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It is a truism that Western economies face a demographic problem: more older people and fewer working-age people will mean a higher dependency ratio. This future problem, we are told, requires action now, Now, NOW! We must prepare for the future by raising the retirement age and reducing superannuation payments.

Except that the future is already here, and no one has pushed the panic button.

Brad DeLong gives us the US statistics:

The employment-to-population ratio has fallen in the US. Therefore, the number of people being supported by each employed person has increased. While this is not an increase in the dependency ratio (which is defined by age cohorts), it has the same effect: fewer workers supporting more people. And yet, I’m not hearing the same urgency, the same concern to move heaven and earth to solve the actually existing problem.

I had a look at the NZ statistics, to see how we compare (courtesy of StatsNZ’s Infoshare). I can’t swear to have this exactly right, but this is what I found:

I calculated the proportion of adults employed as (all employed, seasonally adjusted) divided by (people aged 15+), and labour force participation as (all employed + registered job seekers) divided by (people aged 15+). The proportion of adults employed has, indeed fallen by 2 percentage points since 2008. Meanwhile, labour force participation has actually increased. That is, we have people ready and willing to go to work, but we aren’t using them.

Having fewer people employed to support our population is a concern for the future. However, it is also a problem now.

Alex Tabarrok posted at Marginal Revolution about sticky wages. It’s an interesting bit of mathematics. I can see his point, that sticky wages for employed people can keep the labour market from adjusting. Because the unemployed are a minority of the labour force, even large reductions in the wages they are willing to accept have a small impact on the total wage bill.

My reaction to this bit

If all employed workers accepted a 5% pay cut (or if the government ordered such a cut) and the Fed kept targeting inflation, we’d experience rapid economic growth.

was, ‘What’s this “we” stuff?’.

Tabarrok is saying that if ‘we’ take a 5% pay cut, ‘we’ can have economic growth. What kind of economic growth entails having less? My only explanation is that Tabarrok is treating labour costs only as costs, as something to be reduced. There is no recognition that those costs are also the returns to people’s labour, and that increases in those returns are exactly what most people experience as growth.

The second problem with this idea is that it doesn’t fix the problem. The US economy is depressed because of low aggregate demand. Tabarrok’s solution is to take the same insufficient demand and spread it amongst more people. That will put more people back to work, but it doesn’t really solve the underlying problem.

This sort of analysis seems to forget that the economy exists to provide people with goods and services. It isn’t some separate entity whose growth somehow has nothing to do with the people involved.

I’ve been turning this over in my head for weeks. Obviously, the economic/political problems in the US are one of biggest economic issues going, and I’ve not blogged about them. Part of the reason I haven’t is that it is very difficult to separate the political from the economic.

I should also say that I’m not a macroeconomist. I discussed this a bit here (p. 6), but I studied macro in the 1980s, and what I remember most is confusion. Our professors tried to teach us all the contemporaneous strands – Keynesian, neoclassical, monetary – but I didn’t understand until much later that they couldn’t all be true. Going into the problems of 2007, I didn’t have good models for thinking about what was going on. For example, I saw the huge build-up of the money supply, and thought it would bring inflation.

I have learned a lot about macro in the last few years. I have spent a fair amount of time reading articles and blogs, trying to make sense of what has been happening in the US. What I have found is that Krugman and DeLong have been right, and lots of other economists have not. That is, they have been able to say, ‘here is what we would expect to happen in this situation’, and they have been right.

Thus, it is also a distinct disappointment to find posts like this one from kiwiblog. He has the economics all wrong. The economic situation is what we would expect – given the correct model – from this type of recession and the tepid government response. The US is suffering from a lack of aggregate demand, and the government can currently borrow at zero percent to lift demand now. To quote Krugman:

By contrast, the Krugman/Thoma/DeLong axis (I still like it!) is basically using standard macroeconomics, applied to a nonstandard situation. The Hicks/Keynes model — in which demand drives output in the short run, interest rates are determined by the tradeoff between liquidity and yield, and extreme negative shocks push you into a liquidity trap in which conventional monetary policy loses traction and deficits don’t crowd out private spending — has worked very well in this crisis, which is why we keep using it with a few twiddles (such as emphasizing the role of private debt).

We are lucky, here. I shouldn’t say this too loudly, but I think NZ is probably well-placed to weather this storm without too much trouble. Government debt is low. Our main trading partners are Australia and China, both doing well. We export food, which people still need. We should take the opportunity to learn from other countries’ pain. We could learn which models fit the facts, and which ones don’t.

NZIER (where I work) has just published a new Insight on the next steps for water policy. The Royal Society recently published an issues paper on ecosystem services. Natural capital and the value it creates for the economy is clearly topical.

It isn’t just a neat research area, either. I had an interesting conversation today with some District/Regional Council people, and they are grappling with ecosystem degradation. In their case, the amount of water available is declining, and the quality of drinking water is falling below international standards. If their ecosystem weren’t overloaded, then the aquifers would be recharging and the natural water-cleaning processes would be adequate. That’s not happening.

