The Eclipse of the Public Corporation

Saturday, December 10th, 2016

Back in 1989 Michael Jensen, a subsequent Nobel Laureate, wrote a piece predicting the eclipse of the public corporation:

Quoted companies, he wrote, have a grave flaw: “an absence of effective monitoring of managers”. Shareholders are too dispersed and too ill-informed to exercise proper control of chief executives. This causes several nasty problems.

One, said Professor Jensen, is that bosses will want to build up cash piles to give themselves freedom from capital markets. If companies held no cash, they’d need to raise funds in the market every time they wanted to invest. This would give investors control over the company’s plans. If, however, companies can invest internal funds, this control is lacking and so bosses are freer. Events have vindicated Professor Jensen; in both the UK and US, corporate cash holdings have soared in recent years.

Secondly, he said, when companies do invest the job is likely to be badly done. Bosses will prefer grand schemes that gratify their ego rather than humdrum projects that maximize shareholder value. Perhaps the worst economic decision of our lifetime was RBS’s takeover of ABN Amro – a move that was due to shareholders’ failure to control Fred Goodwin’s megalomania.

To these failings we can add that bosses plunder directly from shareholders by extracting big wages for themselves. The High Pay Centre estimates that CEOs are now paid 150 times the salary of the average worker, a ratio that has tripled since the 1990s – an increase which, it says, can’t be justified by increased management efficiency. “No countervailing forces have been deployed to stop this,” it says.

Failures such as these, said Professor Jensen, would cause quoted companies to be supplanted by private equity, as this permits a few well-informed investors to properly oversee managers. This is what has happened.

How Two Trailblazing Psychologists Turned the World of Decision Science Upside Down

Sunday, November 27th, 2016

Michael Lewis explains how two trailblazing psychologists turned the world of decision science upside down:

Danny was always sure he was wrong. Amos was always sure he was right. Amos was the life of every party; Danny didn’t go to the parties. Amos was loose and informal; even when Danny made a stab at informality, it felt as if he had descended from some formal place. With Amos you always just picked up where you left off, no matter how long it had been since you last saw him. With Danny there was always a sense you were starting over, even if you had been with him just yesterday. Amos was tone-deaf but would nevertheless sing Hebrew folk songs with great gusto. Danny was the sort of person who might be in possession of a lovely singing voice that he would never discover. Amos was a one-man wrecking ball for illogical arguments; when Danny heard an illogical argument, he asked, What might that be true of? Danny was a pessimist. Amos was not merely an optimist; Amos willed himself to be optimistic, because he had decided pessimism was stupid. When you are a pessimist and the bad thing happens, you live it twice, Amos liked to say. Once when you worry about it, and the second time when it happens. “They were very different people,” said a fellow Hebrew University professor. “Danny was always eager to please. He was irritable and short-tempered, but he wanted to please. Amos couldn’t understand why anyone would be eager to please. He understood courtesy, but eager to please—why?” Danny took everything so seriously; Amos turned much of life into a joke. When Hebrew University put Amos on its committee to evaluate all Ph.D. candidates, he was appalled at what passed for a dissertation in the humanities. Instead of raising a formal objection, he merely said, “If this dissertation is good enough for its field, it’s good enough for me. Provided the student can divide fractions!”

The piece is adapted from The Undoing Project: A Friendship That Changed Our Minds.

Arnold Kling’s Obamacare Notice

Saturday, November 5th, 2016

Arnold Kling just got mugged by reality, when his Obamacare notice arrived:

Yesterday in the mail, my wife and I got our premium notice from the health care exchange. Our monthly premium is going up 70 percent, and our deductible is going up also.

I wonder if any of the pundits who claim that Obamacare is working are actually getting their health insurance through an exchange.

I wonder how many of us who have not supported Donald Trump are feeling mugged by reality.

