Tuesday, March 25, 2014

Guest Post at Carola Binder's on The Second Machine Age

My thanks to Carola, Berkeley economics PhD student and excellent blogger. The post tackles one of the biggest issues of the day, Will the explosion in computer/robot/machine ability result in mass unemployment this time, even though previous technological revolutions haven't? I make use of insights from MIT professors Brynjolfsson and McAfee's important new book, as well as their first book on this subject, Race with the Machine.

Sunday, March 16, 2014

It's not just growth, it's also absolute level

Paul Krugman writes today:
Some people seem to think that something like Spain’s slight recovery this year — the best estimates now are that it may grow 1.5 percent — are as big a failure for the critics of austerity as the kind of thing I show above is a failure of the finance canon. But lots of stuff can cause the economy to grow a percentage point or two more or less than your forecast.
I'll add that also current absolute level, of course, matters, not just growth. If your economy gratuitously shrinks by 15% over four years because you chose austerity, then it grows 1.5%, it's still at least 13.5% smaller than it was, and could have been. Especially with an unemployment rate of 25%, that's a horror, not reason to claim victory and vindication.

If, as an investor, you lose 90% of your family's life savings, then you get a 1.5% return, do you say, Yea! See my strategy was right! Or do you say that if I had followed a smart strategy I'd be at 110% of where I started, not at 10.15% of where I started -- and claiming victory and vindication. 

Sunday, March 2, 2014

Private student loans, so important, so often unmentioned

Cornell professor of government Suzanne Mettler has a great New York Times article on the horror of for-profit colleges. I urge everyone to read it. These predators do tremendous harm to our young and our country, and of course they should at least be severely regulated. In fact, the problem may be so profound, the asymmetric and poor information so bad, and they may be so hard and expensive to regulate, that it may be best to require all colleges to be (true) non-profits or government. But want I want to focus on in this post is another problem that's also very important, and rarely noted, the private student loans heavily used by these companies.

This is the big flaw in Mettler's otherwise excellent article. She writes, "Nearly all of their students take out loans to attend, and the amounts are staggering.", but never notes the crucial point that these student loans are much more likely to be private than with government colleges. This is just enormously important. And sadly almost everyone misses this, a tragic flaw of our system, and of a very dominant paradigm of writing that overly stresses smoothness, brevity, and simplicity over accuracy, non-misleading, and not leaving out very or crucially important detail and specificity.

Because of the 2005 BAPCPA bankruptcy law private student loans are never escapable in bankruptcy, with extremely rare exception -- something like you now have full body paralysis. And these loans are usually for large amounts, often at very high interest rates. I've heard as high as 19%, where due to the awesome power of compound interest at a high rate, debt grows 5.7 fold every decade! 

These unsuspecting young people are at serious risk of being made into lifetime indentured servants with no escape ever (other than trying as best they can to avoid wage garnishment and seizing of any substantial assets they will ever achieve in life by things like moving to one of the states that restricts this the most). This is their reward for doing the right thing, trying to improve their education and skills to become more productive citizens. Yet the Republican response is good! More prey for the plutocrats to feed off of!

Federal government student loans, by contrast, are a completely different story. They also cannot be escaped in bankruptcy, but they have powerful income based repayment and loan forgiveness protections that make them completely safe, in fact one of the safest major loans in history. For example, the vast majority of federal student loans today qualify for a program called Pay-as-you-Earn. Under this program the most your payments can ever be is 10% of your family's discretionary income (which is usually much less than total income). And it's very progressive, so it's usually much less than 10%, and can easily be zero. Yet after 20 years of payments (including when the payment drops to zero), no matter how much you still might owe, the balance is 100% forgiven. And there are programs even much better than that if the student takes a job that's defined as "public service". For more, see this article I did with the help of student loan expert, advocate, and attorney Heather Jarvis.

So it's huge that with for-profit schools the loans are much more private, and this – and the reasons why it's important – should always be noted, but rarely are.

Sunday, February 9, 2014

What else advances "one funeral at a time"?

