Monday, November 24, 2008

Economics of dating: Contestable markets, moral hazard, and my stomach.

There was a documentary on SBS a while ago, in which an old, fat Italian lady, sitting like a beached whale on the edge of the South Adriatic, stared at a flock of pert `classical looking' young Italian girls. "Italian women are-a-very-very beautiful," she said, "until dey get-a married."

In Middle Park, Australia, where I work, the married women are less rotund. They drive Audis, and jog. They sometimes stay pretty well past forty.

Two economic concepts go a long way to explaining the disparity in these waistlines. The first is `moral hazard', and the second `contestable market hypothesis'.

Moral hazard is the better know of these two; it states that when someone is certain of an outcome, they will alter their behaviour. So the driver with comprehensive insurance and a layer of pillows over their car will drive slightly worse than my grandmother, while the driver whose steering wheel has a large spike ripe for impaling will drive more cautiously.

Contestable market hypothesis states that a monopolistic firm will behave like a competitive firm if the barriers to entry in the firm's industry are low. So the sole airline flying a certain route will charge a competitive price if there are no barriers to other airlines flying that same route--if it jacks its price up, other airlines will enter, compete, and drive prices down.

Assuming we are talking about monogamous relationships, we can readily apply both of these concepts.

In a secure, long-term relationship, the consequences of `letting yourself go' are less--a loving partner certainly wouldn't dump you over a bit of extra flab, would they? This is classic moral hazard.

At the other end, the men and women who compete with salsa instructors and tennis coaches for their partners' attention are far more likely to keep their bottoms firm and chests proud. Though their partners remain entirely faithful, the sheer prospect of anything unsavoury happening is incentive enough for the morning's push-ups. This is what contestable market hypothesis is all about.

It follows, if one wishes to keep both themselves and their partner in good shape:

-increase the likelihood of a negative outcome from sloppy behaviour. Tell him: "Look honey, I love you, but if you don't stay toned, I will leave you."

-not behave jealously. Jealousy increases the barriers to entry both for the potential suitor of your girlfriend (who is fearful of you thumping him), and barriers to exit for your girlfriend (who is fearful of you thumping her). Competition is key. If you have to compete with her favourite barista, you will keep in better shape. Or, alternatively,

-institute a strong anti-trust policy, encouraging promiscuity for both partners. The additional competition will make them narrower.

Tuesday, November 18, 2008

Kook on wheels.

In Malaysia, I recently came across one of the main obstacles to world peace. Click to get a better look.

Sunday, November 16, 2008

Robert Solow does it again.

If you're keen to spend the next twenty minutes improving, read this article:

Friday, October 17, 2008

Khaki Economist on dating troubles

Dear Khaki Economist,

I'm a bit of a dating disaster and thought when the world of philosophy has failed to answer the question of why I'm still single, I should go back to my true roots and seek the mechanical (and logical) answers of economics.

I feel that I am essentially a "good" in the wrong market. Therefore this means that there is no demand for my dear self. The current market I am in there is an abundance of idiots, so finding a partner in here is more scarce than crude oil.

As mentioned earlier, the main attribute I seek in another is one with equal intellect to myself in order to have real and deep conversations. I feel like a 25 year old amongst a bunch of teenagers who will be waiting a while for everyone to catch up to her.

What should I do?



Dear Jess,

There are several ways of tackling this problem.

First, ignoring the golden rule of entrepreneurship in capitalism (do not open a business in a competitive market with low barriers to entry), you have chosen to join an essentially homogeneous market. In development, micro-business homogeneity is a real problem; poor countries tend to have lots of petty entrepreneurs (for there is no welfare system, and little large-scale investment), but these entrepreneurs all sell the same thing. I have some great videos of kilometres of streets in Indonesia, lined with hundreds of the same store--all selling the same collection of soft drinks, chewing gum, and biscuits. Prices are driven down, and economic profits tend towards zero. In your model, the easiest girl with the best makeup job and largest breasts gets the cake.

You could also think about this along the lines of trade theory. Generally, a country will specialise in an industry that uses inputs that country is most endowed with. So, Australia specialises in industries like minerals (which it has a lot of), agriculture (which uses land, which it has a lot of), and education (it has many English-speaking academics). The problem is, when a certain endowment increases, the rents to that endowment reduce; an increase in China's population would lower their wages, all else equal.

In your model, you are a micro-business selling chips in a street of micro-businesses selling chips; another tech worker in Bangalore's job market. Unless you can reduce your price, or increase your quality, this market is unfavourable to you.

I recommend then changing markets.

What you want to find is a market with many smart guys, and very few females--be the scarce commodity. The glaringly obvious example is the Dungeons and Dragons community. Gamers and comic-fans are starved of such pretty female company as yourself (whether rightly or wrongly), and so would be able to lavish you with steep economic rents. There may be drawbacks--poor personal hygiene, for one--but given your opinions of most young men, these drawbacks would be mere collateral.

