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Nothing is so firmly believed as that which least is known - or why changing your mind is evidence of learning

For a second, consider of all our major public thinkers today. They do the opposite, constantly telling how sure they are of their beliefs and criticizing their “opponents” for changing their minds. Changing your mind is a good thing, Montaigne would say. It means you’ve resisted the impulse to think you’re infallible. He wrote that as part of his profession of getting to know himself he found such “boundless depths and variety that [his] apprenticeship bears no other fruit than to make me know much there remains to learn.” If only we could internalize that attitude—instead of feeling cocky when we learn something, acknowledge that it really just taught us how much more we need to learn. (here)

While I often use this blog to vent frustration, propose new ways of looking at problems and possible unintended consequence of our actions, this does not mean that my ideas and opinions are as fixed once published.  Indeed, if I look back at some of the opinions I held some years back I can imagine a heated debate between current me and previous me.

For example, for a period of time I had a fixation about peak oil and what it meant for society.  I thought in a linear manner, ascribing a reduction in total economic production possible to a reduction in technically possible rates of oil extraction, without thinking of behavioural responses and adaptations likely to take place including a renewed demand for alternative resources.  My last post clearly shows that I have edged away from that view to a more reasoned and 'systems' view of economic behaviour.

I used to be passionate about ‘sustainable’ living (whatever that means).  If we could only all do our little bit our environment, in the holistic sense rather than just the trees and animals sense, would be a better place to live.  However, with more research into the matter it appears that while my own choices are the only ones within my control, there are offsetting effects from the actions of others that may render my personal actions ineffective.

While my ideas evolve slowly as I seek evidence one way or another, I can’t help but marvel at how quickly strongly held beliefs can change in a time of crisis, even when evidence for the new idea is as sparse as the one previously held.  

CPI surprise

Today’s Australian CPI data, according to the headlines, was ‘lower than expected”.  This was the first part of a forecast I published here back in early September, when I said “Inflation and GDP will surprise on the low side in the September quarter”.  GDP figures come out with the National Accounts on the 1st December so we had a little while to wait before assessing my prediction (1st November is the ABS capital city price index which may also show some surprises).

But the CPI print really shouldn’t have been a surprise.  Maybe most economists have loyal wives and girlfriends (or husbands and boyfriends, although it is a male dominated profession) to do their shopping, so they wouldn’t have noticed the price declines in food, health, communications and transportation in the previous quarter.

It is evidently odd that the US can experience no price growth with a collapsing dollar, while Australia’s currency has gained strength yet our favourite media hungry economists forecast high inflation and multiple interest rate rises. The high dollar was always going to dampen any inflationary pressures.

On a far more interesting note, Google has been experimenting with a real-time price index compiled, I assume, by experimental software that searches for listed prices of items on the web.  Their index has showed a “very clear deflationary trend” for the US, and has the additional benefit of compiling the same (or at least comparable) indexes across countries.  By the same measure the UK has shown a slight inflationary trend, attributable to the weak sterling.

The automatic nature of the index also provides the possibility of releasing multiple indexes with different scope and purpose, to provide a much richer picture of prices changes across the economy.  For example, hedonic price adjustments can be in one index and not in another, and the basket of goods can be quickly changed to suit different social groups.

There has been a strong push for the ABS to publish multiple prices indexes to address these very issues, particular with regard to quality adjustments.  I have demonstrated the Lower Bound Problem of Hedonic Price Indexes before, although Rob Bray makes the argument more concisely:

Revise the approach to quality adjustment to take account of the actual utility consumers achieve from changes in product ‘quality’; and also consider an approach which reflects the extent to which products actually exist in the market place for consumers to purchase

Twice the quality is not the same as half the price.

The benefits of real-time data available to Google are yet to be fully understood by economists, but there is no doubt the Hal Varian, Google’s chief economist, will change that soon enough.

Mr Varian also discussed some of his other work on using Google’s search data for economic forecasting. He said that he is working on “predicting the present” by using real-time search data to forecast official data that are only released with time lags.

For example, searches for “unemployment insurance” may be a good tool to predict actual claims for unemployment insurance, or the unemployment rate.

This is something I have tested before with the US housing bubble, clearly demonstrating that search volumes can be amazing predictive tools.  It won’t be long before these real-time measures become commonplace in mainstream economic publications.


Zombie Economics

This Friday, 29th October the Young Economists will host the launch of John Quiggin’s much anticipated, and creatively titled, book, Zombie Economics: How Dead Ideas still Walk among Us.


