On Pianos and Automobiles

Jeffrey Tucker at the Mises Institute has written an interesting article on the U.S. piano industry and its parallels to the current problems facing the U.S.automotive industry. As he points out,

Today the highest-price good that people buy besides their houses is their car, and this reality leads people to believe that we can't possibly let the American car industry die.... What about the time before the car? Look at the years between 1870 and 1930. As surprising as this may sound today, the biggest-ticket item on every household budget besides the house itself was its piano. Everyone had to have one. Those who didn't have one aspired to have one. It was a prize, an essential part of life, and they sold by the millions and millions.

As it turns out, the piano industry followed a pattern similar to that of the automotive industry: At one time U.S. pianos were the best and the economic conditions in the U.S. permitted piano manufacturers to be successful exporters. After 1930, piano sales began a decline lasting until after WW II. In 1960, foreign producers (notably Japanese producers) began competing and by 1980 only Steinway remained as a domestic piano manufacturer.

Was there a bailout of the U.S. piano industry? No. Rather, the market for U.S. made pianos largely collapsed due to economic pressures. Should the U.S. and Canadian governments bailout U.S. car makers (the Canadian government has offered loans to those producing in southern Ontario, contingent on U.S. support)?

In the end you have to ask, is it really worth trillions in subsidies, vast tariffs, impositions all around, just to keep what you declare to be an essential industry alive? Well, eventually, as we have learned in the case of pianos, this is not essential. Things come and things go. Such is the world. Such is the course of events. Such is the forward motion of history in a world of relentless progress generated by the free market. Thank goodness that FDR didn't bother saving the US piano industry! As a result, Americans can get a huge range of instruments from all countries in the world at any price they are willing to pay.

Today government is even more arrogant and absurd, and it actually believes that by passing legislation it can save the US car industry. It can subsidize and pay for uneconomic activities, and pay ever more every year. The government can also pay millions of people to make mud pies because mud pies are deemed to be an essential industry. You can do this, but at what cost and what would possibly be the point? Eventually, even the government will have to accord itself to the reality that economics reminds us of on a daily basis.

Winter Tires

Anyone who has been driving in Calgary over the last week has had their nerves tested. After a storm and high temperatures hovering around -20 C, the roads are covered with ice and packed snow. Perfect conditions for slipping and sliding. If it were a game of bumper cars, it would be perfect.

One problem is that it seems not many people in Calgary have snow tires. Well, maybe its time for a law similar to that passed in Quebec:

Quebec has a new law that makes winter tires mandatory from Nov. 15 to April 15, whether you live in Val-d'Or or downtown Montreal. Austria has a similar law and, in Germany, many insurers will not pay winter weather-induced claims if your vehicle is not properly equipped with winter tires. Ontario is debating a mandatory winter tire law of its own.

While this may impose an additional cost on drivers, when one looks at the current conditions on the roads, its hard to imagine that people aren't incurring similar costs in terms of time lost in traffic, vehicle damages, and tax money spend pulling accidents from the road.

Calgary to purchase the Cecil Hotel

Yesterday the City of Calgary approved the purchase of the Cecil Hotel for $10.9 million. The Cecil Hotel, which sits at the entrance of downtown Calgary when entering from the east using Memorial Drive, has developed a notorious reputation, known as a magnet for drug dealing, prostitution, and violence. According to the city of Calgary responded to 1700 police calls at the Cecil last year (as quoted in the December 16, 2008 article entitled "City to pay $10.9 million for Cecil"). In defending the price tag the city will pay for the Cecil, Mayor Dave Bronconnier said "There is no question there was, in fact, a premium put on the acquisition, but I think when you look at long-term, 1700 police calls are not inexpensive either." The city plans to tear down the Cecil Hotel, potentially replacing it with a parkade.

While many people are concerned with a price tag of the purchase (and the use of tax payer money), I think the city needs to also consider the effects of displacing the people who stay and live at the Cecil. This does not appear to be something the city has seriously considered. In fact, in recent months the city has opposed the development of additional space to house the Mustard Seed and Inn From The Cold (both of which assist homeless and low income individuals and families). On the corner where the Cecil sits, the city recently closed the tavern in the Cecil Hotel and Beer Land, a liquor store which was frequented by individuals of low-income. All of this has been part of the city's plan to clean up downtown and attract more commerce and people into the core.

At the same time as these closures have taken place, there has been an increase in crime in the surrounding neighborhoods of Bridgeland, Renfrew, and Inglewood. Recent statistics show that, for example, break-ins in these areas have increased from two per month to seven per month. Moreover, if one takes a drive through the residential areas of Bridgeland (north of the downtown core) one notices many more people hanging out in back alleys and drinking during the day.

While I think it's important that Calgary make an effort to revitalize downtown, it seems the city is only partially addressing the issue with its current policies. This has been the mistake made by other towns (e.g., San Jose ,California) where cleaning up one part of the city (e.g., downtown) necessarily involves moving those problems to another part of the city. This is a shortsighted approach as it doesn't address the fundamental causes (poverty, drug and alcohol addiction) that motivate city Council to clean up the downtown. Personally, I would've liked to see the city take a more proactive approach, perhaps purchasing the Cecil allowing but using it for low income housing while providing counseling and training services to the individuals who frequent the area. It seems to me that this is a more complete approach to "cleaning up downtown.".

More on Music and Economics

I've written on the subject (I guess), but here's a new piece for those building a portfolio of papers on music and economics.

