Invertebrates and discount rates

Grandpa, when you were young, did you see the Houses of Parliament?

Of course. I walked past them all the time.

There’s a school trip there next week. We’re going to sail the boat over the top of Big Ben. That was where all the decisions were made before the Emergency Committee ran things, wasn’t it?

That’s right.

Grandpa... why didn’t people then do anything about global warming? Didn’t they realise what was going to happen? Did they get the science all wrong?

No, lots of people realised and we had a pretty good idea about the science. We knew just what we were doing. In fact, we worked it all out using advanced economics. We calculated exactly how much effort we should make to move to a low-carbon economy.

So why did London get submerged, and we have to build dykes in play hour? You must have made some big mistakes in your sums!

No, we got our sums right. You see, we used a formula where your happiness now was as valuable as half of our happiness back then. So, for example, one person getting Ebolaic Footrot then was as bad as two people getting Footrot now.*

You counted us as half as valuable as you?

That’s right. Don’t upset the worm bucket or we won’t have any dinner. It’s perfectly simple. We used a time discount rate of 1.5 per cent per year. So over 50 years, a unit of your future welfare worked out to about 0.985 to the power of 50 = about 0.46. A 50% discount.

But why shouldn’t I count just the same as you?

Well some people suggested that we use a 0% discount so that the future would count just as much as the past. But other people said* that because people didn’t care much about the future, it would be wrong for politicians to care about the future either. 

So how did you come up with a 1.5% discount rate?

We worked that out from the capital market.

The capital market?????!!!!!

Yes. To calculate the discount rate people used, we looked at capital market returns, because that’s where people’s rational behaviour reveals their true long-term preferences.

Wow. And when did you work all this out?

About at the time of the Great Financial Crisis.

(Pause.)

Well, let’s get back to Mother for dinner.

Grandpa, one day can we use the worms to catch fish?

Nonsense! Worm soup is good for you.**

* Ungated version here.

Why Nations Fail thoughts, part 5

A&R argue that economic growth under extractive institutions is unlikely to be permanent. This is also what North, Wallis and Weingast think, and it leads all these authors to be skeptical of China’s present growth spurt. A&R use the analogy of the Soviet Union, which also grew fast up until the 1970s before crashing. There may well be a slowdown, or even a political crisis, in China, but I don’t believe in the USSR analogy, for the following not-very-scientific reason. Visitors to Soviet bloc countries in the 1960s found them drab and depressing places: think shortages, rationing and queues, bad service, no consumer choice, crappy cars, unhelpful and corrupt officials.... Visitors to China in 2011 come back with very different impressions – not uniformly positive, but far from stagnation – fast trains, massive growth, a booming middle class. Even the problems, like the arrogance of the newly wealthy, arise from rapid change. 

My instincts are that the statistics are not the whole story; and that if politics fights economics in China, economics will win and the new bourgeoisie will replace the Communists with a more pliant executive committee, or even perhaps a system of teams which compete for office. In short, economic growth can throw up new assertive classes and generate its own political pressure. 

There are certainly places which do fit the idea of unsustainable growth (Pakistan, Venezuela) and here growth tends to be based on commodity prices or foreign aid rather than innovation. (By the way, innovation does not have to mean “being the next Apple”. There is also what Dani Rodrik calls “within-the-frontier innovation”, ie within the technological frontier, ie being the first firm in your province to sell bottled lemonade or littlepackets of shampoo.) China just looks different to these cases.

[That's enough of my incoherent thoughts on this very interesting book. Go and read it!]

Depressing graph of the day

Patent applications of UK residents, 2002-2011:

Patent applications, residents

Data from World Bank

(Of course there are alternative interpretations. Maybe UK firms are patenting in the US more. Or maybe the UK was just very active around the dot-com period.)

Why Nations Fail thoughts, part 4

[Don't worry, this series ends soon!]

What creates good political institutions? A&R answer: “critical junctures” in which “small differences become important”. Game theorists would call this transitions between different equilibria. In a sense this is not a very useful answer, because “small differences” is likely to mean “differences too small to detect a priori”. But it might be a true answer.

However there are some unconsidered candidates. For example, Gibbon thought that the Roman empire’s break-up was important because it created a set of competing states in Europe. In turn, competition between states limited their ability to extract rents and gave them incentives to innovate. (Historically, a lot of innovation has been driven by war.) This argument suggests a corrective to A&R’s praise of centralization as a necessary condition for the development of inclusive institutions.