Monday, October 13, 2008

Dating Markets and the Sub-Prime Crisis

I wrote in a previous post about various mate selection models. These are based upon the idea that, in the period before you develop an emotional attachment to someone, you will work out whether hooking up with them is optimal. If they look to be about as high-quality as you can manage, you will begin to become emotionally attached, otherwise let them go and continue the hunt.

This is fine and well, but leaves aside a possibility. What if the initial due diligence process returns the `all clear--engage emotions' report, but the underlying partner is of poor quality? They are junk bonds spliced, diced and packaged up to be AA-rated debt?

This is the situation our banks find themselves in today. They have wed themselves to large amounts of debt--holdings over houses which are plummeting in value--without the knowledge of their partner's hidden drug addiction, or shoe fetish.

Singles periodically find themselves in cycles of `crush and crash'. They meet a prospective partner, and after an initial attraction build up a large picture of how they imagine that partner to be. This is entirely rational; we find it difficult to manage incomplete pictures of people, even though these pictures may not be correct. On becoming emotionally attached, and spending some more time around the person, the picture is gradually painted over by reality. The reality could be much like the assumptions, or the girl could end up being a nutjob.

Whether or not the crush couples or crashes is dependent on how initial behaviour is altered by the perceived value of prospective partners. That is, if a man meets a lady, and perceives her to be of a certain quality, he may alter his behaviour in order to woo her. This is like the bank, which on acquiring what it thought was high-quality debt, accelerates its loan-writing, comfortable with the strength of its balance-sheet. If the lady meets the man's expectations, his altered behaviour is rewarded. However, if she fails to meet his expectations--the bank's purchased debt is junk--his efforts were emotionally damaging. The bank's balance sheet ceases to balance.

The policy response for both dating markets and mortgage markets is mandating better levels of transparency. Failing the government's giving all prospective partners comprehensive personality tests (which, funnily enough, a girl I dated once gave me, before ceasing to date me), those prospective partners must employ better due-diligence techniques. They must abstain from emotional attachment until they have thoroughly examined each other's books (or bookshelves, which I've always thought to be a good indicator), and decide upon purchase, or partnership, only when it looks like the books are in order.

I wonder if Moody's offers potential partner risk analysis?

Saturday, October 11, 2008

Today's question, from Roslyn, is:

I read today that Zimbabwe's inflation rate has hit 231 million percent. What drives inflation so high in some countries? How can Zimbabwe return inflation to a reasonable level?


I'm not sure inflation has ever been described more eloquently than by Ronald Reagan, who complained America's inflation problem was of "too many dollars chasing too few goods." That is, an increase in all prices will occur due to an increase in the number of dollars floating about. Zimbabwe has simply printed too many dollars.

We've all heard about those hyperinflations, like the Weimar inflation of 1923-24, when an old guy would cash out his retirement savings to buy a sodapop. But for what reason do countries allow them to happen in the first place?

The answer can be told by looking at a few historical hyperinflations. An early hyperinflation occurred in what we now call New England, during the seventeenth century. Lacking a superior monetary authority, the de facto currency of the region was tobacco, which was durable, divisible, and transportable--all good traits of money. As hoards of pilgrims landed in Boston harbour, one could wander down to the docks with just a few pounds of tobacco, and purchase a freshly imported wife. The savvy bachelors among Boston's small population saw a good deal here, and began to plant tobacco, wholesale. This increased the money supply, and so, like in Zimbabwe, began to increase the price of brides. Just a few years later, the cost of wiving had rocketed in terms of tobacco; one would have to horse down cartloads of dried leaf for the purchase of even an ugly girl. The lesson, however, was not learned.

A few centuries later, an uncharacteristically smart Irishman called David O'Keefe came across Yap, an island now in Micronesia (I'm not sure where it was before). The Yapese used small round stones specific to Palau, a boat-ride away, as their currency. As the fairly primitive Yapese had trouble transporting these rocks, they formed an acceptable currency. O'Keefe, with his large boat, smelled opportunity. With a taste for Melanesian ladies and sea cucumbers, he saw the small cost of sailing to Palau to collect rocks worthwhile, for what (or who) he could purchase. In increasing the Yapese money supply in this manner, the currency was debased, requiring larger and larger denominations--just like the Zimbabweans, who until August had denominations up to the trillion. The rocks became larger.

Today, Yapese villagers still use large stones for some transactions, though they use US dollars for small ones. The stones, in some cases up to three or four metres across, can be used to purchase livestock, houses, and (you guessed it) brides. Some stones--the especially large ones--are not even moved around, but merely transferred in ownership between one holder and another. I guess that saves a trip to the bank.

