Sunday, March 31, 2013

What you think you think depends on what your brain does.

My friend Julianne brought an interesting article to my attention that describes a model proposed by psychologist Jonathan Haidt. The article suggests that
Our beliefs are shaped by unconscious drives and deep-seated emotions, but our minds come up with ingenious ways of justifying them and presenting them to the world as reasonable and well thought out.
 Haidt and his colleagues suggest a framework of six moral foundations.

  • care/harm, which makes us sensitive to signs of suffering and need;
  • fairness/cheating, which alerts us to those who might take advantage of us;
  • loyalty/betrayal, which binds us as team players;
  • authority/subversion, which prompts us to respect rank and status; 
  • sanctity/degradation, which inspires a sense of purity, both literally (physical cleanliness) and symbolically; and
  • liberty/oppression, based on the desire not to be bullied, it leads to distrust of big government on the right and of big business on the left. 
I am not sure that the model will hold up in the long run, but it is interesting. Haidt goes on to suggest that the balance among these moral foundations separate liberals from conservatives and that they are found in different frequencies in different nations.

Saturday, March 30, 2013

Evolution of the Global Gross Domestic Product

Source: The Economist
Most of the economic growth in the world for the past five years has come from Brazil, Russia, India, China and South Africa -- the BRICS.

U.S. Hospital Charges Are Out of Control

Ewe Reinhardt is a very good health economist. In a recent Economix post he notes:
it is higher health spending coupled with lower – not higher — use of health services that adds up to much higher prices in the United States than in any other member nation of the Organization for Economic Cooperation and Development. Aside from a few high-tech services, Americans actually use less health care and rely on fewer real health-care resources than do residents of other industrialized countries.
He goes on to state:

My explanation for the relative high prices Americans pay for health care relative to other countries is that the payment side of the health care market in the private sector is fragmented, weakening the bargaining power of individual insurers, especially vis-à-vis the increasingly consolidated hospital sector, although other factors, including malpractice premiums, play a part as well. 
To endow the payment side of health care with more market muscle, I have proposed an all-payer system based on the models used in Germany or Switzerland or in the state of Maryland. In these systems, government does not dictate prices. Instead, health care prices are negotiated at what Europeans call a “quasi market” level.
Fortunately, I live in Maryland and I belong to an HMO, blessed by good health insurance. I suggest that the rest of the nation follow by improving the negotiations for prices and participation in health maintenance organizations.

Without comment

By CATHERINE RAMPELL, Economix, March 28, 2013

Friday, March 29, 2013

A Thought about the federal budget

There is a good post by Nate Silver (the guru of election statistics) in his New York Times blog on the evolution of government expenditures. Since 1980, federal expenditures have varied between 20 and 25 percent of GDP. State and local government expenditures have varied between 12 and 16 percent of GDP. Having peaked during the stimulus after the 2008 crisis, total government spending is about 40 percent of GDP. He provides the following graph showing how the federal budget has evolved:

 The chart
documents the growth in federal government spending over the past hundred years as a share of gross domestic product spending is broken down into four major categories:
1. Entitlement programs, under which I classify government expenditures on health care programs; pensions and retirement programs like Social Security; and welfare or social insurance programs like food stamps and unemployment compensation.
2. Military spending
3. Interest on the national debt
4. Infrastructure and services, under which I include everything else — the pot that is often referred to as discretionary spending: education spending; fire services, police and the criminal justice system; spending on physical infrastructure including transportation; spending on science, technology, and research and development; and the category called “general government,” which largely refers to the cost of maintaining the political system (like salaries for public officials).
Compare the government expenditures with revenues:

Source of graph:
The blue is for the federal government, the red for state and the green for local government. Generally state and local government do not run deficits but rather adjust spending to revenues.

The basic problem is that the federal government has accepted more and more responsibility for health care, social security and pension and welfare programs without adding funding for them. The funds have tended to come from reductions in other budget items.

  • The interest payments have been relatively low. Foreign nations have wanted dollars and wanted to invest in the United States and so interest rates have been low. As the debt increases, and as (perhaps) the dollar loses its luster, interest payments may be expected to increase.
  • Military expenditures have decreased as a portion of GDP, in part because the Cold War is over. Still the United States spends much more on the military than do other nations, or indeed than groups of nations combined. With the end of the wars in Iraq and Afghanistan, there will be a need to rebuild their weapons base. There will also be trillions of dollars of medical and pension costs for which funds have not been set aside and saved.
  • Federal expenditures for infrastructure and services totaled only about 2.5 percent of gross domestic product in 2011; moreover they include many things that are important for the continued growth of the GDP.
Silver also provides this figure:

Remember, government expenditures can grow at the same rate as GDP without increasing government share of the total. The protection and law enforcement is a small item in the total, but one that has been allowed to grow rapidly. Education, transportation and science and technology have been losing share, and we can't afford to economize on these areas.

The real problem is entitlements. My read would be that there are some savings to be had in making health care more efficient and perhaps some in welfare by increasing employment, but that we have to increase government revenue to pay for more pensions for our aging population and more government provided health care. 

To some extent this is a shell game: if we are not to deny health care to those who can not afford it, the funds have to come from somewhere. Shifting them to government does not increase the total burden on society. But the further implication is that federal government revenues should increase in step with the increase in health care and pension expenditures.

Here is one more graph to polish off this post:

Source: Morning Sun blog
The increase in the public debt to the size of the GDP is worrisome, and it is likely to increase further in the next few years. There is not much that can be done to reduce the expenditures of government, so increasing revenues seems necessary.

A thought about civil and religious marriage.

Essentially, a religious marriage ceremony sanctifies a union in accord with the practices of the specific religion involved. A marriage recognized by the state has many but not all the characteristics of a contract, but also has consequences in the law that a contract does not have. In some cases a single ceremony satisfies both religious and civil requirements, but not always.

In Maryland, where I live, couples who qualify can obtain a marriage license and may be legally married someone authorized to conduct marriages by a recognized church or by someone authorized by the Circuit Court; in either case the officiating person  would normally then issue a certificate legalizing the union.

Note that a couple might be married in a civil ceremony with license and certificate, and the marriage not accepted as such in the couple's religion. Thus the Catholic Church would not recognize a civil service as the sacrament of marriage unless the ceremony was performed a priest. Indeed, it does not recognize divorce so that if either bride or groom had received the sacrament of marriage with a living person, then the couple's new marriage would not be conducted by a priest and their civil marriage would not be recognized by the Catholic Church.

Equally, a priest or minister might perform a wedding that would not be recognized by the state. Most simply, were a wedding to be performed without license and/or without a certificate of marriage, it would not be recognized by the state. Similarly, same sex marriages performed in churches in Maryland would not have been accepted as civil marriages before this year. Were some church to perform a group marriage, a polygamous marriage or a polyandrous marriage in Maryland, the result would not be seen as legal in the state.

