Sundry links

No time for writing this week, so I'm listing blog posts and articles that caught my eye recently:

1. Liftoff levers. John Cochrane is doing a fantastic job explaining how the Fed's reverse repo operations are supposed to work. Start with this post, and then read this other one.

2. A "new" working paper, by Katharina Knoll, Mortiz Schularick, and Thomas Steger, looks at global house prices in the really long run (1870-2012). From the abstract:

...house prices in most industrial economies stayed constant in real terms from the 19th to the mid-20th century, but rose sharply in recent decades. Land prices, not construction costs, hold the key to understanding the trajectory of house prices in the long-run. Residential land prices have surged in the second half of the 20th century, but did not increase meaningfully before. We argue that before World War II dramatic reductions in transport costs expanded the supply of land and suppressed land prices. Since the mid-20th century, comparably large land-augmenting reductions in transport costs no longer occurred. Increased regulations on land use further inhibited the utilization of additional land...

3. An Icelander goes to Cyprus and tells us why Cypriots keep cash worth 6% of GDP under the mattress.--Sigrún Davíðsdótti at A Fistful of Euros.

4. China's monetary and exchange rate framework under pressure.

           4.1 Huge FX inflows turn into small outflows, and the PBoC switches from draining renminbis to injecting them. To keep base money growing, the central bank has introduced new tools. By Gabriel Wildau for the Financial Times.

           4.2 Time to ditch the renminbi-dollar peg? The Chinese currency has depreciated and is hitting the central bank's target band.

           4.3 On the internationalization of the RMB, a colleague forwards several papers and reports
                 Paths to a reserve currency, at the Asian Development Bank Institute.
                 The rise of the redback, by HSBC.
                 Yuan is fifth world's payments currency, at the WSJ.
               
An important event to keep in mind is that the IMF is reviewing the SDR basket in 2015. China is under pressure to step up the internationalization of the renminbi, ahead of the basket review.

5. Dani Rodrik summarizes the results of his latest paper on de-industrialization.

Premature deindustrialization is not good news for developing nations. It blocks off the main avenue of rapid economic convergence in low‐income settings, the shift of workers from the countryside to urban factories where their productivity tends to be much higher.

Industrialization contributes to growth both because of this reallocation effect and because manufacturing tends to experience relatively stronger productivity growth over the medium to longer term. In fact, organized, formal manufacturing appears to exhibit unconditional convergence (Rodrik 2013), which makes it special and an engine of growth. Since low‐income countries tend to start with small manufacturing sectors, the dynamic within manufacturing initially plays a small role, overshadowed by the reallocation effect. But over time, the within‐manufacturing effect becomes a more potent force as the manufacturing sector becomes larger.Premature deindustrialization throws sand in the wheels of both engines (Rodrik 2013, 2014).

The consequences are already visible in the developing world. In Latin America, as manufacturing has shrunk informality has grown and economy‐wide productivity has suffered. In Africa, urban migrants are crowding into petty services instead of manufacturing, and despite growing Chinese investment there are as yet few signs of a real resurgence in industry. Where growth occurs, it is driven largely by capital inflows, transfers, or commodity booms, raising questions about its sustainability.  

In the absence of sizable manufacturing industries, these economies will need to discover new growth models. One possibility is services‐led growth. Many services, such as IT and finance, are high productivity and tradable, and could play the escalator role that manufacturing has traditionally played. However, these service industries are typically highly skill‐intensive, and do not have the capacity to absorb – as manufacturing did – the type of labor that low‐ and middle‐income economies have in abundance. The bulk of other services suffer from two shortcomings. Either they are technologically not very dynamic. Or they are non‐tradable, which means that their ability to expand rapidly is constrained by incomes (and hence productivity) in the rest of the economy.

I couldn't help but tie Rodrik's paper to that other paper by Pritchett and Summers, the one about regression to the mean of long-term growth rates. Growth is far from a uniform process. It tends to happen in fits and starts. Those who are projecting high growth rates of developing economies, based on past high growth rates, which in turn hinged on industralization, are probably going to be disappointed.

6. The translation industry.The Economist opines that translation is very hard for machines. Humans will need to stay involved, but technology will improve productivity.

A different question: Do improvements in translation bode well for language diversity in the world? How about the language learning industry? I see this as a race between technologies that allow machines to translate better, and technologies that allow humans to learn languages faster. The machines are winning, by a long shot. We're clearly on a path to better simultaneous translation capabilities. Soon we'll be able to listen to anything, anywhere in our native tongue, in real time. That means humans won't have to know more than one language. Learning languages will become a hobby, like dancing. (Sorry, parents, but you're wasting your money on Mandarin lessons.)

