Friday, February 24, 2012


I just read something very interesting:

"From the earliest times of which we have record-back, say, to two thousand years before Christ-down to the beginning of the eighteenth century..."

The rest of that sentence and its context is not relevant to this post, except that it was written by a very well-educated man in the year 1930.

For all of my life, I have been aware of at least 10,000 years of human history. Yet here is a man, one of the smartest intellectuals and best economists of his time, who only knows about 4,000 years of human history.  Most of that probably comes from the Old Testament and other written records. Anything before Ancient Greece and the New Kingdom of Egypt is a mystery to him, and he shows no knowledge of the millenia-long histories of India and China.

In 1930, archaeology was basically just Indiana Jones-style tomb robbing and nobody had any clue about the overall history of humankind beyond what happened to be preserved in a few written texts. There was no concept of learning about the people of the past by looking at the bones and debris they left behind. Most of the background knowledge of human history and development that I take for granted was simply absent.

It is an incredible state of ignorance. Now I understand how Robert Howard could invent the ancient, advanced civilizations that populated his prehistorical world. As far as anyone knew, it could have happened. Human history might have involved hundreds of millenia of civilizations rising, prospering, and then falling into myth. It is only in the last 50 years of so that we have surveyed enough of the planet to know, with high probability, that there were no forgotten ancient civilizations with Iron Age tech or higher. 

We can trace our history to the beginning. We know where we came from and how. This was not true 80 years ago.

Archaeology has been responsible for this. It has advanced our knowledge of the world and ourselves in many ways. But it is hard to measure the value of this knowledge and put a good price on it, which is why archaeologists are constantly low on cash. It does not produce fun toys like research in physics and chemistry. But I think the quality of my life is higher because I know the history of the human species in a way that previous generations did not.

Edit: I posted to soon, I should have finished reading the article. The fun continues:
The absence of important technical inventions between the prehistoric age and
comparatively modern times is truly remarkable. Almost everything which
really matters and which the world possessed at the commencement of the
modern age was already known to man at the dawn of history. Language, fire,
the same domestic animals which we have to-day, wheat, barley, the vine and
the olive, the plough, the wheel, the oar, the sail, leather, linen and cloth, bricks
and pots, gold and silver, copper, tin, and lead-and iron was added to the list
before 1000 B.C.-banking, statecraft, mathematics, astronomy, and religion.
There is no record of when we first possessed these things.
At some epoch before the dawn of history perhaps even in one of the
comfortable intervals before the last ice age-there must have been an era of
progress and invention comparable to that in which we live to-day. But through
the greater part of recorded history there was nothing of the kind. 
This is so wrong that is it both funny and sad. Note the speculation of advanced civilizations before the last ice age. Archaeologists and historians have have given us records of when we first possessed all of the things he mentions.

Sunday, February 19, 2012

The Fallacy of "Consumption Driven Growth"

There is an annoying bit of economic illiteracy floating around that needs to be addressed. It often shows up in the newspapers and the other social sciences, and it needs to be squashed. This is, as the post title says, the idea of "Consumption Driven Growth".

Here's the example that inspired this post. My friend is a TA in a Geography class. One of the exam questions asked students to compare the economic growth of China and Brazil and the answer key said

China's growth in more investment driven. That means the Chinese are making things that make other things: factories, roads, telecom systems, urban metros, etc. Brazil's boom on the other hand is largely consumer and consumption driven, which doesn't create more favorable conditions for future growth.

This is wrong. It is completely backwards. It is the equivalent of me telling my class that jungles cause rain.

The correct answer is that productivity improvements are propelling growth in both Brazil and China. China has a higher higher investment rate, which is causing a temporary, and unsustainable, boost in the growth rate.

To show why, I will give a quick overview of the Solow Growth Model. This is normally an intermediate Economics issue, but it is included in the intro Econ textbook that I use, and this inclusion was one of the reasons I chose the book.

All economic output is divided between investment and consumption. Consumption is things like food and shelter that make your life better. Investment increases your capital stock, which is things like roads and factories that help you produce output more efficiently. More capital means more output, which means more resources that can be invested. If you keep investing the same percentage of your output, this would cause a never-ending positive feedback loop if it were not for depreciation.