Music and the Market: Song and Stock Volatility

Abstract:
I compare the annual average beat variance of the songs in the US Billboard Top 100 since its inception in 1958 through 2007 to the standard deviation of returns of the S&P 500 for the same year and find that they are significantly negatively correlated. With the recent high stock volatility, people should now prefer less volatile music. Furthermore, the beat variance appears able to predict future market volatility, producing 2.5 volatility points of profit per year on average.

Keywords: music, trading strategy, billboard, variance, volatility

Has economics as taught in Canadian Universities become irrelevant?

In the Calgary Herald on Saturday, Peter McMartin wrote a story that challenges the relevance of economists given that so few anticipated the recent economic crisis, and perhaps even worse, seem to have no clue as to how this mess might be fixed. The usual critics of neo-classical economics are represented by JK Galbraith's son James, an economics professor himself. About the abysmal forecasting ability of economists of late, Galbraith states:

"It's an enormous blot on the reputation of the profession. There are thousands of economists. Most of them teach. And most of them teach a theoretical framework that has been shown to be fundamentally useless."

But it's not just Galbraith. Agreeing with Galbraith, Rick Harris of SFU adds:

"What is it we teach? What is taught is the textbook properties of what I would say is a normal functioning economy. And most of that stuff has nothing to do with what is going on now."

Paul Beaudry of UBC is not as down on economists as Galbraith and Harris over the recent events since Beaudry discounts the importance of forecasting as one of our profession's core purposes. Instead, Beaudry sees economists in playing a bigger role in analysing events after the fact and to use that knowledge to prevent crises from re-occuring:

“Really, the science is managing (the economy) after all this stuff has come out. Have we learned from the previous crises? And if we’ve learned from previous crises, what policies should we follow to prevent them from happening again?”

From this story, it appears that economists are either irrelevant for understanding and managing the economy, or just useless over the short run.

Read the full story, Peter McMartin, "Economists go soul searching", Calgary Herald, Nov. 22, 2008, page C2.

Most of the story is available at:
http://www.canada.com/calgaryherald/iphone/business/calgary/story.html?id=e683dc66-0e6b-406a-8487-3e167bd2e05f

Women in the Economics Profession

It's no secret that women are underrepresented in the economics profession. Part of this, as has been pointed out by many, is a selection story: women aren't attracted to the economics profession the way men are. However, Christian Zimmerman, who runs the RepEc service, posted the following:

Women have always been underrepresented in Economics. For example, regarding US faculty, the Committee on the Status of Women in the Economics Profession (CSWEP), a subcommittee of the American Economic Association, determines in its latest annual report that women represent 28% of assistant professors, 21% of associate professors and 8% of full professors in PhD granting Economics department. As a whole, they represent 19% of all Economics faculty.

The point of this post is not to complain about the low proportion of women in the profession, or about their dwindling share up the ladder, but about the lack of involvement on women in RePEc. Currently, their share is at 14.5%. It is clearly below the 19% mentioned, although it is slowly increasing (it was 13.6% a year ago and 12.7% two years ago). Why this underrepresentation?

The importance of health

While the headlines have been full of the financial crisis, and the monster $700bn bank bailout, health care continues to be a key story in the US, which spends approximately 16% of GDP annually on health care but achieves poor average outcomes. If the US could reduce its health care spending to the levels of other OECD countries, it would save approximately $700bn per year, enough to pay for a bank bailout every year, without compromising average health outcomes... There are some very large potential gains the Democrats can harvest.

the Case Against Multiple Choice Exams

I recently gave a midterm in my intermediate microeconomics class. A portion of the midterms was multiple choice at the request of many students. One of those against a multiple choice portion on the midterm sent me this. I have to say I agree. I hate taking multiple choice exams almost as much as i hate writing them.

AC/DC and the Economy

I'd like to thank my colleague Chris Auld for pointing me to this article. It turns out that AC/DC record sale are counter-cyclical... well, sort of. Basically, an article in the Guardian points out that when times are bad, AC/DC's sales are up. The reasoning is as follows:

AC/DC's appeal in unpredictable times is straightforward. People crave something uncomplicated and dependable in a time of uncertainty, and rock music has never produced a band so uncomplicated and dependable as AC/DC.

For 35 years, they have done exactly the same thing - which in guitarist Angus Young's case involves dressing like a naughty schoolboy - unaffected by changes in fashion or band personnel.

Not even the death of lead singer Bon Scott could stop AC/DC cranking out hard-edged, wilfully basic blues-rock, decorated with lyrics in which the phrase "rock 'n' roll" figures heavily, but not as heavily as sniggering innuendo about scrotums.

This makes my research look a little less silly.

Asking forgiveness

Daniel Klein, is the editor of Econ Journal Watch, a publication which addresses controversies and discourse in economics. He, along with Peter Gordon, are putting together a symposium on preference falsification in economics wherein economists can bear their souls regarding their behavior in the professions, particularly regarding research:

The symposium will be edited by Professor Peter Gordon of University of Southern California. Authors who wish to remain anonymous in print will nonetheless disclose their true identity to Professor Gordon, who will serve as confidante of such authors. No one else will be privy to such information. Authors may need to disguise specific facts. Professor Gordon will verify all facts that are reasonably verifiable.

Professor Kuran will serve as an advisor to the project. In that capacity he may review some of the manuscripts at an advanced stage. He will not be privy to the identity of the authors.