Why Nations Fail thoughts, part 3

A&R's story has two dimensions: economic and political institutions. The economic institutions story is basically Adam Smith’s: “peace, easy taxes and a tolerable administration of justice” lead to economic growth. For most of the past two centuries, with some unfortunate exceptions, this has been the conventional wisdom. The question is how you get good economic institutions. Here they argue that good political institutions, which allow people to control their rulers, are important. This is the nub.

A&R don’t list any particular institutions as always inclusive. Is democracy inclusive? (This blog post of theirs offers some relevant thoughts.) It certainly allows people to control their rulers and a change to democracy is likely to generate large one-off gains as policies are altered to benefit the people, not the elite. However, the potential for extraction (transfer of money from the many to the few) persists, for two reasons.

First, many political systems have very limited competition. For example, first past the post systems are basically duopolies, because once two parties are ahead in the polls, it makes no sense to vote for a third party. On subjects where competing parties share interests they will soon agree not to offer the voters a choice.

Second, voters are rationally ignorant of policy, and therefore easily swayed by intellectual fads and media manipulation. (I think A&R's blog post claim, "[t]he available evidence doesn’t indicate that the uneducated masses are ignorant and irrational" is quite wrong, if by "uneducated masses" you mean voters, and by "ignorant and irrational" you mean ignorant and rational. There is a ton of evidence for rational ignorance.) This allows for a lot of extraction behind their backs.

Another dimension is long-run prudence. A monarch who will tax his people ruthlessly may also take care of their long-term well-being, because he will benefit from it. A democratic ruler may provide short-run benefits to people for fear of losing office. But because he may lose office, and expects only to be in power half the time or less in future, he may also have few incentives to do the right thing in the long run. This means that democracies may under-insure themselves against rare risks, and may accumulate long-term weaknesses and vulnerabilities.

Why Nations Fail thoughts, part 2

Here is an alternative explanation of the fall of the Roman empire:

“No doubt the imperial State created by the Julii and the Claudii was an admirable

machine, incomparably superior as a mere structure to the old republican State of the patrician families. But, by a curious coincidence, hardly had it reached full development when the social body began to decay.

Already in the times of the Antonines (IInd Century), the State overbears society with its anti-vital supremacy. Society begins to be enslaved, to be unable to live except in the service of the State. The whole of life is bureaucratised. What results? The bureaucratisation of life brings about its absolute decay in all orders. Wealth diminishes, births are few.... After the time of the Severi, the army has to be recruited from foreigners. Is the paradoxical, tragic process of Statism now realised? Society, that it may live better, creates the State as an instrument. Then the State gets the upper hand and society has to begin to live for the State. But for all that the State is still composed of the members of that society. But soon these do not suffice to support it, and it has to call in foreigners: first Dalmatians, then Germans. These foreigners take possession of the State, and the rest of society, the former populace, has to live as their slaves- slaves of people with whom they have nothing in common. This is what State intervention leads to: the people are converted into fuel to feed the mere machine which is the State. The skeleton eats up the flesh around it. The scaffolding becomes the owner and tenant of the house. ”

This story is superficially close to A&R’s. But the author blames the Roman state itself, not the way that state was used, for the decay of the Empire. An important point is that the centralized state which is the focus of A&R’s story is not actually a historical constant. For much of history, the state has simply lacked the capacity to impose its will directly, and has instead ruled through intermediaries, such as aristocracies. A&R tend to treat these forms under the rubric of “inadequate centralization”. That is not revealing: the feudal system is really not like modern Somalia.

Just before this bit, our author explains how states can decay:

“But the mass-man does in fact believe that he is the State, and he will tend more and more to set its machinery working on whatsoever pretext, to crush beneath it any creative minority which disturbs it- disturbs it in any order of things: in politics, in ideas, in industry.

The result of this tendency will be fatal. Spontaneous social action will be broken up over and over again by State intervention; no new seed will be able to fructify. Society will have to live for the State, man for the governmental machine. ... Such was the lamentable fate of ancient civilisation. ”

Again this is close to A&R: extractive political institutions foreclose innovation. But here the problem is the existence of the state machinery itself, not its control by a greedy minority at the top.