Each year, some percentage of your capital stock falls apart and needs to be replaced. You have to divert investment spending to repairing things. While depreciation is a constant fraction of capital, each extra unit of capital gives you diminishing returns. Eventually you hit a point where the extra output that something adds to the economy is less than what it costs to repair. Think Bridges to Nowhere. Assuming no technological growth or improvement in the institutions of the country, depreciation plus diminishing returns mean that the economy will find an equilibrium where the capital stock is constant.

A one-time investment will do nothing in the long run, if people keep the same investment rate, because it will just fall apart. The capital stock will decay back to its initial equilibrium. We see this when some charity builds a road in Africa, where the government cannot maintain it, and it falls apart.

A permanent increase in the investment rate will permanently boost the capital stock. This causes a temporary boost in the growth rate, but you will eventually hit an equilibrium where the capital stock is no longer growing. Once you hit that equilibrium, the growth rate goes back to normal.

You cannot keep a permanently higher growth rate through investment, because you would have to keep constantly increasing the percentage of output invested, and the investment rate is limited to 100%. There exists some rate of investment that produces the highest amount of consumption in the long run, and it does not make sense to invest more.

Every economist knows that China's investment driven growth rate is not actually sustainable. They are doing what Japan did back in the 80's, and that ended in two decades of stagnation as the economy rebalanced itself. However, there is not anything unsustainable about Brazil's growth, except the bits driven by natural resources. 

The talk about consumer demand driving economic growth is superficial nonsense. All economic growth comes from productivity. You can have temporary bubbles driven by debt, or inflation, or transfers from other places, but that is not happening in Brazil. Their economy is growing because they are getting better at making stuff. The Brazilians are choosing to spend more of their new wealth on consumption, and their government is not using any financial repression to stop them.

There is a theoretical way for "Consumption Driven Growth" to happen. People split their time between leisure and work, and work allows them to purchase consumption goods. If people are all consuming a lot of leisure, and someone introduces a new consumption good that is highly desirable, than people will choose to work more because the relative rewards of work have gone up. This would generate economic growth. This situation, however, is not an accurate description of any major period of economic growth. Brazilians are working less, and enjoying more leisure, than before. All throughout history, the introduction of new consumer goods has happened along with with shorter workdays, not longer ones.

It is true that people are motivated to work, and become more efficient, and generate economic growth, because of a desire to consume. But this fact is pointless as a tool of economic analysis. The desire to consume is always there. It is a human universal to want more consumption, and to use consumption as a signal of social status. What matters is if you have the resources to fulfill those desires, and that depends on how much you can produce. Saying that consumption caused some period of economic growth is like saying that sex caused the baby boom.

Saturday, February 18, 2012

Fractal Camouflage

When I walk across campus, I am always looking around at the surroundings and other people. I like to be in the habit of maintaining good situational awareness, and it is very rare for anything to surprise me. A couple days ago, I was mildly surprised when I suddenly became aware of a person about twenty feet away that I had not seen before. It was a cadet wearing a fractal-camouflage Army Combat Uniform with a patrol cap. He had been looking down at his smartphone, so the visor of the cap covered his face, and I only noticed him when he looked up and his face was visible.

He had not been making any effort to hide. He was just standing around, against a backdrop of a grassy field that sloped up. The camouflage was good enough to completely fool the part of my visual cortex that looks for patterns and tells me when someone is nearby.

This incident is interesting by itself, but it is also related to the book Thinking, Fast and Slow, that I have been reading recently and highly recommend. The book surveys decades of research that show that much of our thought is automatic and unconscious, and subject to cognitive illusions that can hide the truth from us just like the optical illusions that let a cadet hide in plain sight.

Friday, February 17, 2012

Good Student

There is a student in my intro Econ class who really loves the class and my teaching style. His family includes bankers and finance professionals, so he is glad that he is learning enough to be a part of their conversation. He really likes the way that Economics uses math to address social issues, and the course has already changed his mind on the minimum wage and drug laws.

He is a senior, finishing up a mechanical engineering degree. He is doing a co-op with a power utility, and is on the management track. He came to my office yesterday and we had a nice long chat. I learned a lot of interesting things about our electric grid and the contracting arrangements between the different companies and organizations that make everything work well. I used my knowledge of the Coase Theorem to make a guess about arrangements for power line maintenance that was so accurate that it literally stunned him speechless.