The impetus of the symposium is to provide an outlet for exploring preference falsification and other forms of moral or intellectual compromise within the economics profession. Authors are encouraged to be introspective and personal, and yet impartial. The purpose of each essay should be to share experiences that speak to situations to which many can relate. We seek biographical essays that will help others understand widely shared problems.

In his or her essay, the author should clarify the kind of preference falsification in which he or she has engaged. For example:

• Building models one does not really believe to be useful or relevant.
• Making simplifications that obscure or omit important things.
• Using data one does not really believe in.
• Focusing on the statistical significance of one’s findings while quietly doubting economic significance.
• Engaging in data mining.
• Drawing “policy implications” that one knows are inappropriate or misleading.
• Keeping the discourse “between the 40 yard lines” so as to avoid being outspoken; knowingly eliding fundamental issues.
• Tilting the flavor of policy judgments to make a paper more acceptable to referees, editors, publishers, or funders.
• Disguising one’s methodological or ideological views, such as by omitting revealing activities or publications from one’s vitae.
• For government, institute, or corporate economists: Having to significantly play along with things one does not believe in.

Further clarifications:

• Papers need not be anonymous. It is also OK to propose a paper in which you will write as your true identity.
• The voice should not be bitter or conspiratorial. We are not interested in tales of mistreatment. Rather, we are interested in experiences of preference falsification that instantiate and illuminate broad cultural problems within economics.
• Papers should be autobiographical reflections based on narrative. The style should be personable and plain. (For an example, one might consider the tone and style of this article by Michael Marlow.) Authors may wish to open their essays with reflections about why they became an economist.
• Narratives must avoid accusation. Incidents should be suitably told in a generic way, without identifiers. Any flavor of “getting even” will disqualify a proposal. Any flavor of “this is how the world has been unfair to me” will disqualify a proposal.
• Economists from academia, government, the policy community, and the private sector are welcome to submit proposals. Also, narratives about graduate studies in economics are welcome, even by young economists.
• Economists from all parts of the world are encouraged to submit proposals, but everything must be in English.
• Again, only Professor Gordon will know the true identity of authors who are to write anonymously.
• If successful, the symposium will subsequently be turned into a book proposal, in which case selected papers would also be published in a book.
• Though not crucial or necessary, prospective authors may wish to consult William Davis’s article “Preference Falsification in the Economics Profession,” which relates survey findings to Kuran’s theory of preference falsification.
• Length is open, but probably most essays should be fairly short (1000-2000 words).

Halloween Economics

With Halloween approaching, I thought it might be fun to bring to your attention a new paper by Dean Karlan et al. This is a great paper on an important and interesting field experiment.

In the paper, the authors discuss and experiment conducted on Halloween 2007 in which they had trick-or-treaters (you know the kids who show up at your door asking for candy) to choose from an ambiguous urn of types of candy or an urn in which the distribution of candy types was known. Here's the abstract:

We examine whether ambiguity aversion correlates with costume choice amongst children at Halloween. We conducted an ambiguity aversion experiment with children on Halloween during trick-or-treating and correlated this with their choice of costumes. We find that children wearing the most commonly chosen costumes are more likely to avoid a gamble with ambiguous odds. This inquiry is in line with a series of recent papers observing whether choices in simple experimental economics games correlate with theoretically similar non-laboratory behavior.

They actually conducted two experiments, but the second one resulted in such a long queue outside one of the author's house that it proved infeasible. In the results section, they discuss a number of kids who particpated in the experiment but were not wearing costumes. Who shows up to go trick-or-treating without a costume? Maybe you forget a bag or something to carry your Halloween bounty in, but no costume? Which brings up the other question, who gives kids with no costume a treat on Haloween? If they don't have a costume, aren't they chaperones? I usually offer the adults in this "trick-or-treaters" a choice between an urn with an ambiguous distribution of beer or known candy. When given this type of offer, they display no ambiguity aversion.


The complete paper is available here.

Arrow on the Financial Crisis

I'm currently teaching Arrow's work on risk and uncertainty in a graduate course. Here's an editorial from the Guardian by Kenneth Arrow, winner of the 1972 Nobel prize in economics and truly one of the ground-breakers in modern economics. Here's he provides his insights on the current financial crisis.

The current financial crisis, the loss of asset values, the refusal to extend normally-given credit and the great increase in defaults on obligations ranging from individual mortgages to the debts of great investment banks presents, of course, a pressing challenge to the fiscal authorities and central banks to take measures to minimise the consequences. But they also present a challenge to standard economic theory, a challenge all the more important since the development of policies to prevent future financial crises will depend on a deeper understanding of the processes at work.

That economic decisions are made without certain knowledge of the consequences is pretty self-evident. But, although many economists were aware of this elementary fact, there was no systematic analysis of economic uncertainty until about 1950. There have been two developments in the economic theory of uncertainty in the last 60 years, which have had opposite implications for the radical changes in the financial system. One has made explicit and understandable a long tradition that spreading risks among many bearers improves the functioning of the economy. The second is that there are large differences of information among market participants and that these differences are not well handled by market forces. The first point of view tends to argue for the expansion of markets, the second for recognising that they may fail to exist and, if they do come into being, may fail to work for the benefit of the general economic situation.

The value of spreading risks has, of course, been recognized as the basis of conventional insurance as well as the issue of company shares that spread corporate risks widely. The central element of standard economic analysis since the 1870s has been the concept of general economic equilibrium, which, under competitive conditions, leads to an optimal allocation of resources. In the 1950s, it was shown how to incorporate uncertainty into general equilibrium, which suggests, at least, that increasing the number and coverage of risk-bearing instruments would improve the running of the economy. Not only would risks be more efficiently borne, but, more importantly, additional socially valuable risky enterprises would be undertaken. Research showed how derivative securities should be priced, how individuals should choose portfolios to minimise their variability, and how individual contracts, such as mortgages, could be bundled so as to distribute the risks for different parts of the market with different risk tolerances.