The Defense of Marriage Act of the federal government is thought to affect the treatment of "married couples" 1,100 different federal laws. That seems like a lot of legislation to be based on definitions of marriage that differ greatly among our 50 states. I also wonder whether all the laws that make distinctions based on marriage might be better formulated based on other criteria, such as the number of children cared for by a couple. I think about old people who live together and would like to get married by can not afford to do so because of the financial implications of the federal laws. Perhaps we need more differentiated legal situations that would allow all those laws to be more finely tuned to achieve public purposes.

The United States has a strong tradition of separation of church and state. The country would presumably not want to interfere with any religion sanctifying any union that it chose, unless there was an overriding public policy reason to do so (such as child welfare or public health). On the other hand both the federal government and state governments have public policy reasons to promote certain types of marriages. Perhaps, as is done in other countries, that there should be a civil marriage performed by a civil official in all cases to qualify for state and federal treatment as married people. Those who wished to be married also in a religious service would be free to do so.

Tuesday, March 26, 2013

We have not identified most species

Very cool infographic from National Geographic - how many species have been identified, and how many do we think there are left to discover?

More info:

Monday, March 25, 2013

Thinking about the rate of growth of GDP.

The Economist has a column this week questioning the rate of economic growth that may be expected in the United States.

Although the recession was the deepest since the second world war, the recovery has been a disappointment. In the three years since the end of the recession in mid-2009, growth averaged 2.2%, barely half the 4.2% average of the seven previous recoveries.
In part, this is because recoveries from financial crises face greater difficulties. 
Consumers are too much in debt; businesses cannot or will not spend; a damaged banking system stifles credit. But in its annual economic report, issued on March 15th, Barack Obama’s Council of Economic Advisers argues that this is not the whole story. The ......economy returns to an underlying trend rate of growth that is determined by the supply of workers, capital and technology. Mr Obama’s economists argue that the trend is now much lower than in the past.
Thus if the work force increases, it will tend to increase the GDP. U.S. population growth has slowed, but so too has the portion of the population entering the work force. It may be that some of the young people who are extending their education due to the poor job market will thereby increase their lifetime earnings and restore their contribution to GDP growth, but on the other hand young people who just can't get jobs for a few years wind up with lower incomes in future years as well.

Capital is defined as "financial assets", that is assets that contribute to the production of goods and services. Wealth that is simply idle does not do so. Today a lot of people are holding cash rather than investing, and others are investing in gold or art works. (Of course there seems to be more investment in human resources -- education -- which may yield future economic growth.) Note too that capital infrastructure can deteriorate, as the roads and bridges in the United States were allowed to deteriorate for too long.

A significant concern is the rate of growth of total factor productivity. These was a long stretch in which the Information revolution was improving the ways of doing things, yielding a relatively high rate of improvement of total factor productivity and thus of growth of GDP. It is questioned whether we will see the same high rate of reengineering of organizations, restructuring of markets and improvements of technology in upcoming years.

I have previously noted that if producers appropriate a smaller portion of the benefits of their work and consumers more, then the GDP suffers while that actual consumer value of the production may continue to increase rapidly. eBay, Amazon, Wikipedia, online newspapers and other innovations seem to be increasing consumer surpluses.

And of course, if people choose to consume fewer goods and services in order to improve the quality of their lives (e.g. longer vacations, more leisure, a simpler but happier life style) that reduces GDP but not happiness.

A thought about America's failing economic mobility.

I heard Lani Guinier, a professor at Harvard Law School, talk yesterday about the fundamental myth of the United States -- if you work hard and follow the rules you can get ahead. I can see how the myth began. Pilgrims arrived and the survivors multiplied and grew prosperous. Lots of English arrived as indentured servants, served their time, got their own land, and prospered.

I suppose that hidden behind that myth was a racist myth -- that American Indians, African immigrants, and Asian immigrants were not doing well, so it must be their own fault. Was that why they were separated or excluded from the majority white population. Remember too that there was a eugenics movement in the United States that included forced sterilization of tens of thousands of women "to improve the race".

Remember that in the bad old days, the dominant American society considered Jewish, Irish, southern European and eastern European immigrants as different races, each with their own racial epithet. Perhaps it was only when members of these ethnic groups succeeded economically and socially by working hard and obeying the rules that they were accorded entry into the "white" socio-economic class.

Now there are many countries offering more economic mobility than does the United States. There are millions who see themselves as working hard and following the rules but not doing well. Indeed, many of them feel that this is true even though they were members of the dominant elite.

Lani Guinier suggests that these folk are seeking to place the blame for their lack of success somewhere, and doing so by reversion to racism.

Sunday, March 24, 2013

A thought about U.S. executive power.

The president of the United States is dealing with domestic and international issues. He is the head of a huge executive branch, but also dealing with the legislative and judicial branches of government. He has to deal with politics in order to maintain his authority, and as leader of his party to try to assure that his administration has adequate influence in the legislative branch.

There are some 200 foreign nations. The Secretary of State has a huge organization with representatives in those foreign nations feeding information through layers of filters to supply the Secretary with information and analysis. The Secretary travels a lot and actually meets and holds discussions with many foreign leaders. He spends essentially all of his time on foreign affairs. The Secretary of Defense also has a huge organization, with different interests and analytic capacities than the State Department, feeding him information and analysis on which he spends all his time and effort. The same can be said of the Director of National Intelligence. The Secretary of the Treasury similarly has an organization to study and analyze international economic affairs which feeds him information and analysis.

The Secretary of the Treasury also leads an organization gathering information on and analyzing domestic economic conditions and providing him with information and analysis on which he spends all of his time. So too the Secretaries of other cabinet departments in their areas of expertise.

The president has a White House staff and can draw on a National Security Council, and Domestic Policy Council, a Council of Economic Advisers, a Council of Scientific Advisers. He can also draw upon the organization of his political party for advice.

If the president has any sense he will surround himself with cabinet officials who can effectively bring to his attention the most relevant information and analysis from their subordinate organizations on the issues at hand (and likely to arise) while effectively advocating policies and actions relevant to their responsibilities. If he has any sense he will recognize that each and any of those cabinet members may be right and his less informed opinions may be wrong. He will use the White House resources to help him obtain a broad spectrum of informed advice, as well as to follow up and assure that his decisions are being effectively implemented.

The U.S. Constitution was constructed by people who had led a revolution to free their country from the rule of a monarch who believed he ruled by divine right; they set up checks and balances and gave great power to the legislative branch of government. The Congress not only has 538 members elected from all over the country, but a large staff reporting to individual members and to the various committees, plus investigative bodies. It obtains exhaustive advice from the private sector and non-governmental organizations, as does the executive branch.

Even were the president to be so foolish as to wish to ignore the Congress, he could not effectively govern were he to try to do so. He is constrained to come to agreement with them.

A cabinet member has the odd task of forcefully advocating the positions he achieves with the advice of his subordinate organization, while implementing the decisions of the president whether or not they agree with the recommendations he has made, and supporting the positions of the administration publicly and with the domestic and foreign leaders which which he interacts.