Before coming here, he got a 2-year degree in some kind of engineering, and spent a summer working at a co-op in Belgium working with the dikes and water transport systems. Before that, he was a junior manager at a contact lens plant. He is very good at math, has excellent people skills, and has a great curiosity and love of learning, but is a bit disorganized and messy. Overall, he is the kind of student that every teacher dreams of having.

If you have not done so already, form a mental picture of this guy in your head.

He is a big black guy with a backwards baseball cap and diamond stud earrings.

Every year, I seem to have at least one guy that matches that description, who is a good and inquisitive student who likes learning what Economics teaches about the world. I tend to connect well with them, and with older and non-traditional students, and anyone who wants to learn.

Monday, February 13, 2012

A Real Word

A student just came up to me after class and asked 

Is 'technocrat' a real word, or did someone just make it up?

I explained to him that the answer to his question is 'yes' because the answer to both parts is 'yes'. 'Technocrat' is a real word, and someone just made it up. This is true of every single word in our language. Someone invented the word at some point on the past, and it became a real word whenever enough people used it and knew what it meant.

Now, it is a linguistic bastard of a word, because it combines an English prefix and a Greek suffix, but a great deal of English vocabulary was constructed in a similar way. Our language does not really follow any rules other than popularity.

This leads to thoughts of what makes a thing 'real' in a social setting. His question implies that 'reality' in language is defined by some authority. In France it is. They have an official committee that decides what words can be used. This means that French is a more beautiful and logical language than English, but that the French are utterly incapable of succinctly expressing modern concepts like 'weekend' and 'internet' without using English.

There is actually a good lesson there about emergent order versus central planning.

Friday, February 10, 2012

IQ Dogma

Today I got am email from that included the following:

One panel at this week's Conservative Political Action Conference in Washington, DC is called "The Failure of Multiculturalism," and it features the founder of a website that's claimed:
* Black Americans have lower IQs than whites,

The tone of the email email implied that such a claim is a self-evident sin, on the same level as anti-semitism, and that anyone who would associate with the people who make it is evil.

It is a statistical fact that the average black person has a lower IQ than the average white person. This is not an accusation of inferiority. Having a low IQ does not make you a bad person, for several reasons.

First, IQ is strongly affected by environmental factors like nutrition, pollution, and low access to enriching activities. Growing up in the bad environments associated with poverty will lower a child's IQ, and once they grow up, it is too late to change it. As we improve public health, IQ differences will become smaller.

More importantly, IQ tests only measure a very limited slice of human cognitive potential. I may have a higher IQ than the black sensei of my dojo, but he is a far better leader than I will ever be. He is politically astute, a good teacher, has excellent stage presence, and is skilled at working a crowd, commanding attention, maintaining friendships, making people comfortable, making people trust him, and a lot of other little things that are required to turn a disorderly mass of people into a well-functioning team.

For most of human history, his cognitive skills would be far more valuable than mine. The fact that my skills have a much higher market value in our economy does not mean that I am superior. It means that we live in a strange world.

It is probably best to think of a high IQ as a freakish mutation that hijacks the brainpower meant for social organization and uses it to do things that are unnatural, bizarre, and random. The skills that IQ tests measure happen to be extremely useful in the artificial and unnatural technological civilization we inhabit. 

A high-IQ human is to a natural human what a dog is to a wolf. The dog might make a better pet, but it would have much lower survival odds in the wild. It is silly to say that one is better than the other. They are suited for different situations.

We will never be able to think intelligently about human capability and potential, and help all people live good lives, unless we are comfortable with these facts.

Tuesday, February 7, 2012

The Future Looks Good

I am very optimistic about the future of mankind in general and the United States in particular. This post will explain why, with reference to economic theory.

One of the fundamental lessons of economics is that wealth comes from productivity. Wealth, defined broadly, includes everything that makes our lives better, including material goods, leisure, health, a good environment, love, community, and human connection. All of these things are improved by any factor that improves the productivity of human endeavors.

People think that economists are money-obsessed, but an economist is actually more likely than most commentators to look at the big picture when analyzing human choices. For example, we understand that Facebook has given the world a massive increase in wealth and productivity. Facebook has dramatically decreased the time cost of 'purchasing' friendship and community. When people work less in order to spend more time on Facebook, they are sacrificing material goods to gain more social connections. This is a natural and rational response to the new, lower price of social connections.  Anyone who claims that Facebook decreases productivity is focusing only a limited slice of the human experience.

