Some fun with the Fermi Paradox

And here is a fun read about the universe. Read it when you have a few minutes to go through it slowly, allowing yourself to get absorbed in the possibilities. The Fermi Paradox.  

Links on "Capital in the 21st Century"

Piketty's Capital in the 21st Century has generated many comments and thoughts. Here is a non-exhaustive list of the some of the better comments: 

1. Branko Milanovic
2. Brad Delong
3. Justin Wolfers
4. Matthew Rognlie
5. Debraj Ray
6. Robert Solow
7. Larry Summers
8. Paul Krugman
9. Tyler Cowen
10. Suresh Naidu
11. Noah Smith
12. Thomas Edsall (with a good comment from Daron Acemoglu)

Capital in the 21st Century (part II)

In my previous post, I discussed the main mechanism laid out by Piketty in his book. Here, I discuss 3 concerns I have with his theoretical model:

1. r > g is a necessary condition for inequality to rise in Piketty's model. The main strength of Piketty's work is his data analysis and here he does a commendable job trying to identify r and g over a millennium:

Piketty argues that r has been approx between 4-5% for most of history and significantly higher than g until the 20th century. He views the 20th century as en exception rather than the new rule: "r fell because of two world wars as the capital stock decreased." However, i find his justification rather uncompelling. If r was 3% during the 1950-2012 period, right after a period of incredible capital destruction, why would r be significantly higher in a long-run equilibrium?

2. The next point is that even if r is high in the long-run, K^ = r only if r is completely re-invested. However, some portion of r is consumed, especially in the form of housing, so it must be that K^ < r; how much less depends on many factors including the rich's marginal propensity to consume, donate to charity, etc. 

3. In Piketty's mechanism, X = r * (K/Y) is the capital share of the economy. As (K/Y) increases and r remains relatively flat at 4-5%, X must rise. But we generally believe that there are diminishing returns to resources.  Hence as (K/Y) rises, the returns to capital (r) should fall. Piketty handles this criticism by arguing that the elasticity of substitution between capital and labor will increase in the future. A high elasticity of substitution will create uses and generate returns for capital even as its relative stick continues to rise.

I am actually quite sympathetic to a high elasticity of substitution between capital and labor (which I describe in the next post) but  in what way is the high elasticity of substitution a feature of capitalism?  The substitution between labor and capital could happen, and in my view, could accelerate, but is not a given and hence not a feature of capitalism, which is what Piketty is aiming to describe

Capital in the 21st Century (part I)

The book of the year in economics is clearly Thomas Piketty's monograph titled, "Capital in the 21st Century." Piketty, through his empirical research, has done much to advance our understanding of inequality, and hence I was quite eager to read this book. 

As expected, the empirical portion of the book did not disappoint. Wage, capital, returns to capital are very difficult to compute going back in time and Piketty performs a Herculian effort in trying to do so. The picture he paints is strong and convincing. Income and wealth inequality has been increasing in the US and other developed countries for the last several decades and is approaching levels unseen since the Belle Epoch (turn of the last century). 

There are potentially many drivers of inequality over the last few decades. Explanations include technological change, globalization, the decreasing power of unions, and the superstar effect. Piketty goes above the fray and instead of looking at particular causes of inequality today, attempts to develop an overarching theory of capitalism and inequality. 

Piketty's argument is as follows (^ below is used to denote annual changes in the variable): 

Until the 20th century, Piketty demonstrates that the after-tax return on capital (r) has been greater than income growth (g) and he takes the 20th century to be an exception rather than a new normal. Then, if r is completely reinvested, K^ = r and K^ > g. Note that by definition, g = Y^. Hence, we get that (K/Y) is increasing over time. If (K/Y) is increasing and r is fairly constant, than it must be that X = r*(K/Y) is increasing over time, where X is the capital share of the economy. Hence, Piketty posits that the capital share of the economy will increase over time. Since, capital is concentrated in a few hands, inequality will therefore inexorably increase over time.

Since r > g is the key catalyst for inequality in his model, Pikkety argues for a global wealth tax to lower r. In my next post, I'll discuss some of my thoughts on this. 

Rand Paul speaks about the injustices of the drug war

The first 2 minutes of this recent speech by Rand Paul are excellent.  I am happy that Rand Paul is running for president if only for the reason that he is raising awareness of the injustices in our criminal justice system.