And of course, all there people are people -- fallible, emotional, with families and personal concerns, who get tired and sometime sick. It is interesting that we so often presume that the government should make rational decisions based on all but perfect information and analysis, judged against our uninformed and poorly analyzed opinions.

Another great theory killed by real data!

An idea on how to make some money and help U.S. students!

Text books are expensive in the United States.

Source: National Association of College Stores
According to The Economist, Supap Kirtsaeng, a Thai student studying in the United States, realized that the same text books he was assigned in the USA were often available at much lower prices in Thailand. It seems that the U.S. publisher licensed its foreign branch to print copies abroad and sell them for prices that the Thai students could afford.

Kirtsaeng asked friends and family to ship him cheap textbooks from Thailand, which he sold for a handsome profit in America. He made as much as $1.2 million.

Not surprisingly, he was sued for copyright infringement. Now, however, the U.S. Supreme Court has decided that what he did was perfectly legal. If you buy a book legally printed abroad, under U.S. copyright law as first buyer you can legally resell it in the United States.

So if you live in South Asia, East Africa or West Africa and text books are available in your country at low prices that are also used in classes in the USA, then you have a business opportunity. The potential market is significant. There are 4,800 U.S. colleges and universities and many million U.S. students of higher education.

Buy the books locally, ship them in bulk to the United States, sell them on the Internet at a profit, and ship using the U.S. book rate to your customers.

Need some start up funding to get your business off the ground? Try crowdfunding.

Source: The U.S. Census Bureau

Saturday, March 23, 2013

Cartoons helped change the culture of corruption in New York City.

The New York Times in its early days, when it was a small paper vying for influence and readers, set a number of reporters to track down corruption in the governance of New York, especially that organized by the Tweed Machine. Cartoonist Thomas Nast joined that team, and most importantly conveyed ideas in a clear, easily understood and memorable manner.

As we try to change the culture of corruption in developing nations, perhaps it would be important to empower their own political cartoonists to dart the inflated plutocrats of corruption.

I don't see why civilians should have assault rifles.

There are a lot of people more expert than I am about assault weapons, but there seem to be a lot of statements around that are clearly wrong. As a young man I did competitive target shooting with a small caliber rifle, trap shooting and hunted with both rifle and shotgun. I owned rifles, a shotgun and a pistol (which I sold before my first foreign posting). While that is a long time ago, I do have some  experience.

Assault rifles were conceived as military weapons. They are not intended to arm aircraft. They are not artillery. They are not sidearms. Indeed, they are intended for use by foot soldiers who are supported by troops with other weapons. They are definitely not intended "to kill as many people as possible", but rather to be used against enemy soldiers during battle.)

Generally they are designed to be rugged, relatively simple to operate, relatively light and easy to carry, and accurate to a range of 1000 feet. These are characteristics that are also useful for civilian purposes such as hunting deer or other large game.

Assault rifles are designed to allow the rifleman to shoot at people. Other weapons are better suited for varmint hunting, target shooting or hunting large game.

Assault weapons are intended to take enemies out of action.  There are advantages in wounding an enemy badly enough to disable him while leaving him to require medical attention and hospitalization; a hunting rifle on the other hand should drop the game animal and minimize its suffering.

An assault rifle should be able to switch among fully automatic fire, burst fire or single shot fire. There would seem to be no advantage to burst or automatic fire for hunting nor for target shooting.

Target rifles tend to be rather heavy -- they are not carried long distances and are designed to be heavy to increases accuracy.

Assault rifles use intermediate ammunition as it is lighter to carry, has a lighter kick when fired (especially important for burst and fully automatic fire), and produces the kinds of wounds useful for military purposes. They use detachable magazines that support the burst and fully automatic fire; a magazine that can be quickly replaced when one is exhausted. Other kinds of ammunition are better for other purposes (e.g. small bore ammunition for varmint hunting, large caliber for big game). I found single shot rifles appropriate for both hunting and target shooting; double barreled shotguns seem adequate for hunting although I used a single barrel shotgun for both trap shooting and hunting.

Assault rifles might be sought by criminals who intend them to be used against people or at least to intimidate people. We clearly want to prohibit such use and be sure that they don't get into criminal hands. They also can be dangerous in the hands of regular people who would have accidents with them or misuse them due to lack of understanding of their capabilities and proper use.

I don't see any reason why assault weapons would be useful for the average American. They are designed for soldiers. There may be some applications of assault rifles for law enforcement or for people in other specific occupations, and should be limited to those applications.

Friday, March 22, 2013

A thought about man and the universe.

New research results indicate that the universe is some 13.8 billion years old. No one knows how many galaxies exist in the universe, but there are more than 100 million and maybe as many as a trillion. Galaxies come in different sizes, but we can say that there are an average of perhaps between 100 million and one billion stars per galaxie. So maybe there are 1,000,000,000,000,000,000,000,000 stars in the universe. A recent estimate based on astronomical investigation of our region in this galaxy was that there are an average of 1.6 planets per star. I discovered a reference that says that "(t)he National Science Foundation’s “Tree of Life” project estimates that there could be anywhere from 5 million to 100 million species on the planet, but science has only identified about 2 million." There are now more than 7 billion members of our species alive. Perhaps we represent between six and seven percent of all the members of our species who have ever lived. Maybe I am not as important as I might have thooght.

Thursday, March 21, 2013

You may link Obamacare more than you know.

Chart: Many provisions of Obamacare remain popular, three years in. Many of them get at least two-to-one support, but (a) most Americans still have no idea what's in the law; and (b) the most popular provisions are the ones Americans don't know about, while the least popular provisions are the ones Americans do know about. Details on the blog.

Wednesday, March 20, 2013

A thought about the stock market and the economy

Source of graph

Stocks tended to increase in value when total stock market capital was a relatively small portion of GDP. Bubbles in the last years of the 20th century and the last part of the last decade saw market capitalization as 100% or more of GDP. I suppose stock prices are high today because interest rates are very low. One wonders whether a bull market will continue, and whether earnings of companies can in the future justify the high prices of stocks.

A thought about economic bubbles.

Apparently much of economics is based on the assumption of equilibrium. I am currently reading Manias, Panics and Crashes: A History of Financial Crises (Edition 6) by Charles P. Kindleberger and Robert Z. Aliber. It shows a history of hundreds of years in which equilibrium is not achieved.

There are some economists who have been studying systems of non-linear equations, systems with positive and negative feedback, to model economies. Those approaches would allow the modeling of instability and indeed of systems that never achieve a stable state.

Kindleberger and Aliber seem to show a history of change in the economic system as national economies become more and more interlinked. The authors also treat a large number of different "shocks" that can trigger the development of a bubble, treating them as exogenous; a really satisfying model would I suppose treat those events as endogenous, leading to larger and larger systems.

The book focuses on financial bubbles that expand and burst leading to crashes. It seems obvious that one wants to provide some negative feedback in financial systems to reduce the velocity of manias and panics. Alternatively one can introduce drag in the system to damp out excessive oscillation. Indeed, Kindleberger and Aliber suggest that good banking practice is well known as are the regulatory controls to encourage good practice; they do damp the oscillations and limit the occurrence of bubbles and crashes.