I’ve spent a little time on environmental/ecological issues. I keep coming back to the saying, ‘what gets measured, gets managed.’ If we want to manage our ecosystems, we have to measure the aspects of it that we think are important.

At the NZAE conference, Tim Harford had some interesting things to say about measurement. He pointed out that when we enact policies, we are in effect conducting experiments. We should take measurements just like we would in a laboratory. Often, though, the funding isn’t available to take measurements. We conduct experiments but let them go to waste. Sometimes, measurement is even actively avoided.

When it comes to ecosystem services, I don’t think we have that luxury. These are big, complex systems that we don’t fully understand. We need as much data as we can get so we can continue to enjoy New Zealand’s relatively clean environment and profit from it (depending on our preferences).

But we also need the right data, so there is an important role for economists. As the Royal Society paper points out, the value of ecosystem services is bound up in human activity. It is about the services provided to people, and how they value them. It isn’t just about water chemistry, or about how the chemistry leads to clean water, but also about what value people put on the clean water. So economists are integral to this work.

The NZIER and Royal Society publications are helpful additions to the discussion. I hope we can build on them.

I generally stay out of tax debates. I don’t know the economic theories, and valid comparisons are difficult to make.

This comparison by Rodney Hide (via Kiwiblog) bothered me, however:

A business generates $100 a year. The going discount rate is 10 percent. The value of the business is $1,000. That’s if there’s no tax.

Introduce a tax of, say, 30 percent, and the business now yields only $70 a year. The business is worth only $700. The tax liability is capitalised into the value of the business.

Hyde’s no-tax baseline may be official ACT policy, but it isn’t the correct counterfactual. We should compare the tax treatments of different investments, given the objectively observed existence of taxes. Let’s look at the tax treatment of an alternative investment:

A bond yields a return of $100 per year. The going discount rate is 10 percent. The bond yield is treated as income for tax purposes and taxed at 30 percent. The bond is worth $700.

Under current rules, income from capital ownership that is treated as interest income is taxed, while income from capital ownership treated as capital gains is not. Instituting a capital gains tax would address this difference.

But let’s take this one step further. Consider human capital, not physical capital. We’ll start with Hide’s introduction, but change the ending:

Imagine a young widow with children ….’ She has immigrated to New Zealand after her husband was brutally murdered by Maoist tax collectors. She gets an entry-level job in tourism. She starts attending university to integrate into her new country and better her family’s future. She graduates, and becomes General Manager – Tourism for her company.

In this situation, she has invested in her education from after-tax dollars. The return on her investment is also taxed, and at a higher marginal rate than before. This situation certainly looks like double taxation.

By Hide’s logic, the educated among us are over-taxed. There’s a policy position I could support.

Tim Harford, columnist for the Financial Times and author a new book, Adapt, will be delivering the opening keynote address at the NZAE conference on 29 June in Wellington. The main idea (apparently – I’m waiting until the conference to buy a copy) is that we need to adapt through trial and error, rather than relying on experts to design grand solutions.

Slate had an excerpt from the book that I found thought-provoking. It addressed the issue of how to design science funding systems that permit or even encourage new ideas, which are, by definition, unconventional. I have some sympathy for the view that science funding needs flexibility.

The Financial Times liked the book:

[Harford] has assembled a powerful combination of anecdotes and data to make a serious point: companies, governments and people must recognise the limits of their wisdom and embrace the muddling of mankind.

A review of the book takes on the central thesis, however, and finds it lacking (h/t to Crooked Timber):

Tetlock divided his experts into foxes (good at many things) and hedgehogs (good at one thing) and argued that hedgehogs are over-confident because they “reduce the problem to some core theoretical scheme’… and they used that theme over and over, like a template, to stamp out predictions”. And that’s exactly what Harford does here. He sees evolution as a fox-like strategy (trying many things and selecting a few) but doesn’t notice that at the level of individual species, evolution gives us both foxes and hedgehogs, and both do perfectly fine.

So, food for thought. I’m looking forward to hearing Tim speak. Won’t you join us?

My family just got a new game, Rummikub. The last game we bought was Yahtzee. We bought both of them at the shop, and paid $28 to $40 for each one.

We didn’t have to buy either one. Instructions for both are available on the Web. Rummikub can be played with two standard card decks and two jokers. Yahtzee requires five dice and some custom scoring sheets, but the sheets are also on the Web.

So, why did we pay for these games?

In the case of Rummikub, the plastic tiles are easy to use and will last longer than cards. Durability is a reason to pay more. On the other hand, they are also likely to outlast my kids’ interest in the game. In the case of Yahtzee, I have to admit I was annoyed when I realised what the big box actually contained.

By revealed preference theory, we were willing to pay for these games, even though cheaper versions were available. Why?