The author of the above is Ortega y Gasset and the book is The Revolt of theMasses, mentioned in a recent post on the Why Nations Fail blog. My curiosity was piqued and I got hold of a copy. It’s an excellent book – highly tendentious, sometimes very prescient, sometimes way wrong. It provides a nice complement to the A&R book. (Off-topic: don't only read new books! Otherwise you will be historically provincial. Old books are mind-expanding.)

Why Nations Fail, random thoughts, part 1

This is a brilliant book. Daron Acemoglu & James Robinson (henceforward A&R) set out to answer the question “why are some nations poor and others not?” As social science questions go, that is the Big One. And their answer is appealing and plausible: poverty is the fault of elites who set up economic and political institutions to extract money from the rest of us. The next few posts contain some of my not very well-organized thoughts.

A&R make their arguments by historical narrative, although underlying these, there are often academic papers that use the toolkit of modern econometrics. This is a great approach – a credible historical narrative is much more convincing than a bunch of cross-country regressions. And, looking far back into history is surely the correct thing to do. For to answer the question above, you must think both about contemporary variation (why are some nations poor now and others rich now) and about historical variation – why were all nations poor for most of recorded history, before the take-off into growth of Britain, then Europe, then the world in the past 3 centuries. 

These guys are not professional historians by training. This creates a bit of a trust problem. When I read their (very interesting) stories about Ethiopia, the French Revolution, Indonesia, etc. I wonder to myself how many specialist historians of the time and place would agree. Their narratives are plausible, but I can often imagine alternative stories.

One episode where I do know a little is the decline of the Roman empire. Here A&R’s story seems pretty unusual. They blame the end of the Roman republic for the decline of the empire, which collapsed four centuries later in the West and fourteen centuries later in the East. In fact much of the empire’s expansion happened under the emperors. They have no persuasive causal link between political institutions and the overtaxation which may have caused the decline of the Roman countryside in the third century. (Here’s a modern book which gives lots of detail, without losing track of the big picture.)

A poem from long ago

Here's a poem by Enoch Powell from between the wars:

In far Australia to sleep
You snuggle down; I here
Fancy that in your arms you keep
The world’s wide sphere –
This whole great multi-coloured All,
No larger than a playing-ball.
But if I move my lips to speak
Or try to touch your hand,
The coloured tissues with a shriek
To monstrous form expand,
And I apart from you am hurled
Across the endless, dreary world.

(I haven't been able to find the copyright holder -- Falcon Press, which originally published this, doesn't seem to exist. Get in touch if you are the copyright holder and wish to object.)

Bernanke speech

Ben Bernanke's thoughts about the subprime crisis.

"... Contemporaneous data indicated that the total quantity of subprime mortgages outstanding in 2007 was well less than $1 trillion; some more-recent accounts place the figure somewhat higher. In absolute terms, of course, the potential for losses on these loans was large--on the order of hundreds of billions of dollars. However, judged in relation to the size of global financial markets, aggregate exposures to subprime mortgages were quite modest. By way of comparison, it is not especially uncommon for one day's paper losses in global stock markets to exceed the losses on subprime mortgages suffered during the entire crisis, without obvious ill effect on market functioning or on the economy...."

I don't really like 38 degrees, but...

They kind of annoy me -- all those chummy emails from "Marie, Becky, Hannah, David, James, Cian..." seem more like astroturf than a real decentralized group. Plus, I think they are a bunch of knee-jerk Lefties. Nevertheless, they are where the petition is, so I can't really complain when they push an issue I care about.

Therefore, I urge you all to go and sign up to:
https://secure.38degrees.org.uk/stop-the-snooping-plan

Probably late on this meme

But...

Immigration politics with cape and mask

http://www.arabtimesonline.com/NewsDetails/tabid/96/smid/414/ArticleID/181499/reftab/73/t/Lucha-libre-pushing-immigrant-storyline/Default.aspx

"Then he points to the message painted on the backside of his red trunks: “SB1070” - a reference to Arizona's controversial immigration law. The crowd, some wearing masks of their favorite Mexican wrestlers, shrieks even louder...."

Musical interlude

A song from my old landlord:
http://www.macjams.com/song/72513

Immigration politics: two approaches

Immigration in Hong Kong and Shenzhen. Via MarginalRevolution.

Great essay on Republicanism, 2011.