However, when regulations are imposed by government, firms rapidly find ways to get around them (and thus restore the potential for instability). Moreover, there are short term profits available in manias and crashes and thus in the lack of regulation that allow them; the politics behind regulatory law seem regularly to remove feedback controls and drag in financial systems, again leading to instability.

A thought about migration.

The Bureau of Labor Statistics reported 3,693.000 job openings in the United States in January 2013. The Manpower Group reported that 49 percent of U.S. employers cited talent shortages in 2012, leading to unfilled job vacancies. The most frequent fields in which there were talent shortages in the Americas were engineers, technicians, sales representatives, skilled trades workers and production operators.

If you assume that a million jobs could be filled from abroad with more open immigration for people in these fields, and that they might earn say $50.000 per year on average, then that would be a $50 billion shot in the arm for the economy. I suppose that the impact would be higher since these folk would spend money in the U.S. that they earned here, creating a multiplier effect. Moreover they would create more profits for their firms, and they would enable their firms to expand businesses in ways that would create still more jobs.

So why does Congress only allow 65,000 people per year with specialty occupations to come to the United States per year with temporary H-1B visas?

Tuesday, March 19, 2013

The Greening of the Internet

There is an interesting article in The Economist triggered by the recent ITU negotiations on Internet governance. Probably most readers of this blog recognize that most of the important Internet countries will not sign the convention that grew out of the meeting.

I am not surprised that there was a chasm between the democratic, free market countries and those with coercive governments and kleptocracies on Internet governance.

I was taken by this comment from the article:
Today every corner of the digital universe has its own interest group: consumer groups defend online privacy; hackers reject far-reaching software patents; researchers push for open access to scientific journals online; defenders of transparency call on governments to open their data vaults—or take the opening into their own hands........ 
The internet is nothing if not an exercise in interconnection. Its politics thus seems to call out for a similar convergence (to that of the green movement), and connections between the disparate interest groups that make up the net movement are indeed getting stronger. Beyond specific links, they also share what Manuel Castells, a Spanish sociologist, calls the “culture of the internet”, a contemporary equivalent of the 1960s counter-culture (in which much of the environmental movement grew up). Its members believe in technological progress, the free flow of information, virtual communities and entrepreneurialism. They meet at “unconferences” (where delegates make up their own agenda) and “hackerspaces” (originally opportunities to tinker with electronics); their online forum of choice will typically be something such as a wiki that all can contribute to and help to shape.
Count me in among those who "believe in technological progress, the free flow of information, virtual communities and entrepreneurialism."

On the other hand I also recognize that national borders are little protection against Internet crime, and that a lot of spam flows across those borders. If we can have a Geneva convention declaring some forms of warfare to be illegal under international law, then we might have room for a convention making some forms of cyberwarfare illegal.

Proud to be an American! We are tied for number 16!

Source: The Economist

Rosen on the History of Technology

If you drink from a straw there is clearly a perception that you are sucking up liquid. In fact we know that you are creating a vacuum, and it is the pressure of the atmosphere on the liquid in the glass that is pushing the liquid up the straw.

Newcomen, when he invented his steam engine, had the perception that one could drive a piston in a cylinder if the pressure on one side of the piston was different than that on the other side. If one side of the piston was exposed to the air, air pressure would be applied to that side. Steam pressure applied to the other side could drive the piston towards the end of the cylinder open to the air. By removing the steam and creating a (partial) vacuum, the pressure would be lowered to less than the air pressure and the piston could be returned. Newcomen realized that by condensing the steam in a closed system, he could create that partial vacuum.

His steam engine was good enough to make a lot of money pumping water out of the coal mine that were beginning to fuel England in the early 18th century. They were, unfortunately, very inefficient. It took James Watt to recognize the fact that much more efficient steam engines could be built, to discover the key invention to do so, and to start the commercial development of those improved steam engines.

In his book, The Most Powerful Idea in the World: A Story of Steam, Industry, and Invention, William Rosen describes the inventions of Newcomen and Watt. He describes how each built upon knowledge accumulated by their predecessors. He notes that the 17th century was the time in which the English Royal Society of London for Improving Natural Knowledge was created promoting the dissemination of scientific knowledge, and the Royal Society for the encouragement of Arts, Manufactures and Commerce which promotes the creation and dissemination of technological knowledge.

He also describes the evolution of patent law that provided a profit motive for people to invent new devices with practical applications and profit from their commercialization. That is an interesting story. The kings of England had issued patents giving monopoly power over specific markets to favored subjects. Edward Coke changed English patent law requiring that there be some invention to justify the granting of a patent. (His law also specified the length of a patent's monopoly as 14 years, twice the seven years of the apprenticeships of his time.)

Francis Bacon added the requirement to patents that the invention would have to be publicly disclosed. Thus not only did patents give people economic incentives to invent, but they allowed other inventors quickly to learn about and improve every patented invention. Thus by the end of the 17th century the basis in patent law that was critical for the industrial revolution had been created in England. Rosen identifies patenting in this modern sense as the most powerful idea in the world.

He also describes the development of measurement and quantification, its spread to those seeking to invent. Measurement of latent energy, the dependence of boiling point on atmospheric pressure, and other things was critical to the advance of the steam engine. Indeed, improved measurement was critical to other inventions during the industrial revolution and since.

He also describes the improved linkages between people who worked with their hands and worked for a living and those who lived on income and had created knowledge as an avocation. The artisans became more literate and numerate, and some rose to prominence by their experimental and inventive abilities.

Basically, he describes a significant change in institutions that combined most auspiciously in England in terms of the technological revolution that was part of the industrial revolution.

Monday, March 18, 2013

How complex the world is.

Source: Wikipedia
A couple of years ago I read 1848: Year of Revolution by Mike Rapport. It described the wave of political unrest that swept across much of Europe in that year. The table above shows the terrible agricultural disaster that swept across Europe in 1845 and 1846. In their book, Manias, Panics and Crashes: A History of Financial Crises, Charles P. Kindleberger and Robert Z. Aliber describe the crash leading to the failure of a large number of banks in England in the latter half of 1847, which spread to mainland Europe in 1847, especially to France in early 1846. They describe that crash as resulting from speculation in railroads and wheat, leading to a crash when the railroads and wheat brokers could not pay off the loans they had taken out. One can see how the bad harvests led to increases in the price of wheat and then speculation in wheat; perhaps the agricultural crisis also led to a fall in the use of railroads. Looks like a crisis in agriculture led to a crisis in finance as well as a hunger crisis which together led to a political crisis.

Population Growth Rate: Israel, Gaza, the West Bank and Refugee Camps

Source: The Economist
There are as many Arabs in Israel, Gaza and the West Bank as there are Jews in Israel and the West Bank. There are an additional 2.9 million Palestinian refugees outside of the region. The Arab birth rate is higher than that of the Jews. 