The second strand of analysis was a growing recognition of the importance of information in governing reactions to uncertainties. If individuals in the market have different degrees of information, the ability to create securities or engage in other forms of contracts becomes limited; the less informed understand that the more informed will take advantage and react accordingly. This situation was long recognized by insurance companies under such terms as, "moral hazard" (when the insurer cannot tell how well the insured is avoiding risks) and "adverse selection" (when the insurer cannot distinguish among differentially risky insured, so that, at any given premium, the more risky insure themselves most extensively). Economists began to realise that "asymmetric" information was the key to understanding the limits of health insurance and the incentive problems of socialism and then that these concepts found their most important application in financial markets, precisely in the complex securities that the first strand of analysis had called for.

There is obviously much more to the full understanding of the current financial crisis, but the root is this conflict between the genuine social value of increased variety and spread of risk-bearing securities and the limits imposed by the growing difficulty of understanding the underlying risks imposed by growing complexity.

Krugman on Krugman

Paul Krugman won the Nobel prize in economics on Monday. Today, his NYT column was on.. well, him and his research. I think he does a good job explaining his contributions and new trade theory. Here's an excerpt:

The new trade theory starts with the observation that while this explains a lot of world trade, it also misses a lot. France and Germany sell lots of stuff to each other, even though they have similar climates and resources; so do the United States and Canada. What’s that about?

The answer is that there are many goods that aren’t like wheat or bananas, but are instead like wide-bodied jet aircraft. There are only a few places in which wide-bodied jets are produced, because of the enormous economies of scale – you only want a couple of factories worldwide. Those factories have to be somewhere, and those countries that get the factories export jets, while everyone else imports them.

But who gets the aircraft factories, or the factory producing a specialized kind of machine tool, or the plant producing a particular model of car that selected consumers all over the world want? The answer of new trade theory – and it was a tremendously liberating answer – is that it doesn’t matter. There are many economies-of-scale goods; everyone gets some of them; and the details, which may be largely a story of historical accident, aren’t important.

What matters, instead, is the overall pattern of trade: the broad pattern of what countries produce is determined by things like resources and climate, but there’s a lot of additional specialization due to economies of scale, and there’s much more trade, especially between similar countries, than you would expect from a purely resource-based theory.

You may think all this is obvious, and it is – now. But it was totally not obvious before 1980 or so – except for some prescient quotes from Paul Samuelson, you really can’t find anyone describing trade this way until after the theory had been laid out in mathematical models. The plain English version came later.

And you should bear in mind that economists have been thinking and writing about international trade for a couple of centuries; to come along and say, “Hey, we’ve been missing half the story” was a pretty big thing.

Now, on to geography. A decade after the original new trade stuff, I started thinking about what happens when some (but not all) economic resources, especially labor and capital, can move. In the world of the old trade theory, “factor mobility” was a substitute for trade: if factories and industrial workers can move freely, they’ll spread out to be close to the farmers, and neither food nor manufactured goods will have to be shipped long distances. But in the economies-of-scale world I had been studying, the “centrifugal” effect of widely dispersed resources, which tends to push economic activity into spreading out, would be opposed by the “centripetal” pull of access to large markets, which tend to promote concentration of economic activity.

Think of Henry Ford and his Model T. He could have established many factories, spread across the country, to be close to his customers. Instead, however, he found that it was worth incurring extra shipping costs to achieve the economies of scale of one big factory in Michigan.

And once you’re concentrating production in a limited number of locations, which locations will you choose? Locations where there’s a large market – which will be locations where lots of other producers have also chosen to concentrate their production. If the centripetal forces are strong enough, you’ll get a cumulative process: regions that for historical reason have a head start as centers of production will attract even more producers, becoming the economic “core” while other areas become the “periphery.” Thus for about a century, until the rise of the Sunbelt, the great bulk of U.S. manufacturing was crammed into a fairly narrow belt from New England to the inner Midwest; today, 60 million people live along a narrow stretch of the East Coast. Those 60 million people aren’t there because of the scenery; each of them is there because the other 60 million people are also there.

John Kenneth Galbraith

Today would be the 100th birthday of John Kenneth Galbraith. I read his book The Affluent Society in grad school after it as recommended to me by Douglas Dowd.

Here's something written in commemoration of his 97th birthday:

If ever there was a legend in his own lifetime, it is John Kenneth Galbraith, professor emeritus of Harvard University, adviser to Presidents from Roosevelt to Kennedy and Lyndon Johnson, author of more than 40 books, and a man due to celebrate his 97th birthday next Saturday.

Known as JK Galbraith to most and Ken to his close friends, he is the tallest (at 6ft 8in) and oldest economist in America. He is also the most famous living economist in the world - and indeed the best-selling.

In common with many of my generation, I first came across Galbraith's work in The Affluent Society (1958), a hugely successful book - so brilliant and so unmathematical that it incurred the envy and wrath of a certain cohort of his fellow economists.

It was a book that challenged many assumptions about economics and politics (which, for Galbraith, have always been closely linked) and which gave the world some great insights and lasting sayings, including 'the conventional wisdom' and 'private affluence and public squalor'.