  • I think, first, that we cannot discount ignorance. I didn’t know what Yahtzee was, so I didn’t make an informed decision. Rummikub? Well, we had played it at a relative’s house. I suspected that it could be played with cards, but hadn’t really looked that hard.
  • A related factor is convenience. Everything we needed to play the games was in one place, ready for use. No searching needed! We spent a little money to save a little time.
  • Uncertainty also came into our decision. We could have learned more about the games before we bought them. However, without conducting the search, we couldn’t know what we would find. They were ‘unknown unknowns’, to use a memorable phrase. We could decide to conduct a search, but without knowing what we would find, it was hard to decide whether the search would be worthwhile.
  • One really important reason was the rule books, the official rules to both games. We now have a way to resolve our disputes when we play. We are also ready to play these games with other people. We can participate in a common standard, or at least we have a way to find out what it is.

And this takes me to my point. The main thing we bought was reliable information. We felt that it was better to spend some money than to spend time on a potentially fruitless search. We also wanted to guarantee that we had some common understanding with the rest of the world. We bought membership in the network or community that plays Yahtzee.

That reliable, useful information, which in turn allows us to interact easily with others, cost money. All this talk about the explosion of information, costless information, ‘information wants to be free‘, and the like, isn’t the full story.

I have two new games to prove it.

There’s been an interesting discussion on some economics blogs about the state of economics knowledge. It’s part of a larger and perennial discussion/debate about what we should research and teach.

Despairing for their professions:

Brad DeLong reacts to an answer by Larry Summers about which economists are relevant:

Asked to name where to turn to understand what was going on in 2008, Summers cited three dead men, a book written 33 years ago, and another written the century before last.

Paul Krugman has been despairing for a while:

[W]e’re living in a Dark Age of macroeconomics. Remember, what defined the Dark Ages wasn’t the fact that they were primitive — the Bronze Age was primitive, too. What made the Dark Ages dark was the fact that so much knowledge had been lost, that so much known to the Greeks and Romans had been forgotten by the barbarian kingdoms that followed.

In New Zealand, the NZAE may be able to help. We have members from throughout the profession, both producers and consumers of economics knowledge. By talking with each other, we might be able to figure out what the relevant knowledge is and how to produce and transmit it.

But that raises some questions. Is there a market failure in the production of knowledge? That is, are economists really not producing the kind and amount of knowledge that is being demanded by knowledge consumers? Furthermore, would co-ordination help the problem?

The alternative is that the right amounts and kinds of information are being produced to satisfy those with an effective demand for it.

The Government’s new energy policy was released, apparently by accident. Groups and businesses involved in the energy sector have already started commenting on it.

As a general picture of New Zealand’s energy future, the summary on pages 6 and 7 is pretty good. There is a solid economic framework underneath. For example, it includes both supply and demand factors. On the supply side, nearly every source of energy gets a mention (nuclear energy is absent). On the demand side, the policy mentions new technologies to help consumers manage their energy costs. The idea of assessing marginal impacts almost makes it, such as in this passage: ‘Oil is used efficiently and where it is most highly valued.’ Technological growth is given its due, too, with a nod to ‘continuous improvements in energy efficiency’.

Reading just these two pages, you get a sense that there is a lot to think about. Our modern economy is based on cheap energy. An illuminating example is Nordhaus’s research on the historical price of lighting. The amount of lighting one could obtain with 5 hours of labour in 1800, had become nearly too cheap to measure in 1992. If the energy era truly is ending, what does that mean for our economy?

On the other hand, the report also shies away from fully facing up to the potential conflicts. Early the report, we are told that ‘the government is interested in pursuing energy initiatives that have both an economic benefit and a positive overall effect on the environment’. This is a clear statement of non-satiation: we would like to have more of everything. But economics tells us that we also need to consider our budget constraint. It’s when we have to give up some of one good to have more of another that things get interesting.

Putting together my first post made me think about the economics of blogging. Blogging is a tournament game: low barriers to entry, with a very few earning fame and fortune. In that respect, it is similar to dealing drugs (see Freakonomics).

For most bloggers, the return is low. If someone is blogging about economics, and doing a credible job of it, s/he presumably has marketable skills. Banks, universities, ministries, think-tanks — there’s a long list of potential employers. Why bother producing a blog?

Three reasons came to mind:

  • Weak altruism. Working on the NZAE Council, I see how much other people have contributed over the years. Now, through blogging, I can help improve the visibility and relevance of the Association. If economics looks relevant, then I look relevant, too.
  • Consumption good. Although I’m producing something, the real reason for writing a blog is the enjoyment of production. That makes blogging like playing music, knitting, and baking biscuits. Sure, we can argue about the relative quality of home-made versus store-bought, but in the end it’s about the pleasure of producing it yourself. It just so happens that I enjoy producing economic arguments.
  • Signalling. Well-known economics blogs tend to be side-lines. Why are otherwise successful people blogging, and why aren’t more economics bloggers famous in their own right? This looks like signalling in two parts. First, I’m not going to trust Billy Bob’s Forum of Economics and Used Hardware (no link). The fact that someone has a day job (in economics) signals trustworthiness. Secondly, getting involved with blogging signals with-it-ness. I can grok the new media, man. That makes me more in demand for my day job.

So blogging is like the rest of the economy: I am sending signals in order to improve my individual outcome, while contributing to my own tribe (but not too much) and taking pleasure from it.

Here’s to a new and strong signal from NZAE. We’ll enjoy the DIY, and we’ll try to keep the noise down.