Blog of the Day- Economics of Information

Economics of Information

Characteristics of an adaptable organization

Three things: you need to have lots of different experiments going on; they need to be at the right scale, so that a failure doesn't finish you off; and you need to be able work out what is working and what isn't, which is not always easy. (If it was easy, we wouldn't need double-blind randomised controlled trials in medicine.) It sounds sensible enough in principle; the book explores how that actually might work in practice in politics, banking, development aid, science funding, and so on. And of course, in our own lives.

Source:

Ten big infrastructure projects that will transform India?

An interesting column on India's key infrastructure projects by Vinayak Chatterjee;

National River Linking Project
Kalpasar Project
Jaitapur Nuclear Power Plant
Delhi-Srinagar Direct Rail Link
Samudra Setu — India-Sri Lanka Bridge
Western Dedicated Freight Corridor
Delhi Mumbai Industrial Corridor
Eastern Dedicated Freight Corridor
Mumbai as an International Finance Centre (IFC)
Chittagong Port to Agartala (Tripura) Road Corridor

For Discussion: What would be the equivalent projects for China?

'Economics is a set of problems in need of solution'

A highly recommended column from John Kay;

The two branches of economics most relevant to the recent crisis are macroeconomics and financial economics. Macroeconomics deals with growth and business cycles. Its dominant paradigm is known as “dynamic stochastic general equilibrium” (thankfully abbreviated to DSGE) – a complex model structure that seeks to incorporate, in a single framework, time, risk and the need to take account of the behaviour of many different companies and households...

As late as 2007, the International Monetary Fund would justify its optimism about the macroeconomic outlook with the claim that “developments in the global financial system have played an important role, including the ability of the United States to generate assets with attractive liquidity and risk management features”...

In his presidential lecture to the American Economic Association in 2003, Robert Lucas of the University of Chicago, the Nobel prizewinning doyen of modern macroeconomics, claimed that “macroeconomics has succeeded: its central problem of depression prevention has been solved”. Prof Lucas based his assertion on the institutional innovations noted by Mr Greenspan and the IMF authors, and the deeper theoretical insights that he and his colleagues claimed to have derived from models based on DSGE and the capital asset pricing model....

Subsequent policy decisions have been pragmatic and owe little to any economic theory. The recent economic policy debate strikingly replays that after 1929. The central issue is budgetary austerity versus fiscal stimulus, and – as in the 1930s – the positions of the protagonists are entirely predictable from their political allegiances.

Why did the theories put forward to deal with these issues prove so misleading? The academic debate on austerity versus stimulus centres around a property observed in models based on the DSGE programme. If government engages in fiscal stimulus by spending more or by reducing taxes, people will recognise that such a policy means higher taxes or lower spending in the future. Even if they seem to be better off today, they will later be poorer, and by a similar amount. Anticipating this, they will cut back and government spending will crowd out private spending. This property – sometimes called Ricardian equivalence – implies that fiscal policy is ineffective as a means of responding to economic dislocation...

Consistency and rigour are features of a deductive approach, which draws conclusions from a group of axioms – and whose empirical relevance depends entirely on the universal validity of the axioms. The only descriptions that fully meet the requirements of consistency and rigour are completely artificial worlds, such as the “plug-and-play” environments of DSGE – or the Grand Theft Auto computer game...

What is absurd is not the use of the deductive method but the claim to exclusivity made for it. This debate is not simply about mathematics versus poetry. Deductive reasoning necessarily draws on mathematics and formal logic: inductive reasoning, based on experience and above all careful observation, will often make use of statistics and mathematics...

Economics is not a technique in search of problems but a set of problems in need of solution. Such problems are varied and the solutions will inevitably be eclectic. Such pragmatic thinking requires not just deductive logic but an understanding of the processes of belief formation, of anthropology, psychology and organisational behaviour, and meticulous observation of what people, businesses and governments do.

Related:
How Did Economists Get It So Wrong?