This is an opportunity to meet an interesting bunch of economists and young professionals in a social atmosphere and discuss some of the challenging ideas in Professor Quiggin’s book. All are welcome to this free event, and there are free drinks for Young Economist and ESA members.

There are prizes on offer for best dressed living dead economist, and best economic limerick (try here for some inspiration)

A PDF flyer is here.


No limits to economic growth

For an environmental economist these words are blasphemous, but I said them, and I have good reason to. 

The modern Limits to Growth movement gained prominence with the publication of the Club of Rome’s book of the same name in 1972. This book, by Donella Meadows and colleagues, reports on the results of a computer simulation of the economy under the assumptions of finite resources. The World3 computer model produced scenarios showing that under various assumptions, a decline in non-renewable resources will lead to a decline in global food and industrial production, which will in turn lead to a decline in population and greatly reduced living standards for all. 

The following image is one example of the results of their simulations where a catastrophic decline in industrial output, food production and population will result form reaching our finite resource limits. 



While I don’t doubt the finitude of many natural resources, and that the human population cannot grow indefinitely, I doubt that finite limits of resource inputs to the economy necessarily means that economic growth cannot continue indefinitely.

To be sure, I am certain that substantial unforeseen changes to the rate of extraction of some resources will lead to short-term disruption of established production chains, such as shocks to oil supply, but in the long run I see no reason that an economy with finite resource inputs cannot increase production through improved technology and efficiency.

I need to be clear that when I talk of economic growth I mean our ability to produce more goods and services that we value for a given input. Increasing the size of the economy by simply having more people, each producing the same quantity of goods, will be measured as growth in GDP, but provides no improvement in the material well being of society.

A better measure of growth is real GDP per capita. This adjusts for the disconnection between the supply of money and the production of goods, and adjusts for the increase in scale provided by the extra labour inputs. Even then, this may overestimate the rate of real growth occurring, as there has been a trend of formalising much of the informal economy, for example child care, which is now a measured part of GDP rather than existing as individual family arrangements.

On these adjusted measures economic growth is a very slow process. In a world where non-renewable resource inputs are fixed or declining, it is the rate of the decline and the speed of adjustment that will determine the overall outcome for our well being. If the rate of decline of non-renewable resource inputs is below the rate of real growth (our ability to produce more with less) and the rate at which we can substitute to renewable alternatives, we can avoid economic calamity in the face of natural limits.

Unfortunately there are other factors at play.

The rate of population growth will greatly determine the per capita wellbeing in a time of limited growth. While extra labour input will no doubt contribute to production inputs, my suggestion is that this input will be outweighed by a decline in complementary resource inputs. Remember, we care about real economic ‘wealth’ per capita, and with more people there is a smaller share of remaining resources each person can utilise in production, thus reducing wellbeing.

Further, we can begin to take productivity gains as leisure time instead of more work time, thus there is a possibility of maintaining a given level of production in the economy with fewer labour inputs over time.

There is also the reliance of our financial system on high levels of growth. Many economic growth critics cite the need for exponential growth of financial measures of the economy as being in conflict with any finite system. Yet the ‘system’ itself is a human construction and I seen no reason why a stable money supply cannot operate under various levels of growth (even prolonged negative growth) if used cautiously and with little leverage.

Often forgotten is that many resources are currently fixed and yet go unnoticed. There are always 24 hours in a day, but that doesn’t stop us producing more each day. If a shortage of hours was encountered, would a sudden change to 23hrs (a 4% decline) have a dramatic impact? Or would society easily adjust to this new environment of tighter time scarcity?

While a smooth transition to prosperity under much greater limits on resource inputs to the economy is theoretically possible, I don’t expect this to be our future reality. Self interested governments, businesses and the general public will react to short term shocks in unexpected ways, potentially promoting conflict, and taking the bumpy road. I have no doubt that there will extended periods of prosperity in the future, but also expect a rough ride to get to them.

Counterintuitive findings?

Pool fences
Could Queensland’s new tougher pool fence laws offer an opportunity to study the Peltzman Effect? Will we now feel that pools are no longer a safety hazard for toddlers and drop our supervisory guard? One man, who refuses to comply with the laws, has argued this exact point and is strongly supported in his views (if you can trust the newspaper comments).

In one case, a pool owner living on a canal has had to fence their pool, yet is not obliged to fence off access to the canal.  One does wonder about how far governments can go to protect us from our own behaviour.

Pool fences are only there to protect kids from parents who don't. There are no fences around all the lakes in Brisbane, Southbank's lagoons are not fenced, the Brisbane River is not fenced. Why? Because we are responsible enough to ensure our children don't get into danger in these areas.