This article suggests that the majority of the Knesset and a majority of Netanyahu's new cabinet believe in a one state solution with all of what are now Israel, Gaza and the West Bank part of an enlarged state of Israel.

There seems to be a disconnect.

Sunday, March 17, 2013

Thoughts about the biology of mind

I have been involved in a discussion of the biology of mind and the need for an international venue for discussion of the policy implications of the emerging science and its technological repercussions.

Scientists have been illuminating the incredible plasticity of the brain. That plasticity is not that the different organs within the skull migrate physically. Scientists now know that the number of neurons in the brain peaks during early childhood and then some die not to be replaced; they also have shown that there remain stem cells in the brain and new neurons are created long into adult life. Still it is believed that most of the changes are in the connections among neurons and the ability of neurons to excite or inhibit the actions of other neurons.

The biology of mind seems to be an emerging discipline. Imaging techniques, electrical recording techniques and molecular biology are combining to produce rates of scientific knowledge production in this area that were hardly imaginable a couple of decades ago. It seems likely that the burgeoning of knowledge will lead to important applications. This turning point might turn out to be similar to semiconductor physics leading to semiconductor electronics or atomic physics leading to nuclear energy.

We now know the Flynn Effect, that average performance on IQ tests is improving:
The average rate of increase seems to be about three IQ points per decade in the U.S. on tests such as the WISC. The increasing raw scores appear on every major test, in every age range and in every modern industrialized country although not necessarily at the same rate as in the U.S. using the WISC. The increase has been continuous and roughly linear from the earliest days of testing to the present.
This may be because people are increasingly learning things measured by IQ tests instead of other unmeasured things that they learned in the past, or perhaps because people are on average actually becoming more intelligent. (Perhaps a smaller part of the population are subject to poor nutrition and childhood diseases that limit the development of the brain, or are subject to poor intellectual environment and inadequate schooling that would limit their learning opportunities.) Whatever the explanation, since IQ test performance is clearly a function of the behavior of the brain, on average, the brain of today (in industrialized countries) is different than was, on average, the brain of yesteryear.

I see no reason to believe that brains will not continue on the average to change. I would suggest that our objectives in schooling and in lifelong learning would be to encourage brain development, on average, in beneficial directions. Schooling has tended to focus on facts and analysis. Perhaps it should focus more on other aspects of learning. For example, perhaps it should seek to assure that learning excites the pleasure centers of the brain.

Homo sapiens are social animals, and there is evidence that we make better decisions in groups than as individuals. Perhaps we need to consider the biology of the group mind. Perhaps schooling should include specific efforts to help people learn better how to think together, to solve problems in groups.

It has also been suggested that we think with our surround. In my father's day (born in 1905 in Ireland) it made sense for schools to promote the development of memory; in my youth (born 1937) we were taught library skills but had less memory training; today's infants will be brought up with hand-held devices connected to the Internet and will be taught to find and evaluate information from cyberspace. So too, modern schooling should help people learn to use the analytic capabilities of computers to amplify their own analysis.

My point is that the improving science of the biology of the mind should be reflected in changes in educational policy. However, that is but one area of policy that should reflect our emerging knowledge of mind. Clearly psychiatric policy will change as we better understand the brain, and as we develop better technology for diagnosis and treatment of brain dysfunctions; given the relation of "physical" and "mental" health, better science of the mind might also lead to more general changes in medical policy.

Legal policy may well change as we learn more about the brain and the biological bases of decisions and behavior. That seems obviously true for criminal justice, but it may also be true in areas such as legislation regarding marriage/

Information is accumulating as to the interplay between culture and the biology of mind. We know that the language we learn as children influences the allocation of space in the brain to different mental functions. We also know that culture is plastic -- that the cultures of today's nations have changed from the cultures of their predecessors. Not only are Western cultures different today than they were a century ago, but so too are "indigenous" cultures in Asia, Africa and the Americas. Perhaps we might induce positive changes in culture for our descendants through examination of the increasing knowledge of the biology of mind -- perhaps promoting cultures of peace and improved understanding among cultures.

Does Kahneman clarify Manias, Panics and Crashes?

Daniel Kahneman won the Nobel Prize for his work in psychology underlying economic behavior. His book, Thinking, Fast and Slow, explains a theory that two systems drive the way we think. System 1 is fast, intuitive, and emotional; System 2 is slower, more deliberative.  These two thought processes can arrive at different results even given the same inputs.

I quote from a review of the book in the New York Times:

System 2, in Kahneman’s scheme, is our slow, deliberate, analytical and consciously effortful mode of reasoning about the world. System 1, by contrast, is our fast, automatic, intuitive and largely unconscious mode. It is System 1 that detects hostility in a voice and effortlessly completes the phrase “bread and. . . . ” It is System 2 that swings into action when we have to fill out a tax form or park a car in a narrow space. (As Kahneman and others have found, there is an easy way to tell how engaged a person’s System 2 is during a task: just look into his or her eyes and note how dilated the pupils are.) 
More generally, System 1 uses association and metaphor to produce a quick and dirty draft of reality, which System 2 draws on to arrive at explicit beliefs and reasoned choices. System 1 proposes, System 2 disposes. So System 2 would seem to be the boss, right? In principle, yes. But System 2, in addition to being more deliberate and rational, is also lazy. And it tires easily. (The vogue term for this is “ego depletion.”) Too often, instead of slowing things down and analyzing them, System 2 is content to accept the easy but unreliable story about the world that System 1 feeds to it. “Although System 2 believes itself to be where the action is,” Kahneman writes, “the automatic System 1 is the hero of this book.” System 2 is especially quiescent, it seems, when your mood is a happy one.

Now think about Manias, Panics and Crashes: A History of Financial Crises by Charles P. Kindleberger and Robert Z. Aliber in terms of Kahneman's two systems. Presumably it is System 2 that uses financial analysis to determine whether to purchase or sell shares of a given stock at a given price, or uses detailed analysis of pros and cons in deciding whether one can afford a house one might purchase and the mortgage payments that purchase would require. On the other hand, System 1 might be more involved in the emotional aspects of decision making.

Kindleberger and Aliber are concerned with manias, especially in the run up of prices during a bubble in the stock market or housing market, and with panic, especially in the run down in prices as the market crashes. The emotional content of mania or panic would presumably be System 1 responses. For those whose lazy System 2s leave decision making to the intuition for stock and house purchases, bubbles lie in wait.

As Pogo says, "we have met the enemy....and he is us."

Saturday, March 16, 2013

The Kindleberger Model

I think the following is the model proposed in Manias, Panics and Crashes: A History of Financial Crises by by Charles P. Kindleberger and Robert Z. Aliber.