The phrases were good summaries of Galbraith's argument that the goals of economic policy had been distorted and more attention should be paid to the quality of economic growth and the distribution of its fruits.

I first met Galbraith in 1980, after we at The Observer asked him - a redoubtable Keynesian - to comment on Mrs Thatcher's adoption of Milton Friedman's monetarist policies, under which unemployment rose to 3.5 million.

He famously wrote: 'Britain has, in effect, volunteered to be the Friedmanite guinea pig. There could be no better choice. Britain's political and social institutions are solid and neither Englishmen, Scots nor even the Welsh take readily to the streets.'

Galbraith has certainly lived to see Nemesis descend on Friedman. In the Financial Times of 7 June 2003, Friedman conceded: 'The use of quantity of money as a target has not been a success ... I'm not sure I would as of today push it as hard as I once did.'

Galbraith was introduced to Keynesian ideas for curing unemployment in the 1930s and never forgot them. As a wonderful new biography, John Kenneth Galbraith, His Life, His Politics, His Economics by Richard Parker, makes clear, despite some minor differences he adhered to the essential teachings of Keynes.

In advising Kennedy, Galbraith warned of the inflationary consequences of tax cuts and was more interested in channelling any 'Keynesian' budgetary measures towards public spending. By that he did not mean military spending, of which there was quite enough already under what was known as 'the military-industrial complex'.

Galbraith was so close to Kennedy he could have been in White House chief economist Walter Heller's job, but preferred to be ambassador to India, a position from which he was still able to advise his young protégé in a series of letters, of which he once told The Observer: 'First he would call me up to ask what to do. Then to tell me what he was doing. Then he would not call me at all.' Perhaps Kennedy's biggest mistake was in not taking Galbraith's advice over Vietnam ('Don't do it'), although the evidence from the new biography is that the young President certainly took that advice seriously.

Before The Affluent Society, Galbraith had already written a best-seller in The Great Crash, 1929, published in the 1950s and never out of print. But many regard his greatest work as The New Industrial State (1967), a study of the power of big business and large corporations.

And it is a subject that still fascinates him. For some years now I have had the privilege of calling on him at his home in Massachusetts on my way back from annual meetings of the World Bank and International Monetary Fund in Washington.

This year he was showing his age and clearly did not want a full-scale interview. But he certainly wanted to talk about corporations. 'The modern corporation operates under the mystique of the market, which is extensively under its control. This is a matter which modern economics recognises but does not pursue.'

And the man who warned Kennedy about the championing of war in Vietnam added: 'Our military operations, including notably Iraq, are under corporate direction through Rumsfeld and a compliant military staff. In the absence of corporate initiative and power we would not be in Iraq. And, a more poignant matter, we would not have George Bush.'

The great man is still in fighting form.

Paul Krugman wins the Nobel Prize in Economics

Monday, Paul Krugman was announced as the winner of the 2008 Bank of Sweden's Nobel Prize in Economics. He's the third economics Nobel laureate at Princeton, but their first in the economics department (John Nash is in mathematics and Daniel Kahneman is in psychology). Here's the blurb from the Financial Times (14 October 2008).

The Nobel economics prize was awarded yesterday to Paul Krugman, one of the great popularisers of economic ideas and a trenchant critic of the Bush administration. However, the prize was awarded for work done almost three decades ago in developing what is known as “new trade theory” and “new economic geography”.

Earlier trade theories suggested that a country would trade with partners that were different - rich would trade with poor, and capital-intensive would trade with labour-intensive. In practice, rich countries tend to trade with other rich countries.

Mr Krugman’s analysis showed why this was to be expected: many products were most efficiently produced by large companies, but consumers wanted variety and would buy products from foreign giants as well as the dominant domestic corporations.

Mr Krugman’s ideas on the importance of economies of scale could be traced back to Adam Smith, but the new ingredient was a usable mathematical description of what was going on.

Economic geography uses much the same mathematics to explain the location of jobs and businesses. Mr Krugman showed that the forces of globalisation, far from creating a “flat world”, could enhance the power of global cities such as New York and London, because they could do business with a global market.

Mr Krugman, a professor at Princeton University and a prominent columnist for the New York Times, has long been seen as a future Nobel laureate. He won the John Bates Clark medal for young economists in 1991. Yet if the choice is not surprising, the timing - just before the US presidential election - might be. Mr Krugman is an influential and partisan political commentator.

His columns, first in Slate magazine and then the New York Times, were at first clever refutations of popular misconceptions about trade protection or the “new economy”, but they have become far more notable for their stinging attacks on the Bush administration. He has recently criticised Hank Paulson, the US Treasury secretary, for mishandling the credit crisis, while praising the British government for being “willing to think clearly about the financial crisis, and act quickly on its conclusions”. He also warned of the US housing bubble in 2005.

This is not the first time that the Nobel prize committee has recognised an economist with a public profile and an appetite for political debate. Joseph Stiglitz shared the prize in 2001, after a combative stint as chief economist of the World Bank; Milton Friedman was an early laureate in 1976.

Among professional economists, Mr Krugman is admired for his work on currency crises as well as the work on trade that won the prize. Avinash Dixit, a Princeton colleague, once described Krugman’s methods: “He spots an important economic issue months or years before anyone else. Then he constructs a model of it, which offers new and unexpected insight. Soon the issue reaches general attention, and Krugman’s model is waiting for other economists to catch up.”

Mr Krugman’s trade model showed that there were circumstances in which trade protection could be in a nation’s economic interest. This idea was joyfully embraced by protectionists, and Mr Krugman spent much of the 1990s vigorously defending free trade and arguing that trade protection in practice was almost always harmful.