The title refers to a quote by the great physicist Max Planck, "Science advances one funeral at a time."

I've been very interested in this quote for a long time, especially with regard to economics. But recently I've come upon and thought about some other important relevant areas.

I'm currently reading "The Second Machine Age", by MIT business economist Erik Brynjolfsson and MIT computer scientist Andrew McAfee. This is their second book on the crucial subject of revolutionary computer/robot/machine capability, which is only just beginning. I'm especially interested in this subject due to my primary career in personal finance. It puts already hard to get job and income security at even potentially much greater risk in the future. So as a good personal finance expert and teacher, it's very important that I learn as much as possible about this issue, and how people can defend against it. Especially young people where there's still plenty of time and energy to gain the needed education and skills, and as well parents, so they know the important education and skills to promote in their children.

That said, something recently really startled me on page 102. The authors talk about how electrification so profoundly increased productivity. It was the second great GPT (General Purpose Technology) after the steam engine. Yet, initially it did little for productivity, not until factory managers started to design factories for electrical rather than steam power. Electricity had the advantage that machines could be spread out and arranged in a horizontal, assembly line, pattern, as opposed to steam, where machines had to be placed close to the large central engine, both horizontally and vertically (on floors above and below the engine). The difference was profound, and revolutionized industrial productivity.

The quote that struck me was this:
Only after thirty years -- long enough for the original managers to retire and be replaced by a new generation -- did factory layouts change.
And then there's this from Paul Krugman today
It goes beyond what I said about second-order journalism; Rosen argues that there’s a value system at work, where being in the know about political maneuvering is considered all-important, whereas understanding the actual policy issue is for the drones.
This shows the incredible value of the Ezra's and Chait's and Krugman's. But will we have to wait for the old generation of editors and publishers to die off before a new journalism based on substance, expertise, and non-misleading (as opposed to "Balance") can really take over?

So this problem Max Planck alludes to appears to apply widely. There seems to be a significant danger of an entrenched and powerful older generation enforcing their status quo and refusing to allow or admit a new and better paradigm, despite strong evidence for it. The reasons? There are probably many. The older generation may not have the time or energy anymore to learn a new paradigm, so they certainly can be hurt by the old paradigm that they are top experts in, losing value. This can hurt badly both prestige and paycheck. And, people can become intellectually inflexible with age. It's something we have to watch out for and fight.

Moreover, older people are more risk averse and less idealistic than the young, making them less amenable to switching to a new paradigm. The positive externalites from trying a new paradigm can be enormous to the world -- and over generations -- as opposed to the benefits to just a lone individual over just one lifetime, which is not so long anymore for the grayhaired. These externalities clearly may not be anywhere close to fully considered. And the risks to the world and future generations are massively diversified and pooled compared to the risks to a lone individual of moving to a new paradigm

But whatever the reasons, we don't want to have to wait for the funerals, or retirements. That's a horrible gratuitous cost to the generation waiting, and to future generations that will always be behind where they could have been had we not waited so long to move forward. I'm hopeful that the internet and the digital revolution will greatly speed positive evidence-based change, and they seem to be. But we all should be vigilant about this problem and willing to fight it, including in ourselves as we get older.

Sunday, February 2, 2014

Important points that are rarely made on income inequality statistics

There are some very important points here that aren't really being made, or very rarely, in the media, and politics and economics blogosphere.

1) The statistics you almost always see are per household, not per adult, or earner. For some of these quintiles, deciles, etc. you see a slight gain – over 30 or 40 years – but it’s per household, not per worker. To make only slightly more over a generation or more, and then it's only with now both spouses having to work to get it! This should always be talked about. It makes it much worse. You know how much more stressful it is to have to work long hours at work and then have to go home and work long hours on housework, cooking, and all these other things, because now both spouses are working. You know how much time and effort it takes to manage a household and raise children in this day and age, and now you no longer have one spouse who can devote all of his or her time and energy to it. And on top of that, parents are now substantially older, and so have less energy, yet far more total work – all for almost no increase in household income.