There are three overall categories of things that can affect productivity: technology, politics, and culture. Technology is any knowledge, tool, or infrastructure that helps you accomplish things or makes your life easier. Politics is the formal structure of government, and how laws and taxes affect human behavior. Culture is everything else, like religious doctrine, or how children are raised, or the prevalence of discrimination in a society, or shared social attitudes about education, that can affect people's ability to accomplish their goals.

Over the past few years, everything I read about technology made me more optimistic about the future, while most of the things I read about politics and culture made me more pessimistic. It seemed that there was a tug-of-war, with technology pulling us forward while the government wasted more resources and cultural changes harmed people's ability to be productive.

Even then, I was cosmopolitan enough to understand that humanity as a whole would probably be just fine even if things were getting worse in the United States. If you look at the total well-being of every person on the planet, then right now is the best time in human history, and things are getting better at a rapid pace. I had anticipated that the USA was going to experience a gradual decline, in relative terms, as the rest of the world got richer and freer and we got more dysfunctional.

Several things have changed this appraisal. The first is a dramatic improvement in our diplomatic and geopolitical situation over the last several years. Our deft handling of the Arab Spring is making friends all over the world, and our major rivals are revealing themselves to be venal and incompetent. China is making enemies all over Asia, pushing everyone there, including Vietnam and possibly even Myanmar, towards friendship with us. The Chinese regime is also under severe internal stress as the failures of state control become apparent, and its people are ever more vocal in demanding liberty and self-determination.

Another big improvement seems to be coming in education. Our education system is literally stuck in the dark ages; the 'production technology' of a teacher lecturing to a class comes from the days when books were too expensive for students to buy. In the past this was a source of pessimism, but now I predict that technology is going to shake things up, and discard much of the flawed old system entirely, more quickly than many people imagine. I think that online schools of various kinds will displace traditional lecture halls, and a system of electronic records will replace our antiquated credential-based signaling system. This will cause a massive boost in productivity and happiness, and probably some positive cultural change, over the next few generations.

From what I can tell, the USA is further along in developing online education systems than other countries. If we get it right, we will remain the market leader in higher education, just as we are today, and might extend our leadership into many other kinds of education. This would give us an incredible source of financial and social power.

Our short-term relative economic situation is also starting to look better. Europe is still in serious trouble, Japan is still stagnant, and China is showing hints of the kinds of economic imbalances that crippled Japan two decades ago. Meanwhile, we have made a lot of progress at getting rid of the debt imbalances that played a big part in the crisis, and a general recovery seems to be progressing nicely.

In the middle to long term, things still look good for us. We still dominate high tech. iPhones may be made in China, but all of the profits and the good jobs go to Americans. All of the major players in the tech industry are American; the foreign companies have all been reduced to selling commodity products. Of course that itself means nothing, given how fast the tech industry changes, but we always seem to dominate the cutting edge, no matter how things change, which is a good sign. We will probably also have a comparative advantage in the 'App Economy' that is developing. And as much as is annoys me, our entertainment industry is a reliable source of exports and profits and cultural influence. Given that a great deal of the economy of the future will revolve around tech, entertainment, and education, we are in a very good position.

There is a very real possibility that we will soon see a world that is almost entirely free and democratic, and that we will remain the economic, political, and cultural leader of that world.

Our internal politics and much of our culture remain a mess, but as the rest of the world improves, it will force us to improve as well. Right now, an extremely productive American has the choices of putting up with taxes and regulations, lobbying for government change, breaking the law, or not working. The latter two are not credible threats for most people, and true wealth generators do not have a comparative advantage in lobbying, so the people who generate most of the wealth have relatively low political bargaining power and cultural influence.

As long as you will earn more money working in the USA than anywhere else, the government, driven by the desires of society, will be able to extract the difference from you, plus a bit more because moving is expensive. But if enough wealth-generating Americans could credibly threaten to move to India or Estonia and make as much money, then the government would be forced to lower taxes or regulations and/or do something to make the Americans more productive again.