1. There is some exogenous shock (policy switching, technology, financial innovation).
2. Depending on the nature of the bubble"
  • Firms take advantage of the new opportunities creating new products or expanding production.
  • Builders expand the production of housing and new buyers enter the housing market.
3. The boom created is fed by expanding credit which increases money supply.
So far, so good. We want the economy to expand taking advantage of new profit opportunities.
4. The boom leads to a system with positive feedback paths, including unjustified lending, irrational investment, speculation and criminal behavior, creating a mania of rapidly increasing prices.
Woops, now overtrading will lead to prices for the stocks or real property that exceed their sustainable value.
The problems are exasperated by touts whose advice adds to the crowd mentality, media that fail to provide good information to buyers and sellers, and nominal agents whose incentives differ from those of their clients.
5. The book is concerned with bubbles that affect several countries; In these multinational events, overtrading spreads from one market to another (psychological links and others).
6. At the peak some insiders leave the market, there is "financial distress" and a bankruptcy or the revelation of a swindle leads to the final stage; the rush for liquidity.
And here we see panic, losses to many participants in the bubble's expansion, and if the bubble is large enough, damage to the greater economy.
7. The panic (or "revulsion") feeds itself until prices become so low that people are tempted to once again go into less liquid assets, trade is cut off or a lender of last resort convinces the market that three is enough money for all.
I suppose that if the overshoot is small and the panic short, the effect may not be all bad. The economy may reach its stable value quickly. However, it it is large and the panic long and deep, the result may be very bad indeed.
The book's authors state that "our conclusion is that money supply should be fixed over the long run but be elastic during the short-run crisis. A lender of last resort should exist, but his presence should be doubted."

The model presented in derived from "Not bad, but more popular than it deserves: A Review of 'Manias, Panics and Crashes: A History of Financial Crises'"

Mapping Science

Source: Science-Metrix
This is just to recommend a site with a great graphic representation of fields of science and their interrelations -- Science-Metrix.

Looking back at Republican misconduct.

My son pointed out this interesting article by Robert Perry on AlterNet. The story is subtitled "New evidence continues to accumulate showing how Official Washington got key elements of two major presidential scandals of the Nixon and Reagan administrations wrong."

I quote selected parts:

  • "Shortly after Nixon took office in 1969, FBI Director J. Edgar Hoover informed him of the existence of the file containing national security wiretaps documenting how Nixon’s emissaries had gone behind President Lyndon Johnson’s back to convince the South Vietnamese government to boycott the Paris Peace Talks, which were close to ending the Vietnam War in fall 1968."
  • "Newly discovered documents at the Reagan presidential library reveal that Reagan’s neocons at the State Department – particularly Robert McFarlane and Paul Wolfowitz – initiated a policy review in 1981 to allow Israel to undertake secret military shipments to Iran.......Not only did the documents tend to support the statements by Veliotes but they also fit with comments that former Israeli Prime Minister Yitzhak Shamir made in a 1993 interview in Tel Aviv. Shamir said he had read the 1991 book, October Surprise, by Carter’s former National Security Council aide Gary Sick, which made the case for believing that the Republicans had intervened in the 1980 hostage negotiations to disrupt Carter’s reelection."
  • "(T)he CIA’s inspector general in 1998 confirmed that the Reagan and Bush-41 administrations had tolerated and protected drug trafficking by the Contras."
How did Bush 43 win the "hanging chad" election of 2000?

Is there a pattern here? Is it of investigative journalism failing to cover political shenanigans adequately, or is it of serious misconduct by Republicans since Eisenhower?

A thought about markets

Commodity markets seem fairly clear to me. Pork bellies and barrels of crude oil are purchased as raw materials by firms that will process them into products that they will in turn sell. I presume that buyers seek to purchase at a low price, but will not pay more than that price which will allow a profit when the elaborated product to be sold on at a suitable value to pay for processing and provide profit. Indeed, farmers may participate in a futures market for pork bellies to reduce risks in the feeding of pigs, and packing plants to reduce risks of future price rises. The economics of the market seem clear.

The market in stamps for collectors seems much less clear to me. New stamps are like paper money in that they can be exchanged for a service; stamps valued by collectors are valued only because of their rarity and the desires of collectors to own them. There may be some speculators, but at the higher values of stamps people presumably buy them to possess them.

I think also of ticket scalpers at the Super Bowl. Brokers who buy tickets and resell them make $800 to $1200 per ticket bought and sold. It seems clear to me that there is a kind of mania here with the ultimate buyers paying thousands of dollars to a ticket to a game that they will watch for a few hours; a game that they could watch for free on television.

Which brings me to the stock market. Economists suggest that the value of a stock is the discounted current value of its future earnings. That seems clear. Yet we know that there are occasional bubbles when buyers bid up stock prices beyond any reasonable guess as to the present value of future earnings. There is of course an entertainment value of playing the market. There are speculators who buy stocks during the rising part of a bubble not expecting to hold them for future income, but rather to sell them to "the greater fool" in the (very) short term; speculators may also sell stocks short during the falling part of a bubble planning to quickly profit from a different "greater fool". The behavior of the people who fuel bubbles, those who suffer from "irrational exuberance" or "animal spirits" seems better explained by psychologists than traditional economists.

Wednesday, March 13, 2013

More on Manias, Panics and Crashes

I continue to read Manias, Panics and Crashes: A History of Financial Crises by Charles P. Kindleberger and Robert Z. Aliber. (See "A thought about the housing bubble" and "A thought about investing".)

The book is fundamentally about times when things in the economy go out of control. We would like the growth of the GDP to be continuous and predictable but there are recessions and depressions. We would like the stock market to behave predictably, but there are bubbles and crashes.

Engineers and mathematicians have developed control theory to enable the description of dynamic systems and thus the ability to design systems that achieve their purposes with stability.

Perhaps the central fact recognized by control theory is that positive feedback in a dynamic system has the potential to make that system unstable. Kindleberger and Aliber point out that there is positive feedback in markets subject to bubbles and crashes -- people buy more because they see prices increasing (and opportunities for profits) but increased demand leads to further price increases; people sell more when they see prices decreasing (to prevent losses) but increased supply leads to further price decreases.

Using control theory, engineers design stable systems by adding damping so that tendencies to overshoot desired levels of output are damped out. Perhaps more important they add negative feedback. Regulation can add damping to economic systems, and government fiscal and monetary policy can provide negative feedback.

The stock market, real property markets and economies are extremely complex systems. Kindleberger and Aliber focus on events that spread among several countries. Thus they focus on economic events that occur in the linked financial or economic systems of several countries, maximizing the complexity of the systems of concern. It is perhaps not surprising that they are hard to control and sometimes become unstable.

Indeed economists like the idea of "the economic efficiency of markets", their instantaneous adjustment to new information. However, Kindleberger and Aliber point to lags in market responses as common in the systems that the study.

Control theorists are not surprised to see jitter in systems built for rapid response to changes in conditions, but are at pains to see that jitter is contained and does not lead to crashes. So too, control theorists see that rapid response is sometimes achieved by designing systems that overshoot in their response to a new signal but then correct to achieve the desired path. One wonders if there are insights from these aspects of control theory that can be applied to improving economic stability.