In addition, your expenses are much higher with both spouses working, higher transportation costs, higher eating out and services costs due to lack of time, and so on. This alone can more than eliminate any small gain over a generation or two.

Of course, probably most women want to have a career, but it's different to work a job because you want to, than because you have to, and then to only make about the same household money a family was making a generation ago without that income, so you have little or no extra money to hire someone to take up all of the housework that you now can't do when you're at your job.

2) It's not just average income, at all. It's the variance, the riskiness, of income – In finance, you hear non-stop about the risk-average return tradeoff, but when we talk about income inequality over time, it's typically only the average, never the riskiness. But this is such a big part of it. Families are so much more at risk today of unemployment and ruin. A point Harvard bankruptcy and financial distress expert Elizabeth Warren made so well is that in the early 1970's the typical family's basic fixed "must-have" expenses were only about 50% of their after-tax income, and with just one earner. Today it's about 75% with two earners, so just a 25% loss can send them over the edge (see this Senate testimony, especially page nine). And with two earners, the odds of a job loss are, at a first cut, twice as high.

The long evidence and argument for the huge increase in financial riskiness is in Yale political scientist Jacob Hacker's "The Great Risk Shift", Warren's "The Two Income Trap", and the forthcoming, "Chasing the American Dream: Understanding What Shapes Our Fortunes", by a group of accomplished sociologists. For a brief summary of the last book, see this New York Times column by one of the authors.

It's so much not just the average. It's also the risk. And this is just almost never said when income inequality statistics are stated or discussed.

3) So much less of the income of families' is available. First, a far bigger portion of it must be spent on education – and this is really largely a cost of business, a production input, not income. Families a generation ago used to be able to consume this money. Today, often $15,000/year or more is going to pre-school or day care for the kids that wasn't in 1974. And then there's all of the educational products and assistance, and I won't even get into the skyrocketed college costs, where college wasn't at all the necessity it is today. Take that out of the income and then tell me families in the lower -tiles have had a slight gain. Next, of course, medical is much more expensive. Obviously the care is more advanced, but still that takes away your day-to-day money, and adds to the financial stress. Control for that too, and then let's see how families are doing – an amazing 40 years later, when they should be doing far better with the power of compound growth, and given how amazingly the top earners have grown. I'll add one more, that I mentioned briefly above: Because both spouses are now working, often for very little more household income than 40 years ago, there's no one full time at home to cook and do housework, so now they have a much higher expense of eating out and prepared food. And transportation and other business costs are much higher to support two working spouses – Control for that too, and again, then tell me there was a slight gain in lower –tile households.

4) Historic income inequality brings all sorts of positional externalities and expenditure cascades of great cost, pushing families into much more expensive items than before, for often little or no intrinsic utility gain per item. And this has to be done on a household income that has gone up little, if at all, over more than a generation for the lower –tiles.

These really do seem to me to be very important points that I rarely if ever hear, and it looks very misleading to me to leave them out.

Thursday, January 23, 2014

Wonkblog and Wall Street: Awesome Externalities, Positive and Negative

The New Yorker's John Cassidy talks about how keeping Ezra Klein might not have made sense profit-wise for the Washington Post.  He does some back of the envelope calculations to estimate the revenues from Wonkblog:
"That translates into revenues of a hundred thousand dollars per month, or $1.2 million a year."
Many of these Wall Street Guys make that in less than a day. This shows you the incredible positive externalities of good journalism, and negative externalities of much of finance.

Saturday, December 21, 2013

Surveys showing massive ignorance and inexpertise, why no reply from the freshwater and others?

During the recent brouhahas over microfoundations I've been citing in comments surveys on finance expertise, numeracy, and government showing extreme ignorance and inexpertise, and yet these comments are ignored by Stephen Williamson, and even non-freshwater economists. Of course, you could say it's ignored because it's me, but I have been lucky enough to engage in a lot of conversation with bloggers like Williamson, Noah, Nick Rowe, and Simon Wren Lewis. So I suspect it may be more than this.