While these two examples are entertaining, they do not exactly describe why Zimbabwe has needed to expand the money supply so violently. The cause lies, unsurprisingly, in the madness of their dictator, Mugabe, and the international reaction to his rule. When a government needs to raise money, it can do so in two ways--either tax or borrow. When subjects aren't able to be taxed, the government will borrow. When the citizens are too poor to borrow from, the government must borrow from abroad.

As Mugabe destroyed Zimbabwe's export economy, by removing efficient white farmers of their land,
he also starved the country of access to foreign capital. This meant when the government went cap in hand to international financiers, the cap stayed empty.

The only option left to the government was then the worst--to monetize the deficit. This involves the government selling bonds (which they repay only by selling more bonds) to the central bank, who pays them in currency. This is when the money supply begins to accelerate. The inflation accelerates because, at any given level of inflation, more money supply growth must occur for the government to have any additional purchasing power.

The solution, without revolution, is simply to dollarise (or randise). This involves giving up on domestic currency (and the lack of credibility of the domestic monetary authority), and importing credibility of a foreign central bank. Whilst this has costs--relinquishing monetary policy, and the capacity to absorb exogenous shocks via exchange-rate depreciations--they would, in Zimbabwe's case, be less than the cost of inflation.

The other option is regime change, though this has not been shown to restore confidence in the monetary authority (Feige, 2003; Kraft, 2003; Velarde, 2002). My Zimbabwean friend Bethel tells me unofficial dollarisation is occuring, though access to foreign currency is very limited.

Poor bloody country...

Friday, October 10, 2008

Khaki Economist: Bank of Sweden Prize in Economics--a Roundup of the Horses

With the financial world falling apart, crisis inspiring suicides, and the Great Abyss of collapse more or less dependent on next Monday's stock-market reaction to today's Washington crisis talks, now is a great time to be thinking about the Nobel Prize in Economics. The prize, for those unaware, is handed out on Monday, to the economist considered most good-looking.

For the punters amongst us, there are precious few form-guides available in this betting market. This is a great failure. Below, then, is my round-up of the favourites.

Martin Feldstein Odds-on favourite at $8, but not mine.

An American economist, Feldstein is a good macroeconomist and public finance theorist. His close association with the Reagan and Bush administrations earned him the early short odds in this race, though recent events may have changed all this. His eating trough was poisoned earlier in the month, diminishing his prospects for the prize, when the financial products division of AIG, of which he is the chief director, lost a couple of bets. This has cost the US government (so far) around US$115B, which is quite a sum.

His association with Bush, Reagan, and AIG lead me to not recommend your putting money on him.

Thomas J. Sargent paying $12

Sargent is another American macroeconomist, who played an important role in theorising `rational expectations'. Rational expectations allow economists to make a (quite realistic) assumption that people form expectations over the future based on rationality, and vary their behaviour accordingly. Non-economists would be quite shocked to learn economists have not always done this--once upon a time, expectations were assumed to be formed by present conditions, or yesterday's--which is why rational expectations, and the theory's founders, are favoured to win a gong sooner or later.

While I have no doubt of the depth and influence of this theory, I'd not think it fitting to give this years' award to someone in this field, simply due to the Crisis. On the other hand, the voters may want to award a pure theorist, and not a crisis economist.

Robert Barro paying $13--my tip

The second most influential economist not to have won a Nobel already, Barro is a hero of mine. He is, predictably, another American macroeconomist, though specialises in public finance during economic crises--quite a good thing to have specialised in, this week.

His notable papers have included one on `Ricardian equivalence'*, which is when people perceive government debt as personal wealth. Equivalently, this is like people increasing their savings to pay off government debt in the future. I have always had a problem with the Ricardian equivalence argument, as it sounds to me like another endogeniety problem (when one thing looks to have caused another, but it may be the other way around). That is, it would require very foresighted savers to plan to pay off government debt in the future; it is more likely, as governments borrow off the private sector (or foreigners), the savings must be a precondition for government borrowing to occur in the first place.

Another paper, of use today, "On Determination of Public Debt" (1979), presents a situation of a large crisis, during which the government optimally increases debt and the money supply, inflating away some debt, smoothing the crisis, and maintaining tax rates. While this paper is not his most influential, I reckon a lot of policy advisers will be trawling through it and those it influenced over the coming weeks.

*Barro, R., "Are Government Bonds Net Wealth?", Journal of Political Economy, 1974, vol. 82, no. 6

Paul Romer Paying $13

An American growth economist, Romer has been named amongst the 25 most influential Americans by Time (1997), though only makes IDEAS' top 100 economists. His contribution has been to take exogenous growth theory, and look at technological and environmental constraints. This can best be summed up by a quote:

"Economic growth occurs whenever people take resources and rearrange them in ways that are more valuable. A useful metaphor for production in an economy comes from the kitchen. To create valuable final products, we mix inexpensive ingredients together according to a recipe. The cooking one can do is limited by the supply of ingredients, and most cooking in the economy produces undesirable side effects. If economic growth could be achieved only by doing more and more of the same kind of cooking, we would eventually run out of raw materials and suffer from unacceptable levels of pollution and nuisance. History teaches us, however, that economic growth springs from better recipes, not just from more cooking. New recipes generally produce fewer unpleasant side effects and generate more economic value per unit of raw material."