Lucas- Noble Prize Lecture

In Defense of the Hedgehogs

IMF's Koshy Mathai on Sri Lankan economy

We firmly believe that Sri Lanka’s flexible exchange-rate regime is appropriate and that there should be no peg. Of course, a central bank can never be totally hands off – it’s sensible to intervene in order to avoid disorderly movements in the exchange rate that could harm the economy. But econo­mists generally would say that sustained intervention in one direction or the other to keep exchange rates either above or below the levels suggested by fundamentals should be avoided.

Soon after the end of the war, we saw a long period when the rupee was virtually fixed against the dollar. Since then, we’ve seen some flexibility in one direction, with the rupee appreciating. And given the amount of foreign currency flowing into the economy, there’s little wonder that we should have seen stable or appreciating exchange rates over this period.

Going forward though, rising imports and high oil prices could imply smaller balance-of-payments surpluses or even deficits; and in such a scenario, it would be important to illustrate to markets that the rupee is flexible in both directions. This would also encourage the development of forward markets in foreign exchange and discourage short-term, speculative capital inflows, which Sri Lanka doesn’t need.

As for where the rupee should be headed in the medium term, let me just say that I learned a long time ago not to try to predict currency movements! Economists have statistical models that try to explain the appropriate levels for exchange rates, but the results of those models are sometimes difficult to assess, particularly in a world of large capital flows. In the IMF programme here, in Sri Lanka, rather than looking at the price side of things – that is, the exchange rate – we have focused on the quantity side (i.e. the level of reserves at the Central Bank).
Reserves are certainly not a problem for Sri Lanka. In fact, the build-up of reserves over the past two years has been a resounding success, far in excess of what we initially expected – and that’s not just because of foreign borrowings. Nonetheless, reserves are not high compared to levels seen in many other EMEs, and there is probably some scope for at least modest further accumulation. So in the programme, the Central Bank commits to achieving such accumulation and the exchange rate is allowed to adjust however it needs to, in support of that reserves targe

Summary of Chapter One, Adapt

Chapter One: Thomas Thwaites, Eric Beinhocker, Philip Tetlock, John Kay, Paul Ormerod, Donald Green, Michele Belot, Richard Thaler, David Halpern, Matthew Taylor and Jonah Lehrer.

Summary of Chapter Two, Adapt

Chapter Two: H.R. McMaster, Andrew Mackay, John Nagl, George Feese, Dennis DuTray, Jacob Shapiro, Steve Fidler, Toby Dodge, and Adrian Harford.

How VAT works

Under a VAT, businesses pay tax on the value they add to the goods and services they purchase from other businesses. VAT liability is typically calculated in industrialized countries using what is known as the credit-invoice method. Under this method, businesses apply the VAT rate to their sales but claim a credit for VAT paid on purchases of inputs from other businesses (shown on purchase invoices). The difference between the VAT collected on sales and the credit for VAT paid on input purchases is remitted to the government.

Figure 1 illustrates a VAT with a 10 percent rate. A lumber company cuts and mills trees and has sales of $50 to a furniture maker. Assuming no input purchases from other businesses, to keep the illustration simple, the company adds the tax to the price of the goods sold and remits $5 in tax to the government. The purchase invoice received by the furniture maker would list $50 in purchases plus $5 in VAT paid.

If the furniture maker has sales of $120 to a retail store, $12 of VAT would be added to the sales price but the furniture maker could subtract a credit for the $5 VAT paid on purchases and remit $7 to the government. The retailer would receive an invoice showing purchases of $120 and $12 of VAT. Similarly, if the retailer then has sales of $150, $15 of VAT would be added but the retailer could subtract a credit for the $12 paid on purchases and remit $3 to the government.

In total, the government would receive VAT equal to 10 percent of the final sales price to consumers. Thus, a 10 percent VAT is equivalent to a 10 percent retail sales tax in terms of revenue. Under both taxes, the final consumer ultimately bears the economic burden of the tax ($15), except in a VAT, the tax is collected in stages, not just in the final sale.

