A assortment of links

Some excellent links: 

Roberto Solow on Hayek and Friedman

Robin Williams on how only Scotsmen could have invented golf

Noah Smith with an old but excellent piece on libertarianism (local bullies dont like being told not to bully) 

Max Schireson on being a dad and a CEO (h/t from Andrew Sullivan)

Poverty is terrible even if you have nice clothes and a flatscreen TV

In the discussion of inequality, one common retort is to argue that the poor are not really poor since they often wear excellent shoes and clothes, have iPhones, flatscreen TVs, XBox, and drive decent cars. This is a terribly bad argument for two reasons. First, it reveals a poor understanding of the economy. Amenities like clothes, tvs, iPhones, and even cars constitute an increasingly small faction of the average American budget. This is because continuous productivity improvements drive down the prices of these types of goods. That is like saying because you eat as much fruit as a billionaire, you must be extremely rich.  Meanwhile, education, healthcare, housing, and childcare constitute an increasingly large fraction of the American budget. These goods and services are susceptible to Baumol's cost disease: productivity improvements are very difficult in certain areas and hence prices continue to rise. And in these very important areas, the poor are indeed falling significantly behind.  

The second point is about risk. The ability to manage risk is one of the most important components of well-being in life, yet often gets overlooked. Shoes, TVs, and Xboxes will not help if you need major medical surgery or need to spend exorbitant amounts of money to defend yourself properly in the legal system. The threat, worry, and concern of becoming bankrupt at any given point in time because of the vagaries of life is something unique for the poor and lower middle class. The ability to completely manage risk by the upper middle class and rich manifests itself in many ways. First, not having to deal with the stress of bankruptcy is an incredible boost to one's quality of life. Second, not having to worry about risk afford freedom in a variety of ways: the freedom to move geographically anywhere, the freedom to leave a job you hate, the freedom to leave a bad relationship, etc. Imagine having to give up these freedoms because of the inability to cope with risk and tell me if that compares to having nice sneakers or a TV. 

Because of the the importance of managing risk, wealth inequality is a better proxy for capturing real inequality. Wealth captures both consumption and the ability to manage risk. And wealth inequality is more extreme than consumption and income inequality in the US and is getting more extreme. And even wealth inequality underestimates the real separation between the poor/lower middle class and everyone else. The upper middle class/rich have not only their own wealth but also access to the wealth and support of their significant social networks (social capital). If they need money in case of an emergency, they have wealthy families. If they lose their jobs, they have connections that will help them get another job soon. 

So next time someone argues that the poor dont have it that badly, remember two things: (1) differences in access to goods and services such as education, healthcare, housing, and childcare; and (2) the ability to deal with risk in life. It really, really sucks to be poor and we shouldn't let disingenuous arguments about the consumption of amenities obscure the reality.  

Individualism and sports

Today's Men's Wimbledon Finals was an instant classic with Novak Djokovic defeating Roger Federer in 5 thrilling sets. The drama was intense partly because this was such an important finals for both players.

Djokovic came in to the Wimbledon finals with a 6-7 record in grandslam finals. With a loss today, he would be approaching Ivan Lendl territory: one of the finest players of his generation but with a losing record in grandslam finals (8-11) that defined his legacy downwards. I thought Djokovic had turned the corner with his 2011 campaign, one of the best ever, with 3 grandslam wins, a 70-6 record, and 6 wins in finals over Rafeal Nadal. He then followed that up with a win at the 2012 Australian open over Nadal in one of the longest and greatest tennis matches ever. It was perhaps the height of the reign of Djokovic. Since then Djokovic's level has dropped off and more troubling has been his inability to close out matches in the late stages of grandslams, leading to a 1-5 record in the finals of grandslams in the last 2 years. 

On the other side of the net, Roger Federer is on the shortlist of greatest tennis players ever. At 32 he is likely in the twilight of his career but he had stormed through Wimbledon 2014 like it was 2006 with only one service game and set dropped through 6 matches. This may have been one of his best remaining opportunities to capture grandslam win #18 at his favorite tournament. 

The high quality match had incredibly twists and turns, especially in the 4th set, where Djokovic blew a 5-2 lead to lose 7-5. His inability to close out the match, combined with his recent struggles must have played havoc on his mind. Add to that a slight ankle injury, no tie breaker in the 5th set, and the unflappable Roger Federer on the other side; that Djokovic was able to win the 5th set was truly a testament to his mental fortitude. 

I've always wondered something about Americans' passionate love affair with sports. Team sports such as football, basketball, and baseball sit atop the pantheon, which belies another observation: Americans value the rugged individual. A tennis match is truly an individual effort. Preparation itself involves a team but during the match, there are no teammates, there is no coaching, there are no breaks for being tired. It's you and the opponent and nothing else. In that 5th set, Novak Djokovic had no one else to rely on except himself. No teammate to pass the ball to as the doubt crept into his head. No sub to take his place for a few minutes while he got treatment for his body. No coach to give him a pep talk or offer strategy. The pressure, the mind questioning, the body breaking down, legacy on the line. Djokovic re-wrote his today. Tennis tests the physical and mental limits of human's capacity for resilience in sports that team sports simply cannot match. This is why I love tennis.

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.