The Value of University

Wednesday, November 2nd, 2016

The Economist has ranked colleges based on the gap between how much money students subsequently earn and how much they might have made had they studied elsewhere:

We wanted to know how a wide range of factors would affect the median earnings in 2011 of a college’s former students. Most of the data were available directly from the scorecard: for the entering class of 2001, we used average SAT scores, sex ratio, race breakdown, college size, whether a university was public or private, and the mix of subjects students chose to study. There were 1,275 four-year, non-vocational colleges in the scorecard database with available figures in all of these categories. We complemented these inputs with information from other sources: whether a college is affiliated with the Catholic Church or a Protestant Christian denomination; the wealth of its state (using a weighted average of Maryland, Virginia and the District of Columbia for Washington) and prevailing wages in its city (with a flat value for colleges in rural areas); whether it has a ranked undergraduate business school (and is thus likely to attract business-minded students); the percentage of its students who receive federal Pell grants given to working-class students (a measure of family income); and whether it is a liberal-arts college. Finally, to avoid penalising universities that tend to attract students who are disinclined to pursue lucrative careers, we created a “Marx and Marley index”, based on colleges’ appearances during the past 15 years on the Princeton Review’s top-20 lists for political leftism and “reefer madness”. (For technically minded readers, all of these variables were statistically significant at the 1% level, and the overall r-squared was .8538, meaning that 85% of the variation in graduate salaries between colleges was explained by these factors. We also tested the model using 2009 earnings figures rather than 2011, and for the entering class of 2003 rather than 2001, and got virtually identical results.)

College Expected vs. Median Earnings

For example, Caltech’s forecast earnings increase by $27,114 as a result of its best-in-the-country incoming SAT scores, another $9,234 thanks to its students’ propensity to choose subjects like engineering, and a further $2,819 for its proximity to desirable employers in the Los Angeles area.

The ‘Secret History Of American Prosperity’ Needs To Become A Lot Less Secret

Tuesday, November 1st, 2016

The Secret History of American Prosperity needs to become a lot less secret, Nathan Lewis suggests:

While we generally remember the 1950s as a time of economic good health — as indeed it was, compared to what we have become used to since 1971 — it was actually rather mediocre compared to the astonishing performance of the German or Japanese economies of the time, or the U.S. expansion of the late 1960s. Faced with four debilitating recessions in eleven years, Kennedy focused on creating 5% real GDP growth in his 1960 election campaign.

But how? Following the advice of Paul Samuelson, he assembled the leading lights of academia, who told him that he needed easy money and spending projects to take care of the unemployment (the solution John Maynard Keynes had recommended in 1936) and high taxes to prevent inflation. His Treasury Secretary Douglas Dillon, however, was a wealthy Wall Street businessman wise to the workings of the real economy, and also a Republican. Dillon supported the extensive research of the little-known Stanley Surrey, a member of the faculty of the Harvard Law School — not, it should be noted, an “economist,” although he was later called “the greatest tax scholar of his generation,” with twenty books to his credit.

Surrey argued that the 91% top income tax rate of the time was a “phantom rate” that nobody paid: as inevitably happens wherever high nominal rates are found, lobbyists had been hired to punch extensive loopholes in the tax code. Lower rates, he argued, would change incentives and produce more growth. Kennedy actually experimented with the advice of his academics, before disregarding them for the path shown by Dillon and Surrey. The result was a tax reform that lowered the top rate to 70% and all other rates proportionally; and the best economic boom of the 1950s and 1960s.

The first Reagan tax reform of 1982 was basically an exact copy of Kennedy’s 1964 tax cut. This was deliberate, to help raise the needed support in the Democrat-controlled Congress.

Raining In High-Frequency Traders

Tuesday, October 25th, 2016

What is the relationship between high-frequency traders and liquidity?

Ever since high-frequency trading rose to prominence, a debate has raged over whether the ensuing arms race between super-fast traders helped or hindered markets. One side argues that it helps because the massive number of transactions the fastest traders engage in lower costs by reducing the spreads between bids and offers. Critics counter that, in reality, spreads widen since slower traders need to charge higher spreads as insurance against getting caught flatfooted by a fast-moving event.

[...]

Starting in 2010, high-frequency traders began using ultrafast microwave links to relay prices and other information between Chicago and New York. To begin with, only some traders had access to microwave networks. Until 2013, others had to rely on less speedy fiber-optic cable.