-Value-Added Taxes: Lessons Learned from Other Countries on Compliance Risks, Administrative Costs, Compliance Burden, and Transition

IMF to Australia- 'resist pressures to prop up declining industries'

IMF on structural reforms for Australia;

On broader structural reforms, we welcome the steps taken to invest in skills training, which should help workers improve their mobility and income prospects. Looking ahead, it is important to use the window of opportunity provided by the current favorable economic outlook to push ahead with the Council of Australian Governments’ reform agenda, including in the areas of education, infrastructure and harmonization of business regulations. In addition, the government should resist pressures to prop up declining industries

Related;
National Agreement for Skills and Workforce Development: Performance report for 2009

The God Complex

From a reviewer;

I'm not sure the book told me anything I didn't already feel true; for instance, my job history has been an ode to variation, limiting the scope of failure, and adapting to local circumstances. Still, I think this book has a lot to offer for a wide audience.

From Wired;

It took its most potent form in Edinburgh in an outstanding talk by Wired contributor Tim Harford, who urged his listeners to beware the "God complex" -- the dangerous notion that an expert will make the most appropriate decision. Instead, we would be far better off relying on evidence-based decisions -- in other words, working out the best course of action through trial and error.

Harford began with the tale of Archie Cochrane, a second-world-war prisoner-of-war and doctor, whose men (including him) were ill through a mysterious swelling of fluid under their skin. He had smuggled some vitamin C into the camp, and also obtained some Marmite on the black market. After splitting his men into two groups and giving each group a different "medicine", he found that those treated with Marmite -- containing vitamin B12 -- were cured within days. He had kept detailed data in his notebooks -- which persuaded the Germans to allow PoWs to be given vitamins.

Cochrane was the epitome of a fighter against the God complex -- the notion that, no matter how complex a problem, one has an infallible belief that one is right. Doctors often have it; so do politicians and business leaders. That doesn't mean they're right. "We should adopt humility and abandon the God complex for a system that works," Harford declared.

Are GMU Professors taking over Asian Development Bank

Asian Development Review - Volume 28 No. 1
;
John Nye, Edda Claus, Iris Claus, Garrett Jones, Qingqing Chen, Chor-Ching Goh, Bo Sun, Lixin Colin Xu, Philip Keefer, Stephane Straub, and Akiko Terada-Hagiwara write about the Political Economy of Development in the Philippines; Effects of Taxation on Migration: Some Evidence for the ASEAN and APEC Economies; National IQ and National Productivity: The Hive Mind Across Asia; Market Integration in the People's Republic of China; Collective Action, Political Parties, and Pro-Development Public Policy; and Infrastructure and Growth in Developing Asia

Poor Economics

The Experimental Approach to Development Economics- podcast of a talk by Banerjee

Mr. Tanzi vs Mr. Taylor

An interesting interview with Vito Tanzi;

You are known in the literature for the Tanzi Effect. What’s the secret for getting one’s name attached to an economic phenomenon?

The Tanzi Effect was actually described in two of my papers—the first which described the impact of inflation on revenue, and another which extrapolated this effect to the problem it creates when inflation is intentionally implemented to provide resources for investment. However, getting one’s name on a concept is by no means a guarantee! Take, for example, the Laffer curve. Laffer became very famous for his idea that when tax rates are pushed above a certain level, revenue comes down. But I can point you to books written in the 1850s by Italian economists, who present his exact ideas, but in one clear paragraph! Similarly, there was an equation which appeared in a paper that I wrote in 1980 for the American Economic Review. The paper was edited by John Taylor, who later wrote a paper, which established the Taylor Rule, using this equation (which to be fair was not formulated exactly the same way I had written it). So, it’s a bit of a haphazard affair. I’m sorry, but I do not know the secret either! By the way, I had no role in naming the Tanzi effect, and would like to thank the first person who did!

Blog Recommendations

Andrew Leigh

Ed Dolan's Econ Blog

Michael Spence - the world is good hands, the chinese

Eminent Economists- Vernon Smith on Bubbles

Next Book in the pile

Poor Economics

Adapt, Chapter 5, Meet Geof,

Peter Martin reviews Adapt;

Geoff has just seen An Inconvenient Truth and wakes up the next morning determined to take direct action to cut emissions.

He starts his day as he always does, “filling the kettle for a coffee”.

