’s maybe 15 to 20 per cent of [addicts], and they have greatly skewed our picture of the natural history of addiction.

. . .

[W]hen people are choosing the drug, they’re thinking that moment, or that particular day, would be better if they did. A chronic smoker will think that the next three minutes would be better with a cigarette than without. But after a year of smoking 20 cigarettes per day, adding up to 60 minutes each day, you might think, ‘I’d rather have the 60 minutes of not smoking each day.’ Unfortunately, you don’t choose 60 minutes at a time. You decide one cigarette—or three minutes—at a time, and that’s what makes this so difficult.

If Heyman is right, the choice to use drugs is the same as any other choice in a rational choice framework; it depends on the benefits and costs, including opportunity cost, now and in the discounted future.  Is a high intertemporal discount rate a psychological illness?

Note that Heyman’s point is not that addicts are weak and pathetic people.  The point is simply that addiction does not seem to exist outside of the usual framework of cost-benefit decision-making.

At the heart of the notion of behavioural disease is the idea of compulsivity, by which people mean it’s beyond the influence of reward, punishment, expectations, cultural values, personal values. Alan Leshner [the former head of the National Institute on Drug Abuse] says drug use starts off as voluntary and becomes involuntary. But the epidemiological evidence suggests otherwise.

. . .

That you’re making these choices one day at a time. What you’re choosing is to take heroin that day. You’re not choosing to have a miserable life. Eventually, you become stuck, though, where you don’t know what else to do but choose heroin each day, even though you wish it didn’t lead to a miserable life. You know, I’ve always thought it strange that people would think we should not have sympathy for those kinds of situations.

Written by Alex

May 26, 2009 at 4:08 pm

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Do you know Capitalism, or just judge it?

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One of the most important questions floating around these days is what the financial crisis implies for the future of Capitalism. What strikes me as odd is how little is understood about this term. It seems to have morphed into something that could mean the market, materialism, freedom or greed depending on who you ask. So what is it?

This is tough question, especially for those under 30, because Capitalism is basically life as you know it. You are born into a society up and running with a belief system firmly in place. As you grow you see the outcomes and feel the restraints of the system, but what isn’t immediately apparent is the idea behind it all. But that’s all Capitalism is. Not the outcomes or the implications, but the idea.

Unfortunately it’s an idea that’s hard to judge on one side or the other. It seems like those in tough spots seem to really dislike it while those doing well fully embrace it. Can we say whether it’s good or bad thing? In my opinion, we can’t. Many hold that history has proven capitalist societies are more successful in the long run, but that’s the past. Our setting has changed in a big way over the last little while. Corporatism has taken over the business world, monopolizing most of our R&D work. Globalization and trade have linked countries together, implying national choices are now felt beyond borders.

Another important question is whether the metrics that history makes judgements upon still have relevance today. We hold up economic growth as our measure of success, but with a blossoming population of 6 billion+ is this really the best thing to look at?  It seems odd that North American investors cheer on sales explosions in yoga wear while the developing world goes hungry.  There’s a disconnect here.  The world is beginning to talk up sustainability,  however economists still revile at the thought of stagnation. Do these words not mean the same thing, but looked at in different ways?

So I suppose this post is just big questions with no answers. Unfortunately, that sort of sums up where the world is today in terms of this debate.  However, to get anywhere I believe we all need to know what we’re actually thinking about, and that’s why I wrote this piece. The Financial Times has been running a series of articles on the future of Capitalism, and this one by Nobel Laureate Edmund Phelps is truly special (link). In it, he attempts to define the system and then goes on to map its run to where we are today. Here’s the excerpt (it’s long but good):

Capitalism is not the “free market” or laisser faire – a system of zero government “plus the constable”. Capitalist systems function less well without state protection of investors, lenders and companies against monopoly, deception and fraud. These systems may lack the requisite political support and cause social stresses without subsidies to stimulate inclusion of the less advantaged in society’s formal business economy. Last, a huge social insurance system, with resulting high taxes, low take-home pay and low wealth, may not hurt capitalism.

In essence, capitalist systems are a mechanism by which economies may generate growth in knowledge – with much uncertainty in the process, owing to the incompleteness of knowledge. Growth in knowledge leads to income growth and job satisfaction; uncertainty makes the economy prone to sudden swings – all phenomena noted by Marx in 1848. Understanding was slow to come, though.

Well into the 20th century, scholars viewed economic advances as resulting from commercial innovations enabled by the discoveries of scientists – discoveries that come from outside the economy and out of the blue. Why then did capitalist economies benefit more than others? Joseph Schumpeter’s early theory proposed that a capitalist economy is quicker to seize sudden opportunities and thus has higher productivity, thanks to capitalist culture: the zeal of capable entrepreneurs and diligence of expert bankers. But the idea of all-knowing bankers and unerring entrepreneurs is laughable. Scholars now find that most growth in knowledge is not science-driven. Schumpeterian ¬economics – Adam Smith plus sociology – captures very little.

Friedrich Hayek offered another view in the 1930s. Any modern economy, capitalist or state-run, is a great soup of private “know-how” dispersed among the specialised participants. No one, he said, not even a state agency, could amass all the knowledge that each participant “on the spot” inevitably acquires. The state would have no idea where to invest. Only capitalism solves this “knowledge problem”.

Later, Hayek fleshed out a theory of how capitalism makes “discoveries” on its own. He had no problem with the concept of an innovative idea, for he understood that, even among experts, knowledge is incomplete about most things not yet tried. So he felt free to suppose that, thanks to the specialised insights each acquires, a manager or employee may one day “imagine” (as Hayek’s hero, David Hume, would have put it) a commercial departure – one that could not be inferred or envisioned by people outside the individual’s line of work. Then he portrays a well-functioning capitalist system as a broad-based, bottom-up organism that gives diverse new ideas opportunities to compete for development and, with luck, adoption in the marketplace. That “discovery procedure” makes it far more innovative than the top-down systems of socialism or corporatism. The latter are too bureaucratic to learn about ideas from below and unlikely to obtain approval from all the social partners of the ideas that do get through.