But microwave transmissions are disrupted by water droplets and snowflakes, so during heavy storms traders using the networks switch to fiber. Messrs. Shkilko and Sokolov used weather-station data from along the microwaves’ paths to determine when storms occurred and then looked at what happened to bid-ask spreads in a variety of securities during those periods.

They narrowed, suggesting that the slowing down of the fastest high-frequency traders improved market liquidity.

Net Fiscal Cost of Immigrants

Tuesday, October 25th, 2016

Every immigrant without a high School diploma costs the US $231,000, in net present value, according to a report on “The Economic and Fiscal Consequences of Immigration” from the National Academies of Sciences, Engineering, and Medicine:

On average, a nonelderly adult immigrant without a high school diploma entering the U.S. will create a net fiscal cost (benefits received will exceed taxes paid) in both the current generation and second generation. The average net present value of the fiscal cost of such an immigrant is estimated at $231,000, a cost that must be paid by U.S. taxpayers.

[...]

However, a rough estimate of the future net outlays to be paid by taxpayers (in constant 2012 dollars) for immigrants without a high school diploma appears to be around $640,000 per immigrant over 75 years. The average fiscal loss is around $7,551 per year (in constant 2012 dollars).

Slightly more than 4 million adult immigrants without a high school diploma have entered the U.S. since 2000 and continue to reside here. According to the estimates in the National Academies report, the net present value of the future fiscal costs of those immigrants is $920 billion.

This means government would have to immediately raise taxes by $920 billion and put that sum into a bank account earning 3 percent plus inflation per year to cover the future fiscal losses that will be generated by those immigrants.

To cover the future cost, each taxpaying U.S. household, on average, would have to pay an immediate lump sum of over $10,000. Costs would go up in the future as more than 200,000 additional adult immigrants without a high school diploma arrive in the country each year.

The Deep Roots of Prosperity

Friday, October 14th, 2016

Today’s rich countries tend to be in East Asia, Northern and Western Europe — or are heavily populated by people who came from those two regions:

The major exceptions are oil-rich countries. East Asia and Northwest Europe are precisely the areas of the world that made the biggest technological advances over the past few hundred years. These two regions experienced “civilization,” an ill-defined but unmistakable combination of urban living, elite prosperity, literary culture, and sophisticated technology. Civilization doesn’t mean kindness, it doesn’t mean respect for modern human rights: It means the frontier of human artistic and technological achievement. And over the extremely long run, a good predictor of your nation’s current economic behavior is your nation’s ancestors’ past behavior. Exceptions exist, but so does the rule.

Recently, a small group of economists have found more systematic evidence on how the past predicts the present. Overall, they find that where your nation’s citizens come from matters a lot. From “How deep are the roots of economic development?” published in the prestigious Journal of Economic Literature:

A growing body of new empirical work focuses on the measurement and estimation of the effects of historical variables on contemporary income by explicitly taking into account the ancestral composition of current populations. The evidence suggests that economic development is affected by traits that have been transmitted across generations over the very long run.

From “Was the Wealth of Nations determined in 1000 B.C.?” (coauthored by the legendary William Easterly):

[W]e are measuring the association of the place’s technology today with the technology in 1500 AD of the places from where the ancestors of the current population came from…[W]e strongly confirm…that history of peoples matters more than history of places.

And finally, from “Post-1500 Population Flows and the Economic Determinants of Economic Growth and Inequality,” published in Harvard’s Quarterly Journal of Economics:

The positive effect of ancestry-adjusted early development on current income is robust…The most likely explanation for this finding is that people whose ancestors were living in countries that developed earlier (in the sense of implementing agriculture or creating organized states) brought with them some advantage—such as human capital, knowledge, culture, or institutions—that raises the level of income today.

To sum up some of the key findings of this new empirical literature: There are three major long-run predictors of a nation’s current prosperity, which combine to make up a nation’s SAT score:

S: How long ago the nation’s ancestors lived under an organized state.

A: How long ago the nation’s ancestors began to use Neolithic agriculture techniques.

T: How much of the world’s available technology the nation’s ancestors were using in 1000 B.C., 0 B.C., or 1500 A.D.