As for language diversity, I think a more important force than technology is urbanization. The lion's share of the world's languages are spoken by small, rural communities in developing countries. Urbanization increases the usefulness of majority languages, killing the minority languages. And urbanization will happen faster than the spread of cheap, simultaneous translation technology. At some point, however, the trend towards fewer and fewer languages will slow down, as simultaneous translation becomes pervasive.

Insuring irreplaceable assets

Last Wednesday night my computer wouldn’t start up. This is my only computer, the laptop where I keep all my work, and which I haven’t backed up in a while. Understandably, I rush to contact the manufacturer’s support service. Diagnostic: dead hard-drive, DNR. The first technician I speak with suggests that I try to restart the computer with a back-up copy of the operating system, which, he tells me, “would erase everything in the HD.”

A personal computer full of data is a perfect example of an irreplaceable asset. And when I say “irreplaceable” I don’t necessarily mean it in a literal way. Many of my files can be downloaded from the internet or reconstructed, and I can redo my writings. But I would be willing to pay a lot more money than anybody else for that “replaceable” stuff.

Every possession has a personal value (how much it is worth to its owner) and a market value (the price the object would fetch in a sale). They’re equal for assets that the owner can substitute readily in the market. But the personal value can be higher than the market value for objects to which the owner attaches unique attributes. Those are the assets I call “irreplaceable*.”

A classic example is bottles of wine. A 1995 Bordeaux can be purchased in a store now, say, for $60; yet many people who bought a bottle of the exact same wine back in 1995 would not sell it for less than $80.

Assets acquire owner-specific attributes in multiple ways. Sometimes it’s the way in which the owner took possession (family heirlooms); some other times it’s the memories accumulated through years of use (clothes), or the memories they bring back (pictures). But oftentimes the reasons are less sentimental. I value my hard-drive above its market price because it contains information specific to my work, and nobody else’s.

Just as in the case of any other worthy asset, risk-averse individuals would insure irreplaceable assets against loss. And the insured amounts would not be based just on their market value, but on their higher, personal value. Nothing special here. Irreplaceable objects become an interesting economics topic, however, if their loss can shift the utility that their owners derive from wealth. In economics parlance, when people display state-dependent preferences.

As an illustration, consider the case of wealth and parenthood. Parents face two states of the world: in state one the children die, in state two they live. Of course, parents are better off if the kids survive than if they die. But it’s also true that they derive greater utility from an extra dollar of wealth if their kids survive.

State-dependent preferences affect the demand for insurance of assets. If insurance is purchased, an individual foregoes some wealth (the insurance premium) in the good state and receives a certain sum (the insured amount) in the bad state. Because an extra dollar is worth less in the bad state than in the good one, insuring the asset whose loss triggers the bad state is not a good deal. In any case, the premiums and insured amounts are smaller if preferences are state-dependent.

Continuing with the example above, would you buy life insurance for your kids? Most parents don’t. They save themselves the life insurance premiums, which they can spend with their kids in the good state. If the children die, the parents don’t get any money. But the loss of a child puts parents in a state where they don’t get much of a kick out of spending money anyway.


To use an example from the recent news: many American families choose not to have health insurance. Many millions more have low insurance coverage. I don’t mean to play down asymmetric information issues, which can make high coverage unaffordable. But it makes sense that a sick person, who is limited in the range of goods and services that she can consume, gets less utility out of an extra dollar of income than her healthy self. One must seriously consider the possibility that the observed heterogeneity in health insurance coverage arises simply from differences in state-dependent preferences across people.

In civil court cases it’s common to give a monetary compensation to the victim. The practice is as unavoidable as it is inefficient. Let’s say that an individual breaks his femur at work and becomes permanently disabled. The court finds that the accident was caused by the employer’s negligence and grants damages of one million dollars: $750K for lost earnings and $250K for the physical pain and psychological suffering. The $250K may not produce much utility now that the victim can’t walk or drive. And yet, what other form of compensation can be provided? Would an apology be any better?

Investments in prevention are usually more efficient than insurance at protecting individuals in the case of state-dependent preferences. Installing fire-proof ceilings and clearing brush will protect a house in a forested area when the inevitable wildfire occurs. Colonoscopies can prevent the occurrence of the bad state itself (colon cancer). Backing up the content of your hard drive avoids disaster when the bad state strikes.

This morning I called a company specialized in hard-drive recovery. They’ve told me that because the hard drive didn’t suffer any physical damage they should be able to retrieve most, if not all, of my data – which is all I needed to hear to switch to a more pleasant state (of mind) in which to spend my day.

* In this as in the rest of this post I follow the seminal analysis of Philip Cook and Daniel Graham, published in 1977 in the Quarterly Journal of Economics.