What further astounds me is that lack of evidence in the pool fence debate. In one of the more interesting studies I could find, 52% of pools where toddler drowning events had occurred in Western Australia where compliant with the pool fence legislation (compared to 40% for randomly selected pools).  There was no further discussion of this key point – that statistically it appears more likely to drown in a fenced pool that an unfenced one (I would be very interested if anyone can find a more thorough study of the effectiveness of pool fence laws).

While this is just a small sample from one State, and I would question whether general conclusions can be drawn, some more rigorous examination of the effectiveness of pool fence laws is seems appropriate before toughening the laws.  Is the government really going to do the same thing and expect different results?

Cycling by the road rules
The Council is inviting CityCycle subscribers to undertake a Cycling Confidence Course to improve their bicycle skills and brush up on their knowledge of road rules.

Maybe that's a bad idea. Recent research suggests that people obeying road rules are more likely to be killed by trucks than those who disobey the rules by, for example, running red lights. 

Women may be overrepresented in [collisions with goods vehicles] because they are less likely than men to disobey red lights.

By jumping red lights, men are less likely to be caught in a lorry driver’s blind spot. Cyclists may wait at the lights just in front of a lorry, not realising that they are difficult to see.

In more than half the fatal crashes, the lorry was turning left. Cyclists may be deceived by a lorry swinging out to the right to give itself room to make a left turn.

I can’t agree more with these findings.  Every day I see cyclists waiting in the blindspot of a car or truck at traffic lights, and occasionally see a cyclist sneak up the left side of a bus while it is turning left.  I hope Brisbane City Council’s cycling confidence course acknowledges that sometimes it is safer to break the rules.

Congestion (queuing) as an efficient allocation mechanism
I have raised the idea in the past that road congestion is in fact an efficient allocation mechanism provided that there is prior knowledge of expected travel times.  Now, from The Australian we have this:

Sure, if we invested enough in roads, all cars could travel at the speed limit. But the costs of thus expanding road capacity would greatly outweigh the value motorists place on the savings in time and discomfort.

Exactly the same applies to road charging. With charges set sufficiently high, remaining drivers could go at speeds rivalling the Melbourne grand prix. But even Mrs Moneybags, rocketing in her Ferrari, would not value the benefits enough to offset the welfare loss to the peons forced by the high charges to walk to work. Add to their loss the costs of implementing the road charging scheme and the efficiency loss is all the greater.

Murray-Darling Basin Plan: Despite extreme lobbying, you can’t take water that does not exist

The release of a guide to the Murray-Darling Basin Plan is receiving very poor media coverage. This headline – “Basin Authority holds its first public meeting” - is entirely misleading. The Authority had numerous meeting with stakeholders including water users, irrigation groups, farmers groups, local councils, and anyone else who could claim and interest for the past two years. There should be no surprises.

Another here – “As many as 130,000 jobs could be lost because of reduced water allocations in Victoria's fruit bowl region under the Murray-Darling Basin plan, a farmer says” That’s right. A farmer says so, therefore it must be true. 

This is a week the farming lobby has spent years preparing for, and they are basking the attention. 

The further problem which is completely overlooked by the media, is that while the reductions in rights to take water are ‘up to 37%’ that means that most reduction in most rivers are ‘between zero and 37%’. 

Let’s not also forget the fact that these are reductions of paper rights, not volume taken. There would be very few water users whose volume taken matches the volume of their rights due to variability and recent dry conditions.  The graph below shows that recent rainfall conditions are below historical averages, although this is not uncommon in the long term.


What is missing from this mainstream media nonsense is any actual thought about the reason the plan was developed in the first place. Simply put, there are more rights to take water ‘on paper’ than there is water in the system. This leads to both downstream water users suffering at the expense of upstream users, and environmental areas suffering due to upstream water users. When downstream environmental assets, such as wetlands, receive water, the water also flows through to downstream users. 

There is even the possibility that the next five years more water will be used by irrigators than the past five years, even with the Basin Plan, simply because of rainfall variability. The percentage figures are based on long run averages, which are a distant memory for many people in the Basin. 

Imagine I give you a piece of paper that allows you to take 100ML/annum of water from a particular reach of a river. The river flow is highly variable and because of this you get 60ML one year, zero the next three, 100ML the next, then 25ML. You average 31ML. Then, you get told the stream is overallocated and you are getting cut 37%, so that your allocation is now 63ML. If we had the previous six years again the impact would have only occurred in one year - the cut would take your five year average from 31ML to 25ML – a 20% decline in average use, and a once in five year impact. 

If over the next 5 years you can take 63ML, zero, 25ML, 50ML, 5ML and 60ML, you might end up with even more water on average – 34ML/a instead of 31ML/a – despite the theoretical cut to you water right.