Paul Krugman--Paying $16

Rounding up my guide is Paul Krugman, a Princeton professor and New York Times columnist. A favourite among liberals and Democrats, he is equally hated by conservatives and libertarians. This is partly because, as such an industrious economist (and commentator), he provides a large target. Daniel Klein, an economist, wrote "The principle reason I scrutinize Krugman is that he is brilliant, outspoken, relatively candid, industrious, and highly visible and influential. Investigating him is a way of investigating a larger cultural phenomenon" which "is ready to sacrifice poor people's interests for the sake of social-democratic values".

So if he is just a shit-stirrer, why would he be paying these (relatively) short odds? Apart from penning one of my favourite columns, which mainly deals with political economy, he also has been a loud voice on trade theory and international monetary economics. In the early 90s, he savaged the (doomed) fixed exchange-rates of Asia, earning (maybe undeservedly) something of a prophetic reputation--though he denies having called the Asian Financial Crisis. He also recently predicted housing price drops in the US would be between 25 and 50%--rates individual suburbs in New Mexico, Arizona, and Florida are already experiencing.

Despite being so well known, and having so much clout, he is unlikely to pick up the cup this year. The Bank of Sweden prize tends to go to those who've made great contributions to theory, not analysis. Krugman is probably the best analyst around, but enjoys popular influence more than academic.

Khaki Economist: Bill Easterly and the happy-clappy rice farmers

The main problem with governing over Indonesia, for there is a main problem, is it doesn't really exist. Owing to its colonial past, its difficult geography, and a great fertility which for centuries allowed many Austronesian tribes to exist more or less independent of one another, Indonesia is made up of some 300 distinct ethnic groups, each in a different valley, on a different island, with different aims and different outlooks. One of these, met by Dutch missionaries in the Western Sumatran jungle in the sixteenth century, and by us last week, has maintained quite a distinct culture. The Dutch then were surprised at the Minangkabau people's level of advancement. They were already with schooling, the written word, fenced agriculture, a matriarchal property system, and, unlike their Batak co-islanders, didn't enjoy barbecued man. Today, the Minangkabau carry on many of their ancestral habits: the child takes the mother's name; property is passed from mother to daughter; and traditional buildings are ubiquitous amongst the Soeharto-era concrete. And they are proud of it. Tour companies everywhere offer a more matriarchal experience, with more bull-horned buildings, and less of that Javan crap.

Thought the Minangkabau have continued some tradition, the tour companies don't advertise the other great cultural influence—that which rubbed off during the 350 year Dutch visit. As missionaries, the Dutch were useless: there's a mosque on every corner. But below every portrait of Susilo Banbang Yudhoyono, their president, sits a vase of fake tulips. There are entire villages of Dutch-style country houses, dotting the mountain trails. And dozens of towns, peculiarly, light their main shopping strips with large neon windmills.

A long swim off the West Sumatran coast, in the direction of Sri Lanka, lies Nias island, where the story could not be more different. On arriving, the Dutch found a megalithic (large rock worshipping) society, and, undeterred the Nias' national sport was leaping over large stones, almost converted them to Protestant Christianity. Compared with selling daughters for pigs, building houses without nails, and leaping over rocks for fun, the Lutheran and Dutch Reformed churches didn't offer the Nias much excitement. As compensation, the islanders continue their traditional—probably heretic—lifestyles, simultaneously worshipping spirits and rocks alongside Allah (for that is what they call H-m), and attending mass on Sundays as joyous, songful, cheating monotheists. Culture trumps religion. Every single time.

Culture also, every time, trumps economic rationality. This makes the job of development economists, who are trained to make guesses about how slightly rational people act, more difficult. Thankfully, most people, most of the time, behave in ways that look vaguely rational. This allows economists to be of a little value. But when a culture places great value on the irrational, as in Nias, the development economist must face a whole lot of (can I say `human questions' without inferring economists, who are smart, don't normally ask them?) human questions.

A famous paper came to mind, while I was interviewing a rice farmer, while swiping away at big anopheles mosquitoes, while larvae scooted around the stagnant paddy next to us. In the paper, Bill Easterly and Ross Levine*, two economists, showed of all former colonies, current livelihoods can largely be explained by latitude, crop makeup, and their propensity for disasters. Colonisers, so it went, would export their solid institutions to easily habitable colonies, like Australia and Canada. The unfortunate colonies where (wimpy) European colonisers would catch typhus, or tapeworms (like Burundi, where 280 in every thousand colonialists died every year), would have `extractive institutions' forced upon them. These allowed the most efficient exploitation of colonies, which, lets face it, was what the game was all about.