First, what are some of the surveys I've been citing:

Consider these microfoundations from Chicago economist Richard Thayler:
• Suppose you had $100 in a savings account and the interest rate was 2 percent a year. After five years, how much do you think you would have if you left the money to grow? More than $102, exactly $102 or less than $102? 
• Imagine that the interest rate on your savings account was 1 percent a year and that inflation was 2 percent. After one year, would you be able to buy more than, the same as or less than you could today with the money? 
• Do you think this statement is true or false: “Buying a single company stock usually provides a safer return than a stock mutual fund”? 
Anyone with even a basic understanding of compound interest, inflation and diversification should know that the answers to these questions are “more than,” “less than” and “false.” Yet in a survey of Americans over age 50 conducted by the economists Annamaria Lusardi of George Washington University and Olivia S. Mitchell of the Wharton School of the University of Pennsylvania, only a third could answer all three questions correctly.
And these:
From a Center for Economic and Financial Literacy survey: 
"1 in 3 people didn't know how much money a person would be spending on gifts if they spent 1% of their $50,000/year salary." 
"65% of people answered incorrectly when asked how many reindeer would remain if Santa had to lay off 25% of his eight reindeer."
– Personal Finance for Dummies, 7th edition, 2012, page 9
Now, if your models assume that people (the micro units) have perfect public information, and prefect expertise to utilize that information to always find the perfectly optimal strategy (with zero time and effort cost), then I don't think it's unreasonable or stupid to ask how might the real world macroeconomic results differ given the enormous evidence of widespread high levels of ignorance and inexpertise among the people. Why do you think that nonetheless the qualitative results will be the same – or even just about exactly the same?

Yet when I ask about this I'm always ignored, and not just by freshwater economists like Williamson, but by any economists, like it's beneath them to consider something as unfancy as straightforward surveys and tests, where there's no plausible reason for people to lie and make themselves look stupider [1].

Honestly, I think to a significant extent economists are scared to cite simple surveys and tests showing massive ignorance and inexpertise as reasons for why the results of freshwater models are very different from reality. This information is just not fancy enough. They're already going out on a limb questioning the awesome looking math that controls the journals and macro departments. To now cite something so pedestrian as straightforward surveys and test, that's just too scary. If you're going to question those claiming that mantle of high science, with so much power to punish and reward, you want to at least use something fancy sounding, like some Harvard evolutionary theory, or some lab experiments done by a Nobel Prize winner.

But from what I've seen, just pure massive and widespread ignorance and inexpertise seems like a stronger factor in explaining the macroeconomy. I can admit it because I'm on the outside; I'm a businessman and adjunct professor of personal finance, but if I were on the inside in academic economics, where you can be severely punished or rewarded based on how "scientific" you sound, I'd be scared too, even though the best definition of science is logical; logic fully linked from your assumptions to your conclusions – including conclusions from the model to reality, not just conclusions within the model and then we can throw logic out the window when making conclusions from the model to reality. And in making conclusions from the model to reality you will need more assumptions to attach your logic to, but hopefully those assumptions will be relatively mild. Some will, of course, be necessary; what we see actually exists,..., but hopefully nothing too bold.

As I always say, a model is only as good as its interpretation. The interpretation to reality is the most important part of the model to get right, and the right interpretation is usually substantially different from literal. 

The logic for this evidence of massive ignorance and inexpertise mattering, given what I know, is very strong. It should definitely be asked about – and answered. 

______________________________
[1] I must note that in reality it's not at all stupid to have little expertise and knowledge about finance, economics and government. People are terribly busy today with work hours so high, both spouses working, no stay at home spouse to manage the home and children full time, and much greater demands from child rearing today. Of course with their tiny free time they're not going to want to study finance, economics, and government. 

You can be as smart as Einstein, but if you don't have the time to learn, you won't. Einstein actually said, "The hardest thing in the world to understand is the income tax." He had the intelligence, obviously, but he was a little busy with his physics job.