In South Australia for example, irrigators have only been able to access 10% or less of their water rights over the past 5 years or so. If the Basin as a whole shares the water more equitably, these irrigators may be able to use 63% of their previous water allocation – a 37% cut on paper, but a 600% increase in real water use compared to the past 5 years. 

Even the MDBA itself showed just how low actual water use is compared to these theoretical baseline figures from which reductions are calculated. The graph below is from page 130 of the Guide and shows that the average water use since 2002-03 is equal to their most ambitious reduction scenario.


My point is, people are taking the cuts as real water then multiplying impacts to flow on industries then getting bigger and bigger impacts that border on ridiculous. These complementary agricultural industries are clearly already adjusted to any proposed cutbacks.

The only person to present any figures on the media circus is economist Quentin Grafton. He makes his case that farmers are exaggerating losses as follows: 

"In 2000-2001, the gross value of irrigated agricultural production was just over $5 billion, and they used surface water of about 10,500 gigalitres in that particular year," he says. 

"Fast forward to 2007-08, 70 per cent reduction in surface water use, guess what happened to the gross value of irrigated agricultural production? It changed by less than 1 per cent." 

Not only are impacts greatly overstated but water users will generally be compensated for their theoretical water loss at market prices for water – whether the water exists or not. 

Historically most water rights are a gift from the State to landholders. They have generally earned a good living from these gifts, and now that the government has realised that too many were granted, they are going to pay to buy them back. 

While I’m on the water bandwagon, some people are taking the chance to have a dig at cotton and rice growers for their water consumption. What they need to understand is that while Australia is a dry continent, we are characterised by variability of rainfall. Some years it floods and to make use of the water you need a thirsty annual crop. That’s why the virtual desert regions south of St George are cotton areas, even though this intuitively seems bizarre. 

WEIRD people: Western, Educated, Industrialised, Rich, Democratic... and unlike anyone else on the planet

The Ultimatum Game works like this: You are given $100 and asked to share it with someone else. You can offer that person any amount and if he accepts the offer, you each get to keep your share. If he rejects your offer, you both walk away empty-handed.

How much would you offer? If it's close to half the loot, you're a typical North American. Studies show educated Americans will make an average offer of $48, whether in the interest of fairness or in the knowledge that too low an offer to their counterpart could be rejected as unfair. If you're on the other side of the table, you're likely to reject offers right up to $40.

It seems most of humanity would play the game differently. Joseph Henrich of the University of British Columbia took the Ultimatum Game into the Peruvian Amazon as part of his work on understanding human co-operation in the mid-1990s and found that the Machiguenga considered the idea of offering half your money downright weird — and rejecting an insultingly low offer even weirder.

"I was inclined to believe that rejection in the Ultimatum Game would be widespread. With the Machiguenga, they felt rejecting was absurd, which is really what economists think about rejection," Dr. Henrich says. "It's completely irrational to turn down free money. Why would you do that?"
(here)

A recent paper by Dr Henrich and colleagues from the University of British Columbia investigates the psychological differences between WEIRD societies and other societies. In a deep examination of the literature, Henrich shows that while many basic similarities remain common to Homo sapiens, cultural factors play a large role in determining many psychological dispositions. Such differences occur when examining fairness, individualism and cooperation.

For me one standout finding was that the income maximising offer for the ultimatum game (discussed in the introductory quote) was a mere 10% of the total sum for most cultures in the review, while in typical WEIRD cultures a 50% offer was income maximising (see graph below).


So what environmental factors contribute to the difference?

Effective marginal tax rates and Australia’s welfare trap

Australia’s complicated social security system often leaves me baffled. There are so many forms of assistance for families, with rates of benefit and qualifying incomes changing annually, your entitlement (if any) is sometimes a lucky draw.

What I have noticed is the rate at which these benefits decline as the family income increases. So much so that I instinctively feel that earning a few extra dollars is generally not worth the trouble - unless of course my income was already high enough to be out of the qualifying range for family welfare benefits.

So I took the time to examine situation for Australian families, and it is quite revealing.

This recent paper, for example, shows that the effective marginal tax rate (EMTR), which estimates the change in take home income after tax and after accounting for reduced welfare payments, actually declines at higher income levels for almost every family type (see table below). High income families receive a greater percentage of an extra dollar earned than low income families, with middle income families suffering very high EMTRs.


For example, an extra dollar earned by a parent in a family with two dependent children and an income in the middle tax bracket will leave them with an extra 28c in the pocket, while for a high income family, they keep 67c out of any extra dollar.