“But then he remembers the kettle is an energy-guzzler, so he has a cold glass of milk instead. He saves more by eating his usual two slices of bread untoasted. As he leaves the flat - pausing to unplug his mobile phone charger - he picks up his car keys, then thinks again and walks to the bus stop instead. By the time he hops off the bus, the lack of morning coffee is getting to him so he pops into Starbucks for a cappuccino.”

Deconstructing the day, Harford notes it wasn’t as successful as Geoff would have wanted.

“Let’s start with the milk, which requires a critical piece of equipment to manufacture: a cow. Cows emit a lot of methane. And methane is a more potent greenhouse gas than carbon dioxide... In producing about 250 ml of milk, a cow belches 7.5 litres of methane, which weighs around 5 grams, equivalent to 100 grams of carbon. Add all the other inputs to the milk - feed for the cows, transport, pasteurisation - and the 250 ml that Geoff drank produced the equivalent of around 300 grams of carbon dioxide. By not boiling his kettle he saved only about 25 grams of carbon dioxide. His first planet-saving decision, eschewing a coffee in favour of a glass of milk increased his greenhouse gas emissions by a factor of twelve. Dairy products are so bad for the planet Geoff would have done better to toast his bread but not butter it rather than buttering it but not toasting it.”

Needless to say Geoff’s cappuccino on the way to work was a greenhouse gas disaster. It’s almost all milk. Calculations by the UK government-funded Carbon Trust suggest that milk is responsible for two-thirds the emissions embodied of a block of Cadbury chocolate even though it makes up only one-third its mass. By contrast unplugging the mobile phone saved as little as 6 grams of carbon dioxide a day.

Harford’s point isn’t that we are ignorant. It is that no matter how much we knew - even if we had an app that used barcodes to correctly display on our mobile phones the emissions created by each the 10 billion products and services we commonly use - we couldn’t do the calculations. Our brains aren’t that powerful.

Fortunately we have already come up with something that is. This month in Melbourne the Institute of Public Affairs will host a symposium celebrating the Genius of Western Civilisation. That genius has perfected the system of market prices, what Harford describes as a “vast analogue cloud computer, pulling and pushing resources to wherever they have the highest value”.

Imagine, he says, a tax on carbon dioxide and equivalent emissions. It would lift the price of petrol a few cents a litre, creating a small incentive to drive less and more efficiently. A $14 per tonne tax would lift the price of an electricity kilowatt hour “by about a cent and a half if the energy came from coal, but only by three quarters of a cent if it came from natural gas, creating a small incentive to use less electricity and for power companies to build natural gas instead of coal-fired power stations”.

“This would not be because of any grand plan,” he says. “It would just happen: a trucker who ignored the higher price of diesel in setting his shipping charges would simply go out of business; so would a tomato cultivator who tried to absorb the cost of heating a greenhouse rather than raising his prices.”

“Geoff, arriving at the supermarket intending to buy tomatoes, wouldn’t have to point his smart phone at any barcodes: he could just look at the price. What the carbon tax would do is recreate the fantasy carbon calculator app, and give it teeth. Every decision maker, from the electricity company to Geoff himself would be given an incentive to reduce their carbon footprint using whatever tactics occurred to them.”

Harford is a making the same point as Australia’s Productivity Commission did last week, if more engagingly.

The take-home message for Tony Abbott is obvious. If he thinks using public money to hand out grants to worthy carbon abatement projects is better than setting a price for emissions and leaving things to the market, he is turning his back on the genius of western civilisation.

The message for Gillard is that, to a lesser extent, she is falling into the same trap. Agriculture won’t be in her scheme. Cows, beef cattle and sheep can belch greenhouse gas intensive methane as much as they like and Geoff can drink as much milk as he likes without paying the price that will face lesser emitters. The signs are that petrol won’t go up in price either. Without a price firms won’t find it as worthwhile to cleanup our farms and our cars.