Written by jk

April 18, 2009 at 6:39 am

The Changing Nature of Perception

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Here’s an article on the evolutionary nature of our economic system and understanding (link).

This type of thinking really fascinates me.  In general, each day we step out into the world with pre-formed beliefs and values that lead to our perceptions of truth and the actions we take.  But that night when you go to bed, you think about your experiences that day and process all the new things you’ve learned.   You re-evaluate how you see the world and yourself, and your idea of truth shifts.

It’s hard to see this happening on a day-to-day basis, but think back a few years.  Don’t you have a bunch of memories of behaving in a way that just seems so stupid now?  Don’t you wish you could go back and do it again knowing what you now know?

This is the essence of our species; we learn.  But this is also what makes predicting where we’re all heading that much harder.  When an economist comes out with an insightful explanation about how the world works, he’s celebrated for giving us a better understanding of what society is all about.  The only problem is everyone takes this new piece of information, processes it, and begins to behave differently than they did before.

Here’s a nice excerpt from the article:

The problem is that, no matter how “scientifically” these new beliefs were formulated, they are still false. Capitalism is, among other things, a struggle between individual people over the control of scarce resources. Like boxing and poker, it is a soft, restrained, private form of warfare.

Military strategists have known for centuries that there is, and can be, no final science of war. In a real struggle over things that actually matter, we must assume that we are up against thinking opponents, who may understand some things about us that we don’t know about ourselves. For example, if profit can be made by understanding the model behind a policy, as is surely the case with the models used by the United States Federal Reserve, sooner or later so much capital will seek that profit that the tail will begin to wag the dog, as has been happening lately.

The truth is that such models are most useful when they are little known or not universally believed. They progressively lose their predictive value as we all accept and begin to bet on them. But there can be no real predictive science for a system that may change its behavior if we publish a model of it.

Markets might once have been fairly efficient, before we had the theory of efficient markets. If investing is simply a matter of allocating money to an index, however, liquidity becomes the sole determinant of prices, and valuations go haywire. When a substantial fraction of market participants are simply buying the index, the market’s role in ensuring good corporate governance also disappears.

Written by jk

April 5, 2009 at 11:24 am

I grew up during the Great Moderation… (Part 1 of 3)

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I grew up during the great moderation, enrolled during the savings glut and will graduate into a historic financial crisis. If you’re around my age (22), the same goes for you. Unsure what these terms mean? Don’t worry, that’s what this series of posts is aimed to clear up. But to tempt you to keep reading, I will say that these are events and trends that will be written into history as the building blocks for wherever society goes in the 21st century. These have made up the backdrop of our lives for the past 25 years, and stepping back it’s easy to see how they’ve influenced me to make the decisions I have. It’s nice to believe we get to write our own history, but the last few months have made me realize how the directions we go seem to be partially laid out for us.

But enough of that for now, this post will present some facts and I’ll come back to the speculation in part 3. The following will spell out the idea of the Great Moderation. To begin, comments made by Ben Bernanke in 2004 (link)

“ One of the most striking features of the economic landscape over the past twenty years or so has been a substantial decline in macroeconomic volatility. In a recent article, Olivier Blanchard and John Simon (2001) documented that the variability of quarterly growth in real output (as measured by its standard deviation) has declined by half since the mid-1980s, while the variability of quarterly inflation has declined by about two thirds.1 Several writers on the topic have dubbed this remarkable decline in the variability of both output and inflation “the Great Moderation.”

So basically, the main idea is that economic life has been much more predictable during our lifetimes than ever before. What does this mean? On the effects, here’s a blurb from an excellent article I would recommend.(link)

“…as dull as it all may seem, the Great Moderation has been … consequential… It is surely the main reason that political volatility has declined in much of the West. … The economic implications are much larger. In the absence of wild swings in activity, businesses and households can plan much more easily. The most obvious benefit can be seen in interest rates. Longer-term rates … have what is called a “term premium”, an extra amount of interest that lenders require to protect them against the risks that big fluctuations in the economy and interest rates will undermine the value of their investment. But since those swings have been eliminated largely, interest rates can stay much lower.”

These effects map to three types of people in the economy: lenders, borrowers and consumers. The borrowers wake up in a world where the cost of accessing money is lower. It’s now easier to implement your business plan and build that factory.

Lenders wake up in a world that is much more predictable. They feel like their forecasts have more relevance and they don’t have to set so much money aside to guard against uncertainty. The amount of lending done on a fixed pool of deposits can expand to improve bottom lines.

Consumers wake up and notice the money they save doesn’t generate as much interest income. It doesn’t make as much sense to let their savings lie around listlessly. Thus they decide to use a larger proportion of their earnings to buy real goods.

Overall, this was a period favourable to business and enterprise. To date, no one has being able to offer a definitive answer to why our system smoothed itself out, although there are a few competing hypotheses. A few of the prominent ones are suggestions of better inventory management strategies, a fuller economic understanding of monetary policy effects, demographic trends (as the population ages, people become firmly rooted in their careers with fewer fluctuations in the labour market) and even a stipulation that it has all been good luck. But whichever way you choose to look at, this was a period that was very friendly to capitalist society, and those individuals involved with business, finance and the market.  The following is a graph of S&P 500 futures since 1984.

S&P 500 Futures

Written by jk

March 15, 2009 at 3:00 pm