Nias is poorly positioned to be `easily habitable'. In the past while, it has had a large tsunami (which did more damage in Aceh, just across the way), and a few large earthquakes. The larger of these was the twelfth largest ever, lasting more than two minutes, and raising bits of the shoreline two feet. Together, these killed about 1000, though improved the surf, increasing Lagundri's famous seven-second right-hander to nine seconds. The island has also a healthy population of Anopheles, which spread malaria, an impenetrable jungle covering, and your regular cash crops—cocao, rubber and rice. None of these attributes, unfortunately for Nias, lend themselves to making development easy.

The story, though, is not all sad. While Aceh, described by a UNDP worker we interviewed as a "sexy aid destination", gets most attention, a little development aid has trickled on. Most of this seems to have gone into improving the agricultural methods of farmers, which, I admit, sounds dull, but is actually very exciting. The techniques popularised in the 60s and 70s by CNIAR, an agricultural research body credited sometimes with the world's not being in perpetual famine, never really caught on in Nias. The development organisations there want to reverse this, and bring farmers from the twelfth century into the present. The problem is, many of the farmers we spoke to were unsure the present was a nice place to be.

Our rice farmer, whose parents, grandparents, and great-grandparents were also rice farmers, was introduced by the UNDP to a new breed of rice, from Java, which yields twelve tonnes per hectare, three times per year. This compares favourably to her Nias variety, which yields five tonnes a hectare twice a year. After its first harvest, she ate some, decided it tasted different to her old variety (though the difference wasn't apparent to our translator), and replanted her Nias variety, willingly forgoing twenty-six tonnes of rice per hectare per year. The ten tonnes produced are bartered at market for pigs, and carrots, buying her a poor life.

The rice farmer, though, has it easy, because even in a barter market prices can change. Our rubber farmer wasn't as lucky. On Nias, the only Mercedes Benz are driven by partai bosses, and fly partai flags from their bonnets. In return for bribes (I presume), ethnic Chinese merchants are somehow exclusive in their buying produce from certain regions. The rubber farmer had the option to sell her rubber, extracted in the same inefficient way her grandfather did, to one of these, and one only. Economists call this situation, where these is only one buyer, `monopsony', and fear it like any other market failure. The price paid to her does not change, and is about a quarter of the price offered on the mainland. She lives today in a poverty caused by corruption, culture, and tradition.

Naomi Klein and her leafletters would have us believe the world was hunky-dory before the West came along and began exploiting the poor. Don't worry. The poor have perfected the art of exploiting themselves.

Markets don't fail. People do.

Khaki Economist: F Von Hayek and the Caravan of Doom

A label best applied to Sumatra's economy--and society--is "Accidentally Hayekian".

The rulers of Sumatra probably haven't read their Friedrich Von Hayek, the 20th Century economist who, by witness of some of the nastier sides of Statism (fascism, Communism, etc.), thought it silly to let governments meddle with much. They have, though, created a Society to make Fred proud. People go about their way here guided mainly by ritual and self-preservatory instinct, but not by rules. The state limits itself to its most proper role--revenue collection--without much appearing from the other end. No roads, hospitals, or General Order.

The lack of Sanctioned Order, while apparent, does not mean Sumatra is a place without systems. Traversing the island, en rout to our destination, Pulau Nias, provided us the opportunity to see "market organisation" at its most efficient.

In Padang, the capital of West Sumatera, we found there was no "four hour bus to Sibolga" as advertised online. The motorcycle hirer laughed at us, refusing us any of his fleet. The bemo driver was less mean; "I take to someone" gesturing wildly "Sibolga". That someone knew someone else, until we were ping-ponged into an empty ticket office in Bukittinggi, West Sumatra. "Wait!" Our last driver told us. We didn't for long; the perfect deregulated transport market, with its little profit-seeking actors, hadn't made us wait all day--it wasn't going to start now.

A main argument for the regulation of markets, though this necessarily implies inefficiencies, is for the creation of standards: product standards, quality standards, method standards, etc. When the benefit of standards exceeds the cost of them, in terms of efficiency, their adoption is a good bet. It is my professional opinion, as an immensely unqualified trainee economist, that the long-haul busing system in Sumatra wants standards.

It seemed normal enough. We were given printed tickets, seat numbers, and had our bags put in vans. From our trip up, I knew vans made sense in this terrain; Sumatra is slung on a spine of volcanoes, like a large wet towel on a small picket fence. Navigating the place requires a decent understanding of "North". The driver also seemed quite normal, by Sumatran standards--an open shirted chainsmoker, with a twitch. The ticket-master smiled, waved, and wished us a safe fifteen hour trip.

A frequent criticism of unregulated Capitalism, especially by namby-pamby leafletters with limited personal hygiene, is that in pursuit of profit, shortcuts will be taken. We argue back that those who spike their baby-milk powder with melamine will be taken aside and shot, in a process Schumpeter (probably in German) called "creative destruction". The Omniscient Market would quickly discover their shortcuts, and drive them from business, leaving only the most efficient, high quality firms.