It is decades since I took my engineering courses in control theory and I never used the tools of control theory in my professional work. However, I think I developed a little intuition that remains, giving me a different way to understand the phenomena described in this book.

Tuesday, March 12, 2013

One smart old guy!

It isn’t what you don’t know that hurts you. It’s what you know that isn’t so.
Daniel Patrick Moynihan

GDP is not a great indicator of development

Yesterday I wrote questioning whether we need a better measure of progress than growth in the GDP. I was focusing on the growth of consumer surplus as compared with the cost of goods and services.

I suppose the classic example is in health. It is clearly better for people to be healthy than for them to be sick. On the other hand, healthy people will tend to buy only relatively inexpensive preventive health services to keep themselves healthy, while sick people tend to buy much more expensive curative and palliative services. Thus more sickness leads to higher GDP, more health to lower GDP.

I was just listening to Jeremy Grantham on the Charlie Rose show. He pointed out that our society runs on fossil fuel, fertilizer, and some other minerals. If the price of those natural resources goes up, say because they are more difficult to extract, then it appears that GDP is going up. This is in part because they are part of the cost of producing all the other goods and services. But the benefit of a barrel of oil that now costs $100 is no greater than the benefit of a $16 barrel of oil many years ago was to that economy. The Chinese are competing in world markets for fossil fuels and other natural resources, and the increased demand is increasing prices (as is the decreasing supply). That fuels growth in the GDP, but not improvement in the quality of life.

On the other hand, increasing energy efficiency (say by insulating buildings better or using energy efficient lighting) decreases energy use without decreasing quality of life. The rapid growth in renewable energy and its substitution for energy based on fossil fuel similarly tends to keep quality of life high while cutting back on the rate of growth of GDP.

Grantham points out that population growth has contributed to growth in GDP but that a smaller population is better for the environment and the conservation of natural resources. We must keep human population within the carrying capacity of the earth, and indeed within bounds that will allow a decent standard of living.

Grantham is famous for predicting stock market bubbles, and his philosophy seems to suggest that we may be living in a centuries long "bubble". The technological revolutions that have fueled our economic development have literally been fueled by the exploitation of fossil fuels built up over millions of years, and we are depleting those fossil fuel resources while pouring greenhouse gasses into the atmosphere. If we drive climate change and environmental degradation too far while depleting natural resources and overpopulating the earth, the quality of life will necessarily deteriorate.

I have a feeling that there are great gains to be had in quality of life through the right kind of education. Schooling children and young adults does cost money for schools, teachers and supplies. At some point, however, people can move into lifelong learning modes that are beneficial to all aspects of life, but that don't require schools. The more that people learn, I suppose that they can be more productive as workers, better citizens, more able to protect their own health and that of their families, etc. If their schooling has given them the enthusiasm to continue self education, the social network to share learning with others, and the tools to learn for the rest of their lives then there is great benefit with little cost.

Food and agriculture is another area where focus on GDP may have perverse effects. We live in a society that eats too much, and too much of the wrong things. There is an epidemic of obesity. We eat too much meat while data show that a Mediterranean diet would be better for our health; that diet does not seem to reduce the quality of life for the Greeks and Italians as compared to us fat Americans. Obviously, producing and distributing more food increases the GDP; so does producing the high fat, high sugar processed foods that contribute to health problems.

My point is that "the good life" is different than "the affluent life". It would be better to focus on fundamental values and seek a life style that maximizes them than to focus on income and wealth, maximizing them while sacrificing other (more important) values. A focus on increasing GDP in a society with high rates of school drop outs, poor health statistics, high rates of crime and addiction, huge numbers of people in jail and other social problems is not the way to progress.

GDP versus Stock Market Index Growth Trends

Evolution of the U.S. GDP

Evolution of the S&P 500: 1959 to 2009
The following graph updates the last one, bringing the data up to August of last year. Now


As I understand it, one of the classic signs of a stock market bubble is when stock prices increase more rapidly than the Gross National Product for an extended period. That was what happened in the 1990s, followed by a drop of the index value to its long term trend. It also looks like that was what happened prior to 2008. There was a recession in the aftermath as would be consistent with the the bursting of a bubble.

The U.S. market indices have now returned to a region similar to that prior to the financial crisis of the late 2000s, and so too has the GDP. It rather looks like the rate of GDP growth trend has returned to its long term trend after several years of more rapid growth than might have been expected.

The volatility of the S&P index seems high at the moment, but the ratio seems consistent with the long term normal value.

I found a reference that indicates that the current Price to Earnings ratio for the S&P 500 is quite high (above 21) While P/E can be higher in times of low inflation rates such as now, the current rate is relatively high even for the current inflation rate (albeit much lower than during the late 90's tech bubble).

The interest rates are currently being held low by the Federal Reserve, meaning that returns on bonds are low. That leads to high P/E ratios on stocks as well.

Monday, March 11, 2013

Do We Need To Supplement or Replace GDP as Our Key Economic Indicator:

An article in The Economist describes a number of studies showing that consumer surplus is quite high from Internet applications:

  • 'Shane Greenstein of Northwestern University and Ryan McDevitt of the University of Rochester calculated the consumer surplus generated by the spread of broadband access (which ought to include the surplus generated by internet services......The authors reckon that by 2006 broadband was generating $39 billion in revenue and $5 billion-$7 billion in consumer surplus a year. Based on its share of online viewing, Mr Greenstein thinks Wikipedia accounted for up to $50m of that surplus..........the advent of new services such as Google and Facebook meant internet access in 2006 was worth much more than in 1999. So the surplus would have been bigger, too."
  • 'IAB Europe, a web-advertising industry group, McKinsey, a consultancy, asked 3,360 consumers in six countries what they would pay for 16 internet services that are now largely financed by ads. On average, households would pay €38 ($50) a month each for services they now get free. After subtracting the costs associated with intrusive ads and forgone privacy, McKinsey reckoned free ad-supported internet services generated €32 billion of consumer surplus in America and €69 billion in Europe. E-mail accounted for 16% of the total surplus across America and Europe, search 15% and social networks 11%."
  • "Another way to infer consumer surplus is from the time saved using the internet. (Social scientists) asked a team of researchers to answer questions culled from web searches. The questions included teasers like: “In making cookies, does the use of butter or margarine affect the size of the cookie?” On average, it took participants seven minutes to answer the questions using a search engine, and 22 minutes using the University of Michigan’s library. Hal Varian, Google’s chief economist, then calculated that those savings worked out to 3.75 minutes per day for the typical user. Assigning that time a value of $22 per hour (the average wage in America), he reckons search generates $500 of consumer surplus per user annually, or $65 billion-$150 billion nationally."
  • "Erik Brynjolfsson and Joo Hee Oh of the Massachusetts Institute of Technology note that between 2002 and 2011, the amount of leisure time Americans spent on the internet rose from 3 to 5.8 hours per week. The authors conclude that in so far as consumers must have valued their time on the internet more than the alternatives, this increase must reflect a growing consumer surplus from the internet, which they value at $564 billion in 2011, or $2,600 per user. Had this growth in surplus been included in GDP, it would have raised economic growth since 2002 by 0.39 percentage points on average."
I can think of other areas. There must be a considerable consumer surplus from watching movies on television and the Internet (doing so is more convenient and cheaper that going to a movie theater). eBay and online used book sellers allow consumers to buy with more selection and lower prices, thus almost certainly increasing consumer surplus over bricks and mortar stores.) Indeed, the discounts provided by Amazon and other online stores that are challenging bricks and mortar stores suggest more consumer surplus.