His main points:
1) Black teens gets jailed at 3-4 times the rate as white teens despite similar drug use rates
2) The jail sentences are way too extreme for youthful, victim-less mistakes and are tearing apart families
3) Felons' voting rights should be restored after they have paid the price for their crimes

I could not agree more. I think Barack Obama probably agrees on all three accounts. But, ironically, Rand Paul has a better chance of moving the needle in terms of public opinion, and even perhaps legislation than Obama on this issue. I hope Paul continues to make these issues front and center of his campaign and fights for this whether he wins or loses his campaign for presidency.  (Disclaimer, I am not supporting of Rand Paul for President. But glad he is running since he is the only person I have seen bring up these issues, which are vitally important). 

Tiered justice system

In December 2012 HSBC admitted to laundering money for Mexican and Colombia drug cartels. The bank was fined $1.9 billion (5 days of revenues) and not a single person went to jail.  On the other side of the drug trade, you have the story of Anthony Smelley: 

Early on a morning in January 2009, Smelley, who is 22, was pulled over while driving along I-70 in Putnam County, Indiana. Months earlier, he'd been in a car accident and won a $50,000 settlement. He states in court documents that he had taken around $17,500 with him that January day en route from his home in Detroit to St. Louis, to buy a new car for his aunt. 
Smelley was pulled over for making an unsafe lane change and driving with an obscured license plate. He was also driving with an expired driver's license. His traffic stop should have ended with citations for those infractions. Instead, the police officer asked Smelley to get out of the car and patted him down, finding the cash. The officer then called in a K-9 unit for a sniff search of Smelley's car for drugs. The dog alerted twice. Smelley and two passengers were arrested, and the police seized Smelley's money. 
A subsequent hand search of Smelley's car turned up no illicit drugs, and no criminal charges were ever filed against Smelley or his passengers. Smelley produced a letter from a Detroit law firm confirming he had been awarded the $50,000 from the accident. That didn't matter. Putnam County has since held Smelley's money for more than a year. The prosecuting attorney said, “We can seize money if we can show that it was intended for use in a drug transaction at a later date…”

So if bankers launder money for drug cartels, shareholders pay a fine but not a single banker is prosecuted for jail time or pays any fees. Meanwhile, Smelley’s money can be confiscated because there is a chance he may buy drugs in the future? For a long time I used to think the inequalities in the American legal system were noise in an otherwise beautiful system. But the more you read, the more you realize that we have three legal systems. The one for the middle of the country operates reasonably well and is the envy of the world. There is a second one for the rich and white collar criminals. And there is a third for the poor and blue-collar criminals. 

Here is another example of how the criminal justice system works if you're poor via stop and frisk in Miami Gardens, FL: 

Earl Sampson has worked for nearly three years at the 207th Street Quickstop, a convenience store that has become the epicenter for police stops. Earl, 28, says he’s been stopped more than 200 times by the Miami Gardens Police Department (MGPD). According to records obtained by Fusion, MGPD stopped him and filed a field contact report 181 times. In addition, Earl was arrested 111 times. Seventy-one of those arrests were for trespassing at his place of work. "They walked through the door, grabbed me and just take me out,” says Sampson. "I told them I work here and they said I don’t care.” Quickstop owner Alex Saleh says he was so appalled that he installed video surveillance cameras in his store - not to record crime but to record police misconduct. In January 2012, Alex says he gave his employee, Earl Sampson, a place to live inside the store to protect him from the police. But even that was no deterrent..police are seen storming into Earl’s bedroom in the back of the store. 

Matt Taibbi contrasts the top and bottom tiers of our judicial/legal system in greater detail in his book American Injustice in the Age of the Wealth Gap and I highly recommend reading his book. Learning about our vastly different tiers of our justice system is heartbreaking and infuriating. And as economic inequality rises, the tiered nature of justice in America could increasingly define us. 

Efficiency vs equality (part II)

In the previous post, I discussed “efficiency” without defining it. Economists have a very strict definition of this important term: if a state of the world can make some better off, without hurting anyone, that state of the world is more “efficient.” On the other hand, a new state of the world, that increases the overall size of the pie but makes some better off and others worse off is not “efficient” by this definition. One reason why economists use the stricter definition of efficiency is that under diminishing marginal utility, overall social welfare may not necessarily increase in the second case. However, in the first case, social welfare is always higher.

Economists have spent considerable time arguing that international trade is efficient. (As a caveat, Stiglitz and others have demonstrated instances where international trade can be inefficient but that is a discussion for another day). So in theory that means international trade makes some people better off and no one worse off. But at the same time, economists acknowledge that international trade leads to “winners” and “losers.” But there are no “losers” in a more efficient state of the world. How to square this circle? Economists argue that there can be a transfer of monies from the “winners” to the “losers” such that the “winners” are still better off and the “losers” are no worse off than before. Hence, as the example of international trade shows, efficiency and redistribution are not mutually exclusive. In fact, redistribution is absolutely necessary for international trade to be efficient!