Technorati tags: economics, insurance, state dependent utility, irreplaceable asset, optimal insurance

Temporary marriages

“German politician suggests temporary marriages” was a recent news story . Gabriele Pauli, the member of the conservative CSU who launched the proposal, believes that anyone wanting to stay married more than seven years would have to apply for an extension. Otherwise, the union would automatically expire.

Brilliant! Why should spouses have to stick together forever? Life takes many twists and turns that might make you want to part ways with your one-time sweetheart. Besides, couples could always chain fixed-term marriages and remain together for as long as they liked. In fact, given the high rate of failed unions, temporary marriage is a necessary institution. Is it?

After thinking about this for a while, here’s my conclusion. If you believe that people are perfectly rational and far-sighted, then temporary marriage is a redundant arrangement. Modern, secular societies have accepted four behaviors or institutions that accomplish the same goals. Those institutions are: cohabitation, divorce, pre-nuptial agreements and pre-marital sex. On the other hand, if you think that humans are inattentive creatures that postpone inevitable losses, then temp marriages can be useful.

Temp marriages are redundant

Taking your partner for a test drive sounds like a great idea. You don’t want to get stuck with a lemon on a coast-to-coast ride. And I don’t mean learning about your partner’s sense of humor, income, or intelligence -you figure that out in the first couple of dates. I’m thinking about experience traits such as earnings growth potential, resilience in the face of job or family setbacks, or health.


But the importance of learning about your partner is one of the reasons why society allows and practices cohabitation. Even in relatively conservative America, 41 percent of women ages 15 to 44 have lived with an unmarried man, according to the 2000 Census.

In spite of all that learning before tying the knot, people still misjudge their partners. And some harmful habits, such as domestic abuse, alcoholism, drugs, or snoring, appear only after years of life in common. Other people develop the proverbial “seven-year itch.”

But this is why societies have sanctioned divorce. Committing to a fixed-term marriage, while retaining the possibility to get a divorce, is meaningless. The divorce option can be defined as “I can quit anytime”; the temp marriage with a divorce option goes “I can quite at the end of the contract, or any time.”

Temporary marriages also ease the splitting process. Presumably, distribution of assets, custody of the children, alimony and child support, etc. would be stipulated on the contract. But spouses who are concerned about the financial consequences of a separation sign pre-nuptial agreements. Since the divorce option, with the attached pre-nuptial distribution of assets, can be executed any time, it is superior to temp marriages.


Finally, temporary marriages allow people to get in intimate relationships without having to commit for life. But modern, secular societies consent sex between unmarried people.

In fact, some religious groups have allowed fixed-term marriages in order to substitute for consented pre-marital sex. The Muslim Shiites allow the “Nikah Mut’ah” or “sigheh”, which is a marriage with a preset duration and, in practice, a way around the official ban on pre-marital sex. The institution is an exercise in hypocrisy, since “sigheh” can last for as little as a few hours and the spouses don’t even need a cleric. (Another motivation for the sigheh is to allow prostitution –some women will accept to “get married” for hours or days in exchange for a dowry.) But the point is that secular societies have accommodated people’s urges by authorizing pre-marital sex, instead of adopting temp marriages.

Temp marriages can be useful

Humans are pretty inattentive creatures. We don’t reconsider the decision to have cable TV every day. Likewise, we typically do not re-evaluate the optimality of our wedlock state very often, even though divorce is an available option every single day. Temporary marriages force us to do that re-evaluation at least once each term, near the end of the contract. This forced re-evaluation would stop relationships that would have withered away for too long otherwise.

Another way to understand the same phenomenon is procrastination. The process of splitting up comes with costs, both subjective and real: the fear of and stress from separation, the attorney’s fees, moving costs, etc. It is perfectly rational to postpone losses, since we apply a discount factor to future events. But when eventual divorce becomes a certainty, postponing it is never optimal: the more you wait, the more difficult it will be to find another spouse, and the larger the foregone happiness from remaining in a bad marriage. Temp marriages cap those losses.

So the evaluation of temporary marriages depends on how rational people are. Which view is more accurate? That’s up to you: I muse, you decide.

Can you think of other reasons why temporary marriages are a valuable option? Is there some other "irrational behavior" that leads people to prolong their (failed) marriages? Why have societies chosen divorce, pre-marital sex and cohabitation as alternatives to fixed-term marriages? Leave your answers in the comments.

Technorati tags:
economics, marriage, temporary marriage, divorce, family

In response to "Canada's shooting gallery"

Today the Wall Street Journal published a letter I wrote. It's about drugs. More specifically, about supervised injection centers. I wrote it in response to an op-ed that appeared in the WSJ this Monday.