The GDP measures that have been dominating economic discussions of course are silent on consumer surplus. If consumer surplus increases significantly with respect to the cost of goods and services, then simply following GDP will fail to adequately capture the evolution of the economy.

Indeed, the French have shown that they prefer leisure time and long vacations to increased work, production and pay. Perhaps increasingly per capita is inadequate as a measure of quality of life, and thus as a basis for economic policy.

Sunday, March 10, 2013

Adults should study science too!

So you graduated college 20 years ago and high school 25 years ago where you last took a science course. I have news for you. Scientific knowledge has not only grown rapidly, but what scientists have learned has challenged what they once believed in important ways.


A thought about the housing bubble

I am still reading Manias, Panics and Crashes: A History of Financial Crises by Charles P. Kindleberger and Robert Z. Aliber. I have come to the part dealing with the housing bubble of the last decade. I find that I think there is an interpretation that does not correspond exactly to the book's proposed model.

The model is based on a market with buyers and sellers much like the market provided by eBay "Buy it Now". That is buyers and sellers each can see the prices for comparable items on the market; the seller can chose a price at which to offer something; the buyer can chose an item to purchase at the offered price. The dominant elements in the process are the psychology of the buyers and sellers. (The model also involved credit; of that more later.)

There is the normal market for housing, which I think of as where almost all sellers are living in the house they are selling and almost all buyers are planning to live for a long time in the house they are buying. (In a housing bubble, many speculators are buying houses to resell and many speculators are building houses to sell.)

I have bought  two houses and sold one. In all three cases, as most people in a normal housing market, I employed an agent. I needed the agent's specialized knowledge of the market as well as good advice on the transaction. As I understand it, in most such transactions there is a three percent fee on the agreed final price of the house, shared equally between the buyer's and the seller's agents. In those circumstances the agents have an incentive to achieve deals as quickly as possible, since they will then get the maximum of return per unit time worked. A $500,000 house would generate $15,000 in real estate agents' fees. If the deal can be reached in five days, that is $1,500 per agent per day; if it takes 10 days, each gets $750 per day. There is also a small advantage to both agents the higher the final price of the house. Since both the buyer and seller are probably interested in a quick sale the incentives for the buyer, seller and agents are more or less in line.

Most people buying a house will need to obtain a mortgage. Thus the buyer is involved both in finding a house and finding a mortgage. A couple of hundred years ago, banks provided the mortgage loans. If there was a small loss on a mortgage, the owners of the bank would lose money; if there were many large loss that broke the bank, the depositors would lose money as well. Thus those negotiating mortgages for banks were under pressure from both owners and depositors to make safe mortgage loans. In the latter part of the 20th century, the government guaranteed deposits, so that the risk of bad mortgage loans was then shared by the stock holders in the bank and the public.

If a potential buyer could not obtain a loan necessary to buy a house, clearly agents, potential buyer and seller all lost out. Thus it was important for the buyer's agent to find a house that the buyer could afford, and similarly, it was important that the seller's agent brought potential buyers to him who could afford the house.

The system changed in the latter part of the 20th century. Then banks came to negotiate mortgages that they sold to brokers; the brokers accepted part of the risk involved in the mortgage, but sole it on to financial institutions that bundled many similar mortgages into mortgage backed securities which they sold on to investors. The investors too assumed part of the risk inherent in the mortgage. The banks then entered into house sales transactions as agents of third parties.

In that system the incentives for all the agents are to make as many sales as possible at as high a price as possible. If a buyer purchased a house that he could not afford, or if the lender was left with a foreclosed mortgage on a property that could not be sold at sufficient price to retrieve the principle, that did not affect the profits of the real estate agents nor the bank. Agents had incentives to encourage people who could not really afford purchases to utilize sub-prime mortgages to purchase houses; they also had incentives to encourage purchases of houses at prices above their real value. Thus the incentives for the agents may have been markedly different than those of buyers and those who accepted the risk on mortgages.

The system that led to the housing bubble in the last decade reduced the risk to the bankers actually negotiating the mortgages. That led to different incentives for the the agents of the buyers, sellers and lenders. Since those agents controlled much of the information for the actual buyers and ellers in most of the housing transactions, the bubble became much more likely.

Are Cultural Differences Relevant to the Housing Market?

I recall years ago we used to visit an antique dealer in a small town in Colombia. All the houses in the village looked pretty much alike. Inside what appeared to be a very humble dwelling, however, the dealer had a rich collection of antiques for sale to discerning customers. His son had a ritzy shop in a high price district in Bogota. His was a culture in which display of affluence in one's house was not accepted.

In Haiti I recall many years ago being told that farmers sought to split their property into many widely separated small fields. The arrangement was inconvenient in terms of their work, but in the kleptocracy of the time, if their affluence was visible they would have been targeted and the ton ton macoute would have taken their property away from them.

On the other hand, Bialystock in The Producers believes that "if you have it, flaunt it!". His was a culture that led to the MacMansion phenomenon of recent decades.

So yes, I think that culture does matter in terms of the choices people make buying their houses.

It has been suggested that in the United States people's aspirations for life style and possessions are determined by those just above them in economic status. As the top one percent got richer and richer, they bought more and more elaborate estates. The aspirations for bigger, fancier houses trickled down. Culture changed toward the MacMansion.

When Is It Good To Reduce Risk to Those Making Loans?

Hernando De Soto, in his book The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else, suggested that giving poor people in developing countries legal rights to their land and houses would contribute to development. In many poor countries poor people actually have possession of land and houses but don't have legal title to them. These poor people can not mortgage their land or houses, can not use their real property as collateral, since the legal system does not allow lenders to take the property if a borrower fails to live up to the terms of a loan. Giving title to real property and creating a legal system that recognizes real property and mortgage responsibilities then mobilizes capital. Owners of property are empowered to borrow against it and invest the proceeds in increasing their productivity; lenders have greatly reduced risk in making loans.

Microfinance programs tend to work with community groups, depending on processes within the groups of poor people to assure that borrowers make payments and honor loan conditions. Again, the group reduces risk to lenders, mobilizing more credit for the group members.

It would seem that these approaches to reducing risk to those negotiating the loans do not lead to bubbles, while the changes in the American system that moved the risk back from the bankers to brokers and investors in mortgage backed securities did contribute to a housing bubble. Reducing risks by making borrowers more likely to pay mortgages may be useful, while reducing risk by moving it back from the bankers to more distant members of a financial change may be dangerous.