Economists who believe in the efficiency of international trade (including myself) should also believe in increasing re-distribution from the “winners” to the “losers”. However, the tax code in the US has become increasingly regressive at the same time that globalization has increased dramatically. This is not efficient by economists own definition of efficiency. (Side note: are there situations under the theory of second best where increasingly regressive taxes contemporaneous with international trade can be efficient?).

In order to make international trade efficient, we need to better understand the “winners” and “losers.” The recent trade literature has luckily ignored Lucas’s advice and spent considerable effort trying to understand who is hurt from international trade. Hopefully this research will move us towards making international trade more efficient, but in the meantime, I am curious why economists have been silent as the US tax code has become more regressive over the years while loudly touting more free trade.

Efficiency vs equality (part I)

Inequality is the topic du jour in the United States and surprisingly even in economics. Surprising, because in my time in academia, it was definitely rarely a topic of research in the field. For example, out of the 100 or so PhD job market papers (which is a good proxy for where economic research is heading) I was aware of between 2008-2011, I dont think a single one was about inequality. Further, only a few academics were publishing papers in top journals on the subject of inequality. Robert Lucas, a nobel prize winner, and undoubtedly speaking for many economists, said in 2004, “one of the tendencies of sound economics, the most seductive, and in my opinion the most poisonous is to focus on questions of distribution.” 

Implicit in this statement, Lucas is assuming that there is always a trade-off between efficiency and equality and that thinking about increasing equality (or lowering inequality) must necessarily lead to less efficiency and is therefore “poisonous.” However, this is wrong for a few reasons. First, the second fundamental welfare theorem in economics posits that there is a very important instance where there is no trade-off between equality and efficiency. There are numerous other economic policy instances where there is no trade-off between efficiency and equality. Second, I would contend that even Lucas would agree that there is likely a certain level of inequality that would lead to sub-optimal economic efficiency. Where that point is, is very hard to say but without scholarship, how would Lucas imagine we could eventually have insights on this. I think that Lucas, and others like him, are perpetually stuck in the Cold War era, where thinking about issues of inequality meant “communism.” While there is no doubt that “communism” was a failure, economists and other scholars do a dis-service by not better understanding inequality. Forever drudging up the specter of communism as if that were the only alternative to an “efficient” model is intellectually dishonest. So with that opening salvo, more of my opinions on efficiency vs equality, inequality to come. 

Here's looking at you kid

Beautiful image in the Sky over Sweden a few weeks ago

H/t Phil Plait Click here

College - an investment or consumption good, and why the difference could matter

People go to college to learn, form networks, build credentials, and thereby invest in themselves. But, a series of studies by Stacy Dale and Alan Krueger found that going to highly selective colleges (versus a low ranked college) does not matter for most students in terms of their job/wage outcomes. On the other hand, it does matter for minority students and students who come from less educated families. How could this be possible and what is the difference between the two groups? One potential explanation could be social capital. The former group has significant existing social capital via their family and so does fine no matter which college they attend. Their college decisions appear to be more like the purchase of a high brand consumption good. Meanwhile, better colleges provide the latter group an opportunity to build their credentials and social capital necessary to succeed. For them, college is more of an investment.

Does it make sense to have only one model of higher education to deliver these vastly different purposes?

One potential cost of this one-size-fits-all model is demonstrated in this recent study. The authors spend 1 year immersed in a large, public flagship school in the Midwest. They find that some students come to college to essentially party and have a good time (college as consumption), secure in their existing social capital. Another group of students, who do not possess the same social capital, sometimes get caught up in the consumption side of the college experience and under-invest in themselves?

Another implication of college as consumption can perhaps be seen in the rapidly rising cost of a college education. There are surely numerous drivers of college tuition inflation (see Baumol's cost disease), but here is what I have in mind: if a significant portion of students value college as a branded consumption good, it is likely that the price elasticity of demand is quite low, contributing to the rapidly rising cost of college. On the margins, this is changing the cost-benefit analysis for students for whom college is predominantly an investment good. For example, if I simply need a credential to signal to the job market, should I have to spend 4 years and upwards of $200K?

Just as students sit along the investment/consumption demand spectrum for college, it makes sense to think we should have post-secondary options that sit along the spectrum: cheaper options for course content and credentialing; expensive options similar to higher ed options today; and hybrid models in between.