The experience may have fuelled his enthusiasm for economic popularisation, although even his early writing betrayed a wit and clarity not common amongst economists: he wrote, in 1978, “A theory of interstellar trade”, commenting that it was “a serious analysis of a ridiculous subject, which is of course the opposite of what is usual in economics.”

Upcoming Event: Law School

As a professor, you often get questions from students regarding options for graduate school, careers, etc. Many ask about graduate school opportunities outside of economics (i.e., grad school opportunities that are available with an economics undergraduate degree but do not involve and M.A. of Ph.D. in economics). I know several individuals who have pursued law degrees and are not fully immersed in what economists study under the rubric of "law and economics." with that in mind, here's an upcoming event on the UofC campus:

Interested in a Career in Law?

Wed, Oct. 22, 5 - 7 p.m. Education Building C179
Are you thinking about going to Law School? If the answer's yes, you'll want to attend an upcoming info session to learn all about:

- The Application Process - including deadlines, tips on submitting a good application, and available scholarships
- Career Prospects - Hear from practicing lawyers about career prospects and the type of work they're involved in. - Student's Perspective -Gain an understanding of what law school life entails from a current law student

Understanding the Financial Crisis in the U.S.

I've been asked by a number of people about the current financial crisis in the U.S. I've been struggling to find a simple way to explain it, but now have some resources.

First, Roger Congleton has put together a good set of notes explaining the credit crisis. (HT to Tyler Cowen)

Secondly, Joesph Stiglitz was on Democracy Now today (October 2nd). He gave an easy to understand presentation of the crisis, its causes, and its relation to the current war in Iraq.

A New Paper

I recently read what I think is a great paper. The paper is "On Amenities, Natural Advantage and Agglomeration" by Doug Krupka. The abstract reads,

A prominent feature of economic geography in America is the positive correlation amongst local incomes, housing costs and city population. This paper embeds a “black box” agglomeration economy within a more neoclassical general equilibrium model of local wages, rents and population to assess the ability of various conceptual models to predict this cross-sectional variation. I use exogenous changes in housing supply to induce changes in population and examine whether the changes in rents and wages move in the same direction under neo-classical assumptions, agglomeration economies in production, congestion in production, or urbanization economies in consumption. On their own, none of these urban scale effects generate the observed pattern. All urban scale effects generate a negative correlation between rents and population. Combining natural advantage with the urban scale effects improves the models’ output. It generally predicts positive correlations amongst the three variables, although some of these effects are ambiguous in the production agglomeration model. If natural advantage and housing supply constraints vary more-or-less independently, the results suggest a better fit of the data is provided by either the congestion in production or the agglomeration in consumption models. The micro-economics of such consumption-oriented agglomeration economies have received less attention than production-oriented agglomeration economies. The results of this model thus suggest that consumption-oriented agglomeration and congestion should receive more attention in the future.

Doug brought it to my attention. The title of the paper should appear as

On Amenities,
Natural Advantage and
Agglomeration

A perfect haiku! In addition to the poetic title, the paper is good.

Washington Mutual

Here's ago, my wife and set up our first joint bank account with Washington Mutual in Sacramento California. Now that bank is on the verge of failure and federal take-over in the states. This would be (in nominal terms at least) the larges bank failure in U.S. history and will have effects across the entire economy.

We still have $209.34 in our account. I hope it's safe.

Canada and the Housing Crisis in the U.S.

There is increasing concern among Canadian economists regarding the effect of the U.S. financial crisis and ensuing bailout on the Canadian economy. Over the past weekend, I attended a meeting of the Canadian Institute for Advanced Research which was attended by both David Dodge and Mark Carney (the latter attended only for a short period, having the crisis to deal with).

One of the biggest concern is in regards to the effect of the crisis on Canadian exports to the U.S. Of particular concern is the exports of Canadian lumber which is a prime input in the U.S.'s struggling housing market. As reported by Bloomberg:

"The current situation poses particular problems" because it affects "areas that matter most for Canada," such as demand for cars and lumber, Carney, 43, said in a speech today at the Canadian Club of Montreal. Policy makers had already identified tighter credit conditions "as the main risk to a modest U.S. recovery next year" and recent events make that possibility "more probable," he also said.

As a result, many economists expect the financial crisis in the U.S. to result in a strong slow-down in Canadian economic growth:

LEVIS, Que. — Canada's economy faces a long period of stagnation as several risks, including softening housing construction and a tougher credit market, will force a quiet and slow recovery, says a Desjardins Group economist.

The firm's projections for Canadian economic growth were trimmed from one per cent to 0.6 per cent this year, and from 1.8 per cent to 1.3 per cent next year.

"With economic projections this low... we are clearly going to see a long period of quasi-stagnation, especially given that there are several major downward risks looming," chief economist Francois Dupuis said in a note Tuesday.

"The recovery will be slow and progressive, with no fireworks."

Dupuis pointed to "fragile" consumption in the United States and a U.S. housing market that shows no signs of recovery as two factors that have impacted Canada's exports.

He coupled that with weakening housing construction in Canada, tough credit conditions and a deteriorating labour market as factors that are taking a toll of the local economy.

"Along with government spending, personal consumption is the only factor that is allowing Canada's economy to keep its head above water," he said.

"With confidence at a low ebb, the hope of avoiding a recession is holding on by a thread."