When estimating each nation’s current SAT score, it’s important to adjust for migration: Indeed, all three of these papers do some version of that. For instance, without adjusting for migration, Australia has quite a low ancestral technology score: Aboriginal Australians used little of the world’s cutting edge technology in 1500 A.D. But since Australia is now overwhelmingly populated by the descendants of British migrants, Australia’s migration-adjusted technology score is currently quite high.

On average, nations with high migration-adjusted SAT scores are vastly richer than nations with lower SAT scores: Countries in the top 10% of migration-adjusted technology (T) in 1500 are typically at least 10 times richer than countries in the bottom 10%. If instead you mistakenly tried to predict a country’s income today based on who lived there in 1500, the relationship would only be about one-third that size. The migration adjustment matters crucially: Whether in the New World, across Southeast Asia, or in Southern Africa, one can do a better job predicting today’s prosperity when you keep track of who moved where. It looks like at least in the distant past, migrants shaped today’s prosperity.

Wealth, Health, and Child Development

Thursday, October 13th, 2016

Swedish researchers looked at wealth, health, and child development, by studying lottery players:

We use administrative data on Swedish lottery players to estimate the causal impact of substantial wealth shocks on players’ own health and their children’s health and developmental outcomes. Our estimation sample is large, virtually free of attrition, and allows us to control for the factors conditional on which the prizes were randomly assigned.

In adults, we find no evidence that wealth impacts mortality or health care utilization, with the possible exception of a small reduction in the consumption of mental health drugs. Our estimates allow us to rule out effects on 10-year mortality one sixth as large as the cross-sectional wealth-mortality gradient.

In our intergenerational analyses, we find that wealth increases children’s health care utilization in the years following the lottery and may also reduce obesity risk. The effects on most other child outcomes, including drug consumption, scholastic performance, and skills, can usually be bounded to a tight interval around zero.

Overall, our findings suggest that in affluent countries with extensive social safety nets, causal effects of wealth are not a major source of the wealth-mortality gradients, nor of the observed relationships between child developmental outcomes and household income.

Maybe Companies Aren’t Too Focused on the Short Term

Tuesday, October 11th, 2016

There are plenty of stories of how U.S. corporations live for the short-term, obsessing over the next quarterly earnings statement to the neglect of their longer-run prospects:

Still, it’s not been established that American corporations are on average more short-term in their thinking than they ought to be.

Perhaps most importantly, it is often easier and better to plan for the shorter term. In information technology, the average life of a corporate asset is about six years, in health care it is about 11 years, and for consumer products it runs about 12 to 15. Very often it is hard for a company to plan its operations beyond those time periods, as the U.S. economy is no longer based on durable manufacturing machines. Production has shifted toward service sectors with relatively short asset lives, and that may call for a shorter-term orientation in response.

Companies often see their short-term problems staring them in the face — think of the need to fire an incompetent manager or lease more office space. It is harder to predict the market 20 years hence, especially when information technology is involved, and thus planning so far out can involve a lot of expense and risk.

Plenty of companies have made big mistakes from thinking too big and too long-term; for instance, a lot of mergers were based on notions of long-run synergies that never materialized. In reality, short-term improvements are often the best way to get to a good long-run plan.

[...]

Equity markets do not seem to neglect the longer run. Amazon has a high share price even though its earnings reports have usually failed to show a profit. Possibly the market judgment is wrong, but it’s hardly the case that investors are ignoring the long-run prospects of the company.

Many tech startups have high valuations even though revenue is zero or low. Again, those judgments may or may not be correct, but clearly investors are trying to estimate longer-run prospects. During the dot-com bubble of the 1990s, there was too much long-run, pie-in-the-sky thinking and not enough focus on the concrete present.

Economics Nobel Laureate Eugene Fama once said, “In hindsight, every price is wrong.” With electric and driverless cars, investors are thinking long and hard about what the future might look like and investing in equities accordingly, with share prices to be revised as events develop. If the long-run thinking of the market were systematically defective, it would be possible to profit simply through superior patience. But it is not an easy matter to see further than others.