The USA keeps slipping down in the rankings of economic freedom, corruption, and a few other measures of political quality. Partly this is because we are getting worse, but mainly it is because other places are getting better. Pretty soon this will generate a powerful moral and practical case for reform that favors wealth generation and productivity over populist redistribution.

The economic conditions of the rest of the world form a lower limit to our productivity and prosperity. We will see one of two possible futures. Either Americans are much more productive than people elsewhere, and the government extracts that difference from people, or we are just as productive as the rest of the world, and the government must remain lean and efficient to compete. I think that other nations will get a lot better, but that we will improve at least as fast. The only real threat to our prosperity is the rest of the world getting a lot poorer and less free, but the odds of that look are very low right now.

Wednesday, February 1, 2012

Human Organizational Incompetence

Reading this post on the consulting industry, and the dozens of supporting comments, set in motion a train of thought that made me realize just how bad humans are at organizing ourselves and coordinating our activities.

I'd recommend reading the whole thing, but if you can't, here's a key quote,

My guess is that most intellectuals underestimate just how dysfunctional most firms are. Firms often have big obvious misallocations of resources, where lots of folks in the firm know about the problems and workable solutions. The main issue is that many highest status folks in the firm resist such changes, as they correctly see that their status will be lowered if they embrace such solutions.

I can recall dozens of case studies with this pattern, and it was true of the firm I used to work at. Managers insist on doing things that literally destroy the organization, because it gives them a feeling of power and control. A typical example is keeping information secret from employees. Most people who have been part of a large organization have similar experiences. Decisions are made based on office politics rather than scientific judgment or business efficiency. This problem seems inherent in human nature; it happens whenever people try to organize themselves to do something.

More often than not, the business consultants are simply there to bypass office politics and give a stamp of approval to what any thoughtful observer knows needs to be done. CEO's and shareholders are willing to pay millions of dollars for this service, which suggests that office politics costs the economy billions of dollars each year.

But economists know that the failures of human-led organization are far deeper. One of the things that we have to do in every introductory class is to explain how the price system works and what it is good for. It has repeatedly been shown that a system of market prices allocates resources far more effectively than central planning in almost every case. Whenever there is something that prevents the price system from working, the result is chaos and mismanagement.

A naive observer of human behavior might think that a human planner would be strictly better than a price system. After all, a price system is one of many possible allocation mechanisms a planner could use. When the price system works, the planner can use it, and when it does not, than a different system can be used. But things rarely work out that way. Central planning, where humans can choose from a menu of options, usually does worse than blind adherence to a simple price system, because of the inherent psychological desires of the human race that cause power to corrupt decision-makers.

Economists always sell the price system as an amazing model of emergent order, focusing on its elegance and benefits. But objectively, allocation via market prices is a remarkably blind, dumb, simple, stupid mechanism. Its flaws are obvious and well-documented: externalities, large income differences, information assymetries, irrational short-term desires, and an inability to accurately measure value can can all cause it to fail.

Our inability as humans to consistently do better than this flawed and senseless mechanism is truly amazing. Human discretion reliably causes dysfunctional outcomes that are far worse than the problems generated by markets. It is one of our more fundamental failures as a species.

A well-programmed computer would not have either of these problems. It would be strictly better than markets, using a price system when appropriate and using something else otherwise. It could capture information not available from market prices, such as social media chatter and patterns of network connections among people. It could measure and test people and products to find ideal fits. It would not be selfish, or play politics, or lie, or be distracted by games of power and signaling. It could do a better job than either human management or markets of aggregating information and using that information to make decisions.

We are already seeing glimpses of this. Think about the recommendation engines of Netflix and Amazon. They already do a better job of predicting what products you will enjoy than most people who know you. They certainly do a better job than market prices. A high price is only a signal of quality if your tastes are very similar to everyone else's and there is a reliable connection between inputs and output quality. Neither of these is typically true of entertainment. The decision of how to allocate your entertainment time is best done not by other humans, and not by market prices, but by a cleverly programmed computer.

I predict that, sometime in the next few decades, a private equity company will program an intelligent-allocation computer and use it to replace the management of companies it buys out. There will be many experiments, and many of them will fail. But when they get it right, a lot of dysfunctional human-led firms will be quickly replaced by machine-directed enterprises who make production and hiring decisions that coordinate human activity better than humans can.