The report noted that oil prices which skyrocketed throughout the year were fairly devastating to the world's economy.

Desjardins predicts that the global economy should advance by about 3.7 per cent this year, down one percentage point from 2007.

Federal Funding of the Arts

I just wanted to note on a couple of things going on locally and federally with regards to funding for the arts.

Here in Calgary, there has been a big push by the mayor to get increased provincial funding for law enforcement. A recent letter to the editor in the Calgary Herald ("Get Tough" September 19 2008) states one view on the issue:

Overhaul the justice system so it no longer hugs a thug and starts treating criminals like criminals. They gave up their "rights" when they broke the law, so treat them the way they have treated the good people of our country. Build more jails and get the criminals in them faster and for much longer periods of time. How to pay for that? No fancy bridges, no high-dollar art in government buildings. Funnel all the money that is spent on art, culture and other non-necessary things. In some Caribbean countries, there is no leeway -- you break the law, you go to jail and you serve hard time for a long time. The penalties are too harsh to even consider breaking the law. We need a federal leader who will grow the backbone to seriously shake up the justice system. Come up with a budgeted, realistic and believable promise to do this, and you'll get my vote.

The view espoused here (to put it somewhat mildly) is that the arts should come second to other public goods. Some of this debate (and I believe the piece the author is referring to) has developed with the arrival of "A Device to Root Out Evil" in Calgary.

One of the questions raised by this debate is "What is the benefit of public funding of the arts?" Many have argued that funding of the arts is essential for preserving and developing a group or nation's idea of identity. In this sense, support for the arts supports Calgarians' sense of identity or pride in their city. (As a note, the Canadian Institute for Advanced Research research group on Social Interactions, Identity, and Well-Being thinks that discussions of identity are often missing form policy debates and economic analysis. Issues of identity have been important in the Council of Europe's research on social exclusion.) Evidence from psychology and economics is that a shared sense of identity can increase cooperation, well-being, and more generally, social capital. In terms of public policy, increases in feelings of shared identity or community could reduce some criminal activity (through increasing the concern individuals have for others or reducing individuals' desire to eschew the law) and increase the productivity of public goods (by reducing the extent of free-riding problems).

Below is a video which takes aim the cuts to arts funding that have occurred under Stephen Harper's government. The message in this video is, I think, one of the importance of arts in preserving (here) Quebecois culture. A couple of notes on the video:

1. Michel Rivard is a a Quebecois singer-songwriter. He is one of the founding members of Beau Domage.
2. The French word for "seal" (the animal) is "phoque". It is pronounced f*ck.

The Marginal Cost of Eggs

Over the weekend, I had breakfast at Chris' Cafe in Coleman, Alberta. The two-egg Denver omelet cost $7.75. The three-egg version costs $7.95. That's $0.20 for the marginal egg. At that price, you're losing money not getting the third egg!

Harper's proposed tax cut

Mr Harper yesterday proposed a reduction in the excise tax on diesel fuel, of 2 cents per litre, to be implemented at some point in the next 4 years, at a cost to the treasury of approximately $600m. It is hard to think of a good reason for such a tax cut, except for a political one: the Prime Minister wants to be able to compare a program of tax "cutting" with the Liberal proposal of tax increases on carbon-based fuels. Of course, a tax cut on diesel just means some other tax cut that can't be implemented.

This proposal is a sad example of the triumph of politics over policy in a campaign.

The Economics of Drive-Throughs

A recent article in the Calgary Herald (“Customers are getting fed up over wait times at retail outlets”, August 27 2008) cited a new study finding evidence that "86% (of Canadian consumers) say that least once they have re-shelved their purchases or skipped the coffee and left the store" due to long lines.

Interestingly, the reporter interviewed a customer at Tim Horton’s. (For those not familiar with Tim Horton’s, it’s a very popular chain of Canadian coffee/donut shops. They are famous for something called a "double-double" which is a coffee with two creams and two sugars.) Being a non-Canadian, I find the Tim Horton’s phenomenon amazing: Aside from serving what I think is very bad coffee, every Tim Horton’s seems to have huge line of customers. In MacEwan Hall on the University of Calgary campus, there are at least three coffee places of which Tim Horton’s is the only one with a significant line (sometimes in excess of 25 people).

A new Tim Horton’s recently opened relatively close to my house. It is included with a Shell station and is about two blocks from another Tim Horton’s (located in an Esso station). What is amazing about the new Tim Horton’s (aside form the fact that people actually drink this coffee) is the lineup at the drive-through. My guess is that it averages six cars throughout the day and I’ve counted as many as 22 cars in the morning. This latter amount is so many that it blocks people from getting gas at the Shell station.

This leads me to wonder a bit about the environmental costs of drive-through services. Most of the cars in the lines are idling, which is probably the least efficient use of one's car. Moreover, most of the people in the drive-through are able-bodied and would be able to purchase their double-double from the line inside (where, incidentally, there are multiple servers as opposed to a single server at the drive through).

Due to these environmental costs, some communities have sought to regulate or even ban drive-throughs. I offer my $.02 on this issue: I think it would be wise for businesses offering drive-through services to include a surcharge for these services. Individuals using the drive-through are likely doing so as a matter of convenience and this convenience is something the company can charge for. By increasing costs the drive-through, firms will capitalize on this additional convenience they provide and increase the cost of idling your car in line. Essentially, this is a profit-maximizing way for firms to get individuals internalize the environmental externality they are imposing when waiting in line at the drive through.