Warfare and Economic Growth in the Preindustrial World

Monday, October 3rd, 2016

Mark Koyama believes the economic costs of warfare are usually dismissed, for a variety of reasons:

1. Arguments like: the Romans destroyed Carthage in 146 BC yet by, say, 0 AD Carthage had recovered and was a major economic metropolis.

2. Arguments from analogy: Japan and Germany were devastated by WW2 yet they recovered rapidly and exceeded previous levels of living standards within a decade and a half.

3. Keynesian-style arguments: warfare was necessary to stimulate aggregate demand.

4. A binding technological ceiling on growth in preindustrial economies. Hence in the absence of warfare, growth was limited.

Again, if you’re in a Malthusian Trap, war might bring a drop in total GDP, but a rise in GDP per capita — until the disruption is great enough to bring down a complex economy.

Retire at 30

Monday, September 26th, 2016

In 2005, Peter Adeney — better known as Mr. Money Mustacheretired at 30 years old:

Leading up to retirement, Adeney and his wife, Simi, both software engineers, stashed two-thirds of their combined $134,000 take-home pay in savings. After just 10 years in the workforce, the couple had accrued about $600,000 in investments and paid off a house worth $200,000, Adeney told Nick Paumgarten of The New Yorker, giving them a solid cushion to retire on.

[...]

He suggests learning to live on less — cutting down your wardrobe, buying used cars — and finding ways to add meaning to life that don’t rely on material possessions. One personal challenge he took on was learning carpentry.

Migrant Competence

Sunday, September 18th, 2016

James Thompson explores migrant competence:

Europe is experiencing enormous inflows of people from Africa and the Middle East, and in the midst of conflicting rhetoric, of strong emotions and of a European leadership broadly in favour of taking more migrants (and sometimes competing to do so) one meme keeps surfacing: that European Jews are the appropriate exemplars of migrant competence and achievements.

European history in the 20th Century shows why present-day governments feel profound shame at their predecessors having spurned European Jews fleeing Nazi Germany. However, there are strong reasons for believing that European Jews are brighter than Europeans, and have greater intellectual and professional achievements. There may be cognitive elites elsewhere, but they have yet to reveal themselves. Expectations based on Jewish successes are unlikely to be repeated.

I am old enough to know that political decisions are not based on facts, but on presumed political advantages. The calculation of those leaders who favour immigration seems to be that the newcomers will bring net benefits, plus the gratitude and votes of those migrants, plus the admiration of some of the locals for policies which are presented as being acts of generosity, thus making some locals feel good about themselves for their altruism. One major ingredient of the leadership’s welcome to migrants is the belief that they will quickly adapt to the host country, and become long term net contributors to society. Is this true?

With Heiner Rindermann he analyzed the gaps, possible causes, and impact of The Cognitive Competences of Immigrant and Native Students across the World:

In Finland the natives had reading scores of 538, first-generation immigrants only 449, second-generation 493. The original first-generation difference of 89 points was equivalent to around 2–3 school years of progress, the second-generation difference of 45 points (1-2 school years) is still of great practical significance in occupational terms.

In contrast, in Dubai natives had reading scores of 395; first-generation immigrants 467; second-generation 503. This 105 point difference is equivalent to 16 IQ points or 3–5 years of schooling.

Rather than look at the scales separately, Rindermann created a composite score based on PISA, TIMSS and PIRLS data so as to provide one overall competence score for both the native born population and the immigrants which had settled in each particular country. For each country you can seen the natives versus immigrant gap. By working out what proportion of the national population are immigrants you can recalculate the national competence (IQ) for that country. Rindermann proposes that native born competences need to be distinguished from immigrant competences in national level data.

The analysis of scholastic attainments in first and second generation immigrants shows that the Gulf has gained from immigrants and Europe has lost. This is because those emigrating to the Gulf have higher abilities than the locals, those emigrating to Europe have lower ability than the locals.

The economic consequences can be calculated by looking at the overall correlations between country competence and country GDP.

[...]