Somehow, our bus operator has escaped a creative destruction, I reckon by sheer luck. CV Nasional's petrol-saving shortcut is to lower the wind resistance on their buses, by having them draft off each other. This method of power conservation is very effectively used in pro-cycling, like in the Tour de France, but there to save Powerbars, and is normally something I'm ok with--I am, after all, very tough.

This peleton of minibuses, though, brought me an indescribable amount of fear. It wasn't all got by their petrol-saving closeness (each three or four feet from the next), so much as their incredible speed--at least double any other vehicle's.

Sumatra, about the size of Victoria, has forty million, most living in villages strung along the main highways. The Caravan of Doom roared past half these, as they looked in horror. Mothers, hearing the four buses' honkings, gathered their children and herded them inside. Youths threw themselves from the streets, leaving their satay sticks. And oncoming traffic, seen by the lead driver as an obstacle, swerved off in hope of longer life.

On-board, the feeling was rather like being held by the scruff off a high cliff, for the entire ten hours, with no knowledge of how to tell the dangler "excuse me, Sir, but I'd prefer you don't dangle me from this cliff".

I'd read in last week's Economist the brain, when under-slept and over-stressed, was capable of inserting REM dreams into a woke conscious, resulting in hallucinations, like the Simpson's Apu thinking he was a hummingbird. My sister pictured Michael Jackson in the front seat. I, a catholic Athiest, began to pray. I can verify now those moments before certain death are the longest.

We arrived in Sibolga, ominously, as the dawn prayers rang through the city. "الله أكبر", they began, "God is Great!".

The Economics of Big Love

The pursuit of potential partners can be distracting to singles. The whole process of dating, meeting, wooing, etc., can be a drag. There needs to be a solution. I propose this model is it.

Let's begin with the single person, and the quality of partner they can expect to attract. A classic study in 1973 (Becker) found, unsurprisingly, people generally pick up other people of similar quality. This is why, unless a lot of money is involved, nice pretty people tend to pair up with other nice pretty people, and not slobs.

A more recent study (Fishman et al, 2004) found people tend to pair up with others of similar aggregate qualities of traits--pretty people with few brains could attract far smarter, though uglier people. In that study, also, men tended to be attracted to women who they perceived as of slightly lesser quality than themselves, which probably says as much about men's perceptions of themselves as their perceptions of women.

Building on these ideas, we can say that `singles have a budget constraint of qualities--looks, intelligence, humour, riches, etc.--with which to shop for a mate'. This is illustrated in Figure 1 below by the curve concave to the origin (joining the axes).

You will notice the budget constraints for any given trait (we use here Looks and Brains) exceed one's own endowments of them. That is, one could possibly date someone far more beautiful than they, or far smarter. However, according to Becker, it is unlikely they pick up someone who is better at everything, which is why the constraint passes through their own combination of looks and brains.

We also need to think about what people are attracted to. If we separate one's attraction to potential partners into bundles of qualities, there must be levels of indifference between qualities for each person. That is, one may be equally attracted to a cuter, boring potential mate and an uglier, interesting one. I for one like funny girls, but compromise willingly if they have an excellent knowledge of geopolitics, or are very beautiful. These levels of indifference are illustrated in Fig. 1 below, by the curves convex to the origin, labelled "Attractiveness level 1", "2", and "2.3".

On each of those curves, one is equally attracted to a potential partner on it. So, for every combination on "Attractiveness level 1", I am equally attracted to them. If they are on "Attractiveness level 2", I am more so.

The curve which bisects the axes is the 'budget constraint'--the area within is the quality of people one could 'afford' to mate. The curves convex to the origin join bundles of characteristics of equal attractiveness--one may be indifferent between one hot dumb person and a smart ugly one...

Now, to optimising.

Under the conventional, monogamous approach, we consider it `optimal' here to snag the best quality mate within one's budget constraint. To hook up with someone, when one could do better, leads to inevitable cheating and separation (unless emotions become involved, but we don't like to deal with emotions here--they're harder to graph).

This optimal `purchase' of a mate is represented here on figure 1, by the tangent point of the budget constraint and the highest attractiveness level, here "2.3". They lived happily ever after...

But wait, there's more!

Under the above model, we limit ourselves to just one partner. Asking how "I can give all this love to just one man" is a valid question here. How do we adapt our model to deal with the nymphs, sluts, philanderers, and womanisers?

I suggest we look at what drives the polyamorist.

Let's say for a moment that one `consumes' mates not as bundles of qualities, but as individual qualities. So, one may decide to have a smart girlfriend, a pretty girlfriend, a funny girlfriend, a bushwalking girlfriend, a rich girlfriend etc. (I am a modern gentleman--women under this model are happily able to have multiple lovers, too).