There are even situations in Australia where the EMTR is greater than 100%! Low income families with dependents on youth allowance have an EMTR of around 110% - for every extra dollar earned, they get 10c less in their pockets.

Unfortunately, I fall into the group with the highest EMTR – families with dependents – where 15% of the group have EMTRs above 70%.

...families with children are more likely to face an EMTR of 50 to 70 per cent than other types of households, due to the accumulation of withdrawal rates for family related payments on top of income support withdrawal and income tax. This is observed even without including the withdrawal of childcare subsidies. On average, the EMTR is highest for couples with dependent children. (here)

After a quick bit of research, it appears that if I earn another dollar we lose 20c from family tax benefits, about 18c in the dollar from child care benefits, and 30c in tax – a 68% EMTR. If my wife earns an extra dollar we lose 40c in Family tax benefits (Part A and B combined), 18c of child care subsidies, and 15c in tax – a 73% EMTR.

In light of this outrageous situation, cutting down to part-time work (4 days/week) provides an extra 48days of leisure per year at a minimal cost to the family.

Also, if we factor in the extra expenses incurred due to extra work hours and time pressure – takeaway meals, remaining child care costs, driving instead of cycling, and splurging on treats because you deserve a reward at the end of a busy day, you quickly see the rational for staying in the welfare trap.

All this makes me wonder just how many families are trapped in high EMTR bands – all earning different incomes, but taking home much the same income ‘in the hand’.

Statistics lessons for property people

I have previously posted about the Property Council of Australia’s cowboy approach to statistics to argue for pro-sprawl planning policies on environmental grounds. Now Brian Stewart, CEO of the Urban Development Institute of Australia (UDIA) Queensland, needs a lesson in statistics.

In a recent bulletin to members he criticised the Local Government Association of Queensland’s interpretation of a report they commissioned on factors affecting home prices in South East Queensland.

He questions the conclusion that the AEC report commissioned by LGAQ refutes ‘for all time the spurious arguments of a so-called under-supply of dwellings in the SEQ market’. If he had paid attention in statistics it would be clear to him that this is exactly what the report does.

Although the report is far from an exemplary analysis of key determinants of residential property prices, the authors did estimate six econometric models to seek the determinants of real median house, unit and land prices in SEQ - eighteen models in total. If we quickly browse the report we find just one model, for house prices, not unit or land prices, where any of their supply-side variables is significant in explain real prices.

To be sure, Stewart’s interpretation of the report was poor, and his bulletin misleading, but I still have reservations about the report itself.

Particularly I have concerns about the choice of, and construction of, variables, including location bias in calculating the median prices and using ratios to total stock rather than sales volumes (particularly in the treatment of the FHOG). It seems odd that with 69 data points and 32 variables at hand they had trouble finding significant relationships in the data – could it be their selection was stacked with the wrong variables to explain prices?

One example of the construction of variable is ‘SEQ housing stock per capita’, which is total stock for SEQ at the beginning of the period at the beginning of the analysis (1991) of 734,126, less an allowance for depreciation (about 0.3%), plus new stock completed IN QUEENSLAND in the period. This variable then accumulates over time to represent the stock of housing.

I first hope that the new stock only includes new stock in the SEQ region and that this is a typo. Second, I can’t see how depreciating a dwelling is good accounting. What should be considered is a factor for demolitions, and it would be easy enough to estimate the demolition to new dwelling ratio based on past census data.

These types of errors abound.

Most importantly I wonder how this controversial variable could be negatively correlated with prices. In the section on housing stock (p13) it shows that dwelling stock per 100 people grew from 38.1 to 41.1 from 1991 to 2006, while real prices grew from around $100,000 to $250,000 in this period (below). Either a) the three other significant variables, the All Ordinaries, unemployment and mortgage rates, explained the most of the change, or b) the variable used in the analysis is the CHANGE IN dwelling stock per person, which was positive but declining over the period.

What is further surprising is the conclusion that the SEQ property market somehow behaves differently to other parts of the country. Given that the analysis failed to explain the behaviour of the SEQ residential property market at all (their final land price model on page 29 had seven variables but just two were significant), one wonders how such conclusions are drawn. I am happy for someone to explain why it is different here (cringe) if they have the evidence to support the statement.

Anyone looking to elastify the supply side should note the report concludes by noting how responsive supply has in fact been to prices:

...the lot stock for SEQ rose from 25,000 during the early part of the decade to reach 50,000 by December 2005 and has stabilised around 54,000 since September 2007. This progression follows the growth in land prices very closely, indicating that supply of undeveloped residential lots has responded to price signals.