Fave quote: "Some call this the closing of the conservative mind. Alas, the conservative mind has proved itself only too open, these past years, to all manner of intellectual pollen. "

Went to see We Need To Talk About Kevin last night

1. Tilda Swinton is ridiculously good.

2. Lynne Ramsay: still the master.

3. ...And people say there is a dearth of great right-wing art.

Links

Voxeu explains some Eurozone central banking mechanics: http://voxeu.org/index.php?q=node/7391
At the same place, Charles Wyplosz argues for decentralised discipline: http://voxeu.org/index.php?q=node/7387

Immigration: ordure approaching fan

If the Eurozone does collapse, or if there is just a second European credit crunch, then Britain will be relatively insulated. We will still suffer a lot, but less than the Eurozone itself. However, the EU has a useful mechanism for sharing the pain: labour migration, guaranteed by freedom of movement within Europe. Although it is low compared to the US, it has still been high enough over the past decade to make immigration a big political issue in Britain. The government has pledged to cut immigration to the tens of thousands. Good luck with that when Eurozone unemployment increases above its already high level. There will be increasing pressure to pull up the drawbridges.

On the Euro crisis

Mainstream opinion seems to be as follows:

1. Creating the Euro was a mistake.
2. We should save the Euro at all costs.

“At all costs” means:

• In the short run, the ECB to buy member states' bonds, or to issue Eurobonds.
• In the long run, centralized budgetary discipline in the Eurozone...
• … and perhaps much greater transfers to provide “automatic stabilizers”

On the face of it (1) and (2) do not sit well together. The argument for combining them is that the alternative is disastrous: government default, one or more countries leaving the Euro, bank runs which governments can no longer prevent, and perhaps a second Great Depression.

Almost anything would be justified to avoid a really serious depression, because events on that scale do not just impose economic hardship – they also risk devolving into political chaos. For instance, I have heard the Great Depression and the collapse of world trade cited as a cause of World War Two, though I don't know enough history to evaluate that claim.

On the other hand, the argument is not completely obvious.

First, it isn't necessary to leave the Euro in order to default. Greece, for example, is keen to stay in the Euro. The cost of staying in the Euro is being stuck with an uncompetitive exchange rate. But countries have survived that. By defaulting they would at least rid themselves of the debt overhang that is forcing them to cut, cut, cut government spending in the midst of a recession. The cost of leaving the Euro is being stuck with a less credible currency, and probably facing bank runs as a result.

On the other hand, if countries do leave the Euro, that may not be disastrous for them. (Or why would they do it voluntarily?) Britain was forced to float its currency 20 years ago; the Conservative government was humiliated, but the economic results were actually beneficial, weren't they? There is a trade-off: chaos at exit versus increased competitiveness with your own currency afterwards.

At the very least, the economic tail is wagging the political dog. European government structures are being created as a panicked response to a crisis. These structures are likely to be less democratic, more centralized (with Germany being the centre), and also to set in stone the Eurozone's problems, as follows:

• There will still be a single currency without the integrated labour markets that would help it to work.
• There will still be the temptation to fiscal indiscipline, which will have to be prevented by centralized control.

Fans of democracy, freedom and responsible politics should not find this an appealing prospect. It would also be a national defeat for Britain, because we would be on the periphery of a large centralized Eurozone with very different economic interests and values to our own.

If the alternative is really a global economic collapse then perhaps this is the best choice of a bad bunch. My personal nightmare is different:

• Europe centralizes;
• Established parties, and elites more generally, face an ever-stronger backlash from their “angry and defrauded young”;
• A new generation of populists enters national governments. They offer fantasy solutions, play fast and loose with deficits, and fail to exercise mutual discipline at European level.
• We have a century of Argentina-style distributive politics, relative decline, and domination by a resurgent Russia.

My instinct is that failed ideas should be discarded; but if we are going to have the Euro, it seems better to have fiscal discipline and a hard budget constraint – a core condition for “market-preserving federalism”. The US has achieved this, so why can't Europe?

Perhaps I am missing something and there's an obvious reason that a default means a Euro collapse, and that Euro breakup must inevitably be an economic catastrophe. Certainly lots of people think so. However, perhaps some of the current panic comes from businessmen and bankers who naturally confuse short-term harm to themselves with the end of civilization.

Ezra Klein explains the Euro crisis

in eight graphs.