How do we represent this on our model?

In figure 2, instead of dating the "optimal partner" from above, we date two people--one smart, one pretty--but both less attractive than the optimal partner by themselves. In aggregate, however (all summed up), one is dating someone far beyond their budget constraint! In loving many, they have `purchased' a (non-existent) partner so far out of their budget constraint, they would otherwise need much surgery, much education, and many riches to woo.

Saturday, July 26, 2008

Welcome to the Khaki Economist

While, ideally, I'd not be the Khaki Economist, but Macgyver, I'm going to play the hand dealt me.

There was always something vaguely boyish about Macgver. Well, not that vaguely. Week to week, he saved the world, or at least a pretty lady, from crazed Russians---who, let's be frank, want nothing less than chaos. He did so using his Victorinox, a chocolate bar, and his first-year chemistry course.

Being a vigilante, however, is probably beyond my capacity. Just yesterday, I almost broke down in tears telling a customer he was being rude. What isn't beyond my capacity, though, is pretending to be the Macgyver of Economics (yes, it deserves a capital).

This blog then, will with the odd reference here and there to my heroic aspirations, address a combination of problems:

  • The first are economic problems in the developing world. The editorial perspective here is one of cynicism.
  • The second is students' economics. The aim here is to provide links for students to read, and to dispel `simplistic economics' as a tool for analysis.
  • The third and final is to introduce economic analysis into areas not normally thought of as economic.

Tuesday, May 6, 2008

Bob Birrell, wrong.

Reflecting on a seminar I went to, quite a while ago, I remembered Dr Bob Birrell from Monash University's Centre for Population and Urban Research (CPUR) saying something like "people want to live in the fringe suburbs---that's why they build them."

The inner economist in me wanted to question this. "Don't people show what they want by how much they're willing to pay to get it?" That's pretty fundamental to economics. If somebody wants one thing more than another, they will pay more for it. Consistent with this, when one person's income increases, their capacity to afford what they want increases, and so their consumption of desirable goods increases.

So do people really want to live in the fringe suburbs, as Dr Birrell would have us believe?

It would seem not. People live in the fringe suburbs because of budget constraints. As many times as you tap your toes together, the fact people pay more per square foot to live close to public amenities (and life) seems not to go away.

Shouldn't we be looking at why the outer suburbs are cheap, and assessing why they are so, determining it is because they are not inner suburbs, and designing future fringe developments like inner suburbs? I think so.

Bogan Tax

On the 250 bus, I bumped into an old friend, Genesis. We talked, as economics students do, of economics, and joked on that topic too. But there was a serious point made. (Actually, this resulted from a commonly had conversation on public transport---that public transport use increases as you increase the number of services, but service providers are often reluctant to run extra services because of the low initial patronage). The point was that people that live in the inner suburbs subsidise the lives of those in the outer suburbs. This goes a way to explaining the cost differences between inner an outer suburbs (there are many, but these are for future blogs).

Urban sprawl is expensive. The per-unit cost of attaching houses on quarter-acre blocks to public utilities---gas, water, roads, schools, etc.---is higher than in denser, more central suburbs. Under the universal service obligations of our utilities providers, however, somebody in Brunswick pays the same utilities rates as someone in Cragieburn, despite the fact it costs far less to provide that service to the Brunswickian. This means that necessarily inner suburbs subsidise the inefficient outer suburbs.

Normally, when we have negative externalities occurring from a type of consumption, we try to dissuade this type of behaviour. A common prescription is a tax: think cigarettes, alcohol, or gambling. Such taxes are generally easier to impose, as there is often already a cultural bias against those activities; anything which lessens that sort of behaviour is more acceptable. How, then, can governments dissuade people from living in outer suburbs, which have many negative externalities, and have not reflected in their housing costs their true costs imposed on society?

Any government which imposed a 'bogan tax' on the outer suburbs would have limited prospects, electorally. Such a sentiment may not be rational, but it would be. You simply could not say to outer suburbs resident: 'because you can't afford to live in the inner suburbs, you must pay an additional tax.' (which of course, is how it would look).

I would say that a far better way to impose such a tax, would be to slowly unravel universal service obligations, to reflect the marginal costs of providing services to specific areas, and properly assign the different marginal willingness to pay of different regions. Such a setup would allow utility companies to make their money from regions with the capacity to pay more (say, the Pilbara Coast, to which city residents effectively pay subsidies), and lower utility fees for suburbs without the means to afford them, or that cost less to provide services to.

Until we get the incentive mix right, town planning in this country will continue to favour the inefficient, ecologically unsustainable fringe developments of our major cities. Is that what our governments really want?