Breaking my own rules about posting one blog entry per week, and doing it on Fridays, here's my letter:

In response to Mary O'Grady's “Canada’s Shooting Gallery" (Americas, Aug. 27) (here's the op-ed if you're not subscribed to the WSJ) :

Providing clean injection equipment and a safe place to use drugs is a far cry from “engaging in drugging the citizenry” or “encouraging drug use”. Supervised injection centers like InSite (I know of a similar one in Madrid) do not provide either drugs or drug substitutes or information on where to get those substances. Plus, they are located in drug- and crime-ridden neighborhoods, and are frequented by destitute addicts. How are those centers supposed to encourage the average citizen to start doing drugs?

As for people who are already in the habit, their addiction is a far more powerful motive to continue using drugs than the free needles. Needles are already cheap and easy to get. Drugs are expensive, dangerous to obtain and potentially deadly, and yet addicts continue to consume them regularly.

Interestingly enough, Ms. O'Grady mentions the “bright white lights,” the “cold clinical setting” and the “no smoking” signs that one can find at InSite. None of that sounds too inviting. Perhaps if we furnished the center with dim, warm lights and plush armchairs, Ms. O'Grady would be right in claiming that the government encourages drug use.

Centers such as InSite send the message, “We know you exist.” Feeling acknowledged may make drug addicts feel part of society and be willing to rejoin it. And, regardless of whether they feel acknowledged or not, simply making it easy for addicts to sign up for detoxification programs, like those centers do, will only increase the numbers of those who quit using.

Technorati tags:
drugs, supervised injection centers, drug policy, InSite

Breaking windows is not good for the economy

Once, as a kid, a friend of mine was littering the street. He said it was ok because he was “generating work” for the city’s street cleaners. Another time, in the midst of the 2001 recession, an acquaintance urged me to go on a Thanksgiving shopping spree on the grounds that “it would be good for the economy”.

I’m sure you have heard arguments like this before, oftentimes to justify acts of destruction or wasteful behavior. Although I am sure that some people who use this rationalization have never thought about the meaning of it, this argument is so ubiquitous and so deeply flawed, that I can’t help writing a few paragraphs to help clarify things.

Let’s take a very clear and simple example. Suppose that the government hires 100 unemployed people to dig holes in the middle of the desert. This project will create jobs. It will also contribute to GDP growth, since the workers will eventually spend their money on goods and services. On the other hand, the project is perfectly useless: digging a pointless hole does not increase anybody’s wealth or well-being.

“How about the workers? They got a job!” somebody will say. Yes, but by having those people digging holes in the desert we are keeping them from doing things which actually have some value: they could have been making clothespins in a factory; driving cabs in the city; baking cookies at home; or bathing their kids at home. Any of these alternative activities produces a good or service with economic value. Digging holes in the desert does not.

We can look at it from a public finance perspective too: the tax revenues that the government spent to pay those workers could have been used to produce something that people actually use. For example, to repair a road or to build a park.

The “it’s-good-for-the-economy” fallacy that I am describing was first pointed out by the French economist Frédéric Bastiat, who created the “broken window” parable in 1850. In this parable, a boy breaks a window. His father bursts in anger because he will have to spend six francs to repair it. His neighbors console him by arguing that the mishap will actually be good because it will generate business for the glazier, who will repair the window.

Bastiat proceeds to write that the fallacy comes from not being aware of “what is not seen”. In less cryptic words, from the failure to realize that the father could have done something else with his six francs if the boy had not broken the window. These “hidden” costs are called opportunity costs by economists.

Individuals and businesses, as well as the government, often ignore the opportunity cost of their actions. I once had a roommate who used to say that leaving the lights on all day, even when there was plenty of sunlight, was “good for the economy” and that it “helped to create jobs”. Maybe he helped boost ComEd’s profit, but my roommate could have turned off the light, saved some money on electricity, and used it to buy himself something he actually wanted, like a trip to San Francisco: he would still have “helped the economy” and he would have enjoyed himself a lot more on vacation than staring at the light bulb.

Notice that some of the opportunity costs I have mentioned do not have any market value. Making cookies at home and bathing your child satisfy some want, and therefore contribute to economic well-being, even though they are not market goods and do not add to GDP. On the other hand, digging holes in the desert or leaving the lights on all day do not satisfy any want, but they do add to GDP. This leads us to the conclusion that not everything that adds to GDP is “good for the economy” (or at least for economic well-being). But this should be the topic of a blog entry of its own.

Beware of anybody using the phrase “it’ll be good for the economy”. Chances are they’d be happy to break your windows.

Technorati tags:
Bastiat, broken window, opportunity cost, good for the economy