Of course, there may be fairness issues regarding those individuals who use the drive-through because they are less mobile (e.g., the elderly, individuals with physical handicaps). I guess this is all simply food for thought (although I wouldn’t recommend Tim Horton’s donuts either).

About Crack and Carseats!

I thought of posting my first with something esoteric - dealing with crack and using child carseats.

The second one is still alien to me and the first one...well lets not get into that so early in the day!

O.K., without anymore unnecessary prologue, lets hear about these two things from an ingenious economist of our time. Just follow the links below and have great fun!



On Crack: http://www.ted.com/index.php/talks/steven_levitt_analyzes_crack_economics.html



On Child Carseats:http://www.ted.com/index.php/talks/steven_levitt_on_child_carseats.html



Best.

Academic Salaries and Research Performance

Some new research has emphasized the relationship between the quality of research and the salaries researchers (particularly economists) receive. For example, from the abstract of Glenn Boyle's "Pay Peanuts, Get Monkeys":

In most countries, academic pay is independent of discipline, thus ignoring differences in labor market opportunities. Using some unique data from a comprehensive research assessment exercise undertaken in one such country -- New Zealand -- this paper examines the impact of discipline-independent pay on research quality. I find that the greater the difference between the value of a discipline's outside opportunities and its New Zealand academic salary, the weaker its research performance in New Zealand universities. The latter apparently get what they pay for: disciplines in which opportunity cost is highest relative to the fixed compensation are least able to recruit high-quality researchers. Paying peanuts attracts mainly monkeys.

The point is that researchers respond to opportunity costs and incentives (as discussed in a previous post). Boyle's finding holds not only in academia, but also in a recent review of the Bank of Canada:

An external management audit on the Bank of Canada's research unit showed the country's central bank could benefit from a staff and officer upgrade.

The review team made up of five leading U.S. economists said the bank's economic researchers are underpaid, focused on micromanagement and investigates irrelevant topics. The bank has 42 staff on its research department.

Reviewer Martin Eichenbaum, an economics professor at the Northwestern University in Illinois, said the Bank of Canada must improve its research capacity for the institution to be able to keep up with the major developments in economics and finance.

"You can't run a good policy without a first-class team... You're talking about decisions that affect people's lives here," Eichenbaum told the Globe and Mail.

Among the body's top recommendation is for the bank to increase the salaries of its PhD economists by $15,000 to $20,000 from their current pay of $90,000 per annum for it to attract the best minds. The $90,000 pay is the equivalent of a professor's pay at a second-tier Canadian university only.

It turned out some of the bank's researchers had no other job offers when they accepted the work at the Bank of Canada, prompting the team to comment, "This salary structure seems like a clear recipe for mediocrity rather than excellence."

The review was completed by the U.S. team in February, but posted in the Bank of Canada's website this month.

Veblen Effects and Status Seeking

Thorstein Veblen argued that individuals have an innate desire to signal their wealth (and thereby obtain social status). In our department, both Curtis Eaton and I have done research on how this type of status seeking can affect behavior and economic outcomes. That said, I don't think either of us thought it would look like this:

Yesterday developer Armin Heinrich posted an iPhone app to the App Store called I Am Rich. The program displays a red gem, has no function but to display your wealth to others through ownership, and costs $1000.

Here's the complete post. (HT to Tyler Cowen.)

New research from the Economic Journal (June 2008)

The recent issue of the Economic Journal has some interesting articles on the effects of regulation on individual behaviors.

First, Sandra Black, Paul Devereux and Kjell Salvanes find that compulsory schooling laws reduce the rate of teenage childbearing. From their abstract:

This article investigates whether increasing mandatory educational attainment through compulsory schooling legislation encourages women to delay childbearing. We use variation induced by changes in compulsory schooling laws in both the US and Norway to estimate the effect in two very different institutional environments. We find evidence that increased compulsory schooling does in fact reduce the incidence of teenage childbearing in both the US and Norway, and these estimates are quite robust to various specification checks. These results suggest that legislation aimed at improving educational outcomes may have spillover effects onto the fertility decisions of teenagers.

Secondly, Thomas Dee finds that the legalization of same-sex marriages helps reduce the incidence of certain sexually transmitted diseases. From his abstract:

One conjectured benefit of a marriage-like legal status for same-sex couples is a reduction in the incidence of sexually transmitted infections (STI). In this study, I discuss how such a policy might influence risky sexual behaviour and STI rates. I also present reduced-form empirical evidence on whether same-sex partnership laws have reduced STI rates, using country-level panel data from Europe. The results suggest that these laws led to statistically significant reductions in syphilis but not in infections that are not sexually transmitted. However, their effects on the incidence of gonorrhoea and HIV were also smaller and statistically imprecise.

In the same issue, there are still some unanswered questions about the gender pay gap. From Alan Manning and Joanna Swaffield's abstract:

In the UK the gender pay gap on entry to the labour market is approximately zero but ten years after labour market entry, there is a gender wage gap of almost 25 log points. This article explores the reason for this gender gap in early-career wage growth, considering three main hypotheses – human capital, job-shopping and 'psychological' theories. Human capital factors can explain about 11 log points, job-shopping about 1.5 log points and the psychological theories up to 4.5 log points depending on the specification. But a substantial unexplained gap remains: women who have continuous full-time employment, have had no children and express no desire to have them earn about 8 log points less than equivalent men after 10 years in the labour market.

Understanding the 10 Principles of Economics

This video always makes me laugh. The comic (Yoram Bauman) is an editor at Economic Inquiry and accepted one of my papers.