Saturday, April 12, 2008

An idea for the 2020 summit

Alert friends will recall a time I aspired to ALP hackdom. That time, having past and having altered my view, created my skepticism; good ideas infrequently go realised. There is, unfortunately, a wide chasm between our political machines, and our industry, and between the great ideas of the educated population. Happy we should be then at Chairman Kevin's thousand blooming flowers in Canberra next weekend. It will be a talkfest, and little will come of it, but it at least provides a forum outside the media, the political machinery, and the moneyed lobbies for ideas of all colours to blossom. Below, despite my absence from the forum, is my contribution.

The expansion of supply is key to improving prosperity. A friend recently had difficulty digesting this, during an argument, proposing instead that prosperity be encouraged by more, bigger, income transfers.

Of course such a proposal is nonsense.

The only way to make everyone better off is to have more stuff created. The incentive to produce fewer things under a regressive, ultra-re-distributive tax regime exists, and so limits prosperity.

Instead, the affluent society will (in some disagreement with St Galbraith) create instead a tax regime which looks both to supply-side-expansion, and medium-run re-distributive targets. Such a scheme would limit excessive income disparity (which we social progressives find abhorrent), and maximise the productive possibilities of our industry. How? To be viable, it would increase the marginal productivity of our least-productive employees in our most efficient businesses.

What would the scheme look like?

Keeping in mind this proposal is where tax policy meets industry polity, its architecture, and effects should look a little like this;

  • Firms would have a portion of their company tax payments returned to them as vouchers to be redeemed at recognised training bodies, for spending on (or at least given priority to) employees earning under a certain threshold, or over a certain age
  • Firms would, presumably, have a better clue of what skills are required in the marketplace than unguided (or unknowing) individuals, and so training programmes---the more productivity-enhancing of which would proliferate under the scheme---would better suit economic conditions of the time
  • More profitable firms, which pay more tax, and are better at their business, would benefit more than struggling firms, which pay less tax and would receive fewer vouchers. This would stimulate the efficiency-creating winds of Schumpeter's 'creative destruction', and so increase output in aggregate
  • Labour productivity would otherwise increase (this is simplified, and design of this policy must consider that many poor have difficulty learning, which contributes to their poverty). Productivity increases would be, in the medium run, be matched by wage increases---a general rule which seems to hold.

Any crusade against inflation must directly target productive-capacity constraints. Making more stuff, and printing fewer dollars, goes a long way! In tandem with the current monetary-policy tightening bias of the RBA, a sensible policy allowing our most demanded industries---which are currently more profitable, and would be the recipients of such grants---to address their capacity constraints, would help. The issue also of providing real, immediately-applicable skills training to low income earners also sits well with a progressive social agenda. Yay.

Wednesday, April 9, 2008

The great de-coupling myth

Current economic circumstances allow us to test an interesting proposition, that an increased degree of economic integration can actually allow two economies to grow in different directions. This view, put forward by Eichengreen and Krugman (and Discussed by Frankel, 1999) would suggest that increased integration would lead to increased specialisation---a situation under which exogenous shocks affect the two economies differently. Antithesis to this view, is the conventional wisdom, held by Frankel: an increase in economic integration will lead to increased income correlation.

It has been interesting to watch, then, the popular media speculating China's present rate of growth can be maintained, or at least remain relatively high, in the face of a US recession. Not one to believe what Fairfax tells me, I decided to check this out, and you can too. Pull off the quarterly growth data for China and the US from 1979 (a handy reference year, as China began to open up) off the OECD website. Now, test the income correlations between the US and China for every business cycle (1979-1982, 1982-1991, 1991-2001, and 2001-2007). What is quite surprising, that is, if you are a true believer in the de-coupling myth, is the increase in income correlation (with fewer, smaller, errors) for every subsequent business cycle in that period. This would tend to suggest, at least in this example, that the conventional wisdom would seem to hold: increased integration between China and the US has further 'coupled' their economies; there is no 'loose caboose'.

What does this mean? Basically, we could say that should this model not break down instantly, that should the US be in recession (which it almost certainly has started), China will indeed slow. This is partly due to lower US demand for Chinese goods, partly due to the currency effect (to be discussed in a future blog) and partly that lower US demand for foreign goods will, ceterus paribus, lower foreign demand for Chinese goods. Exports make up some quarter of the Chinese economy, and from my figures, I'd predict about a 10-12% fall in this. This would equate to a cut of some 2.5-3% off current Chinese economic growth. Should current orders not be scrapped, this will probably set in in the third and fourth quarters this year.

What will this mean for Australia? Thankfully, Australia's exports to China contribute less to the manufacture of durable manufactureds, and more to fixed capital investment---think iron ore and coking coal (which is used to make steel). Fixed capital investment in undertaken on a long-view basis, and is less elastic to short-term income fluctuations than other areas of investment. Indeed, demand for Australian commodities would be likely to rise should the US slow. This would occur if China decides to enact countercyclical fiscal policy in fixed capital expenditure---build freeways and powerplants to employ workers affected by a slow in export growth.

Please feel free to comment.