Harford again:

“If there was some way to reduce the methane being belched out by cows and sheep - almost a tenth of the total gas emissions - that would be a huge achievement. Australian scientists have realised that kangaroos don’t emit methane and are now to trying figure out how to get kangaroo-gut bacteria into the stomachs of cows. It be a blind alley. It may not. But a proper price on greenhouse gases would encourage every path to be explored, even if one of the quests is to make cows belch like kangaroos.”

Memo to Self- Review American System of Bounty Hunting

The Bounty Hunter's Pursuit of Justice

Bounty hunters and bail bondsmen play an important but unsung role in a legal system whose court dockets are too crowded to provide swift justice. When a suspect is arrested, a judge must make a decision: set the suspect free on his own recognizance until the court is ready to proceed, hold the suspect in jail, or release the accused on the condition that he post a bail bond. A bond is a promise backed by incentive. If the suspect shows up on the trial date, he gets his money back; but if he fails to show, the money is forfeited. We don’t want to deprive the innocent of their liberty, but we also don’t want to give the guilty too much of a head start on their escape. Bail bonds don’t solve this problem completely, but they do give judges an additional tool to help them navigate the dilemma.

Related; The Economics of Bounty Hunting (podcast)

Four Stages of Unemployment Searches

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From Hal Varian- "Economic Nowcasting with Search-Engine Data"

Fun with IMF reports

“Going forward, the authorities intend to take fiscal measures to stabilize and reduce the debt-to-GDP ratio and support the economic recovery, while maintaining price and exchange rate stability. They also plan to reform and enhance tax administration, increase fiscal responsibility, and improve transparency for public enterprises. Global developments, including high oil prices, pose risks to the outlook, but upside potential could offset these if projects under consideration materialize. The mission is confident that the determined pursuit of fiscal consolidation and an enabling investment climate will improve the macroeconomic environment and support sustained economic growth.”

Here's the country.

Variation, Survivability, Selection

David Brooks reviews Adapt;

Harford then illustrates how this basic process can work across a variety of contexts, from business to war to poetry. He’s an able guide to the world of human fallibility. For example, he cites James Reason who identifies three kinds of error. First, there are slips. In 2005 a young Japanese trader meant to sell one share of stock at 600,000 yen but accidentally sold 600,000 shares at 1 yen.

Then there are violations, when someone intentionally breaks the rules. This is what Bernie Madoff did. Then there are mistakes—things you do on purpose but with unintentional consequences.

Errors can be very hard for outsiders to detect. A study by Alexander Dyck, Adair Morse and Luigi Zingales looked at 216 allegations of corporate fraud. Regulators and auditors uncovered the fraud in only one out of six of those cases. It was people inside the companies who were most likely to report fraud, because they have local knowledge. And yet 80 percent of these whistleblowers regret having reported the crimes because of the negative consequences they suffered. This is not the way to treat people who detect error.

Harford is an economic journalist, so he doesn’t get into the psychological and spiritual traits you need to live with error and look it in the face, but he offers a very useful guide for people preparing to live in the world as it really is.

Related Podcast;
Who blows the whistle on corporate fraud?

Book of the Month- Adapt

Adapt by Tim Harford

Another hero in the book is Peter Palchinsky, a Russian mining engineer who was imprisoned and executed by Stalin’s government in 1929 after many years of dissent against the human cost of the top-down command and control approach to industrialisation in Soviet Russia. Tim Harford suggests 3 Palchinsky Principles shaped to encourage stronger innovation, better leadership and more effective policies:

1/ Variation - seek out new ideas and try new ideas

2/ Survivability - when trying something new do it on a scale where failure is survivable

3/ Selection - seek out feedback and learn from mistakes as you go along, avoid an instinctive reaction of denial

Book Recommendation

The Ghost of the Executed Engineer: Technology and the Fall of the Soviet Union

Loren Graham

Related:
Peter Palchinsky

Book Recommendations for Public Finance Practitioners

Chipping Away at Public Debt—Sources of Failure and Keys to Success in Fiscal Adjustment

Economic Policy-Theory and Practice Agnès Bénassy-Quéré, Benoît Coeuré, Pierre Jacquet and Jean Pisani-Ferry
Government versus Markets
The Changing Economic Role of the StateVito Tanzi