The natives of the United Kingdom have a competence score of 519 (migrants to UK 499), Germany 516 (migrants to Germany 471), the United States 517 (migrants to US 489). There, in a nutshell, is the problem: those three countries have not selected their migrants for intellectual quality. The difference sounds in damages: lower ability leads to lower status, lower wages and higher resentment at perceived differences. On the latter point, if the West cannot bear to mention competence differences, then differences in outcome are seen as being due solely to prejudice.

Do Immigrants Import Their Economic Destiny?

Saturday, September 17th, 2016

Do immigrants import their economic destiny?

This is one of the great policy questions in our new age of mass migration, and it’s related to one of the great questions of social science: Why do some countries have relatively liberal, pro-market institutions while others are plagued by corruption, statism, and incompetence? Three lines of research point the way to a substantial answer:

  • The Deep Roots literature on how ancestry predicts modern economic development,
  • The Attitude Migration literature, which shows that migrants tend to bring a lot of their worldview with them when they move from one country to another,
  • The New Voters-New Policies literature, which shows that expanding the franchise to new voters really does change the nature of government.

Together, these three data-driven literatures suggest that if you want to predict how a nation’s economic rules and norms are likely to change over the next few decades, you’ll want to keep an eye on where that country’s recent immigrants hail from.

The Most Intolerant Wins

Wednesday, August 31st, 2016

Nassim Nicholas Taleb explains how a certain type of intransigent minority can make the entire population adopt their preferences — while a naive observer would be under the impression that the choices and preferences are those of the majority:

This example of complexity hit me, ironically, as I was attending the New England Complex Systems institute summer barbecue. As the hosts were setting up the table and unpacking the drinks, a friend who was observant and only ate Kosher dropped by to say hello. I offered him a glass of that type of yellow sugared water with citric acid people sometimes call lemonade, almost certain that he would reject it owing to his dietary laws. He didn’t. He drank the liquid called lemonade, and another Kosher person commented: “liquids around here are Kosher”. We looked at the carton container. There was a fine print: a tiny symbol, a U inside a circle, indicating that it was Kosher. The symbol will be detected by those who need to know and look for the minuscule print. As to others, like myself, I had been speaking prose all these years without knowing, drinking Kosher liquids without knowing they were Kosher liquids.

A strange idea hit me. The Kosher population represents less than three tenth of a percent of the residents of the United States. Yet, it appears that almost all drinks are Kosher. Why? Simply because going full Kosher allows the producer, grocer, restaurant, to not have to distinguish between Kosher and nonkosher for liquids, with special markers, separate aisles, separate inventories, different stocking sub-facilities. And the simple rule that changes the total is as follows:

A Kosher (or halal) eater will never eat nonkosher (or nonhalal) food , but a nonkosher eater isn’t banned from eating kosher.

Let us call such minority an intransigent group, and the majority a flexible one. And the rule is an asymmetry in choices.

I once pulled a prank on a friend. Years ago when Big Tobacco were hiding and repressing the evidence of harm from secondary smoking, New York had smoking and nonsmoking sections in restaurants (even airplanes had, absurdly, a smoking section). I once went to lunch with a friend visiting from Europe: the restaurant only had availability in the smoking sections. I convinced the friend that we needed to buy cigarettes as we had to smoke in the smoking section. He complied.

Two more things. First, the geography of the terrain, that is, the spatial structure, matters a bit; it makes a big difference whether the intransigents are in their own district or are mixed with the rest of the population. If the people following the minority rule lived in Ghettos, with their separate small economy, then the minority rule would not apply. But, when a population has an even spatial distribution, say the ratio of such a minority in a neighborhood is the same as that in the village, that in the village is the same as in the county, that in the county is the same as that in state, and that in the sate is the same as nationwide, then the (flexible) majority will have to submit to the minority rule. Second, the cost structure matters quite a bit. It happens in our first example that making lemonade compliant with Kosher laws doesn’t change the price by much, not enough to justify inventories. But if the manufacturing of Kosher lemonade cost substantially more, then the rule will be weakened in some nonlinear proportion to the difference in costs. If it cost ten times as much to make Kosher food, then the minority rule will not apply, except perhaps in some very rich neighborhoods.