Replicating the RBA's housing analysis

Last week the RBA released a research paper which sought to unravel the potential effect of planning controls, like zoning, on home prices in Australia. I think the results of their analysis are wrongly interpreted to be due to zoning, and I quickly made my views known on Twitter.

Nice to be cited in RBA research, but this report is pretty bogus - wrong theory applied to good data giving nonsense outcomes.https://t.co/7RtwzBCaYS

*special note, there is no such thing as the value of physical land - the value is for the rights and regulations that apply. pic.twitter.com/W9FbA94r2I

— Cameron Murray (@DrCameronMurray) March 8, 2018

But, like the good researcher I am, I wanted to check their method. So I put together a sample of land sales from my area and replicated the method, just be 100% certain I understood. Lo and behold, I get the same result. Using twenty-nine neighbouring land sales and estimating ln(p) = A + B ln(area) + e, I get the following result.

The coefficient of 0.54 for ln(area) indicates that a 1% increase in land area only increases the total land price by 0.54%. So if the average price was $100/sqm for a 1,000sqm block (total price of $100,000), an extra 10sqm (1%) would cost just $540, or only $54/sqm.

This indicates that indeed, because of zoning constraints, people are unable to assemble marginal pieces of land at $54/sqm and thus must pay on average $100/sqm instead. The zoning effect clearly accounts for 46% of land value. Quite a stark result.

In my data the actual average land price of a lot was 0.1 pence per square metre while the marginal price was just 0.052 pence.

Pence?

Yes, my average lot size was 4 acres, 1 rood, and 34 perches and sold at 19 pounds, 6 shillings and 9 pence. My randomly selected sample of sales occurred in December 1851 in South Brisbane. Zoning was still nearly a century away from being invented, and the population of the whole state of Queensland was less than 17,000 people or about half the normal attendance at a Broncos football match.

Let me be clear. Either it is true that the method used by the RBA does identify zoning effects, and therefore also identifies zoning effects of a similar scale 167 years ago in a remote and deserted convict colony that we know did not have planning controls. Or, it is true that the method does not identify zoning effects.

You decide.

*Here is a look at some of the data used for this post.

Who really owns Antarctica?

I have often argued with libertarians (and anarchists) that the existence of property rights first requires the existence of a government with a monopoly on coercive force (ie. government requires the largest armed force). If such an entity didn’t exist, then the largest armed force would simply take control and become the government. Many voices in these debates suggested that I need only look to international treaties to show how cooperative we can be without the need for world police.

Putting aside the obvious point that the US is the current world police, with their military budget making up 43% of the world total military spend, and that their international military presence often conflicting with international treaties, we can examine whether libertarian views are vindicated by one of the shining examples of international cooperation – Antarctica.

Back in 1959, twelve countries active in the Antarctic signed the Antarctic Treaty (implemented in 1961), which led to further treaties and conventions to manage activities and resource use (especially fisheries) in the whole Antarctic region south of 60% latitude. Collectively these treaties are known as the Antarctic Treaty System. With the shadow of the Second World War still looming large, the top priority of the original treaty was to ensure that the area remained conflict-free by outlawing a military presence – prescribed in Article I of the treaty. Other peace-inspired provisions include Article V, prohibiting nuclear explosions and the disposal of radioactive material. Who knew that the dominant ideologies of 1960s youth originated in Antarctica?

Since that time the Montreal Protocol was adopted as part of the Antarctic Treaty System with the explicit intention of preserving the Antarctic as a natural reserve devoted to peace and science. Critically, Article 7 of the Protocol prohibited all non-scientific mineral resource activities.

The Antarctic Treaty was a bold and lasting agreement, recently celebrating its 50th year. The treaty’s anniversary gave rise to some optimistic claims

The lesson of fifty years of the Antarctic Treaty System is that the nations of the world can set aside their political and territorial aspirations to share in the management of a vast region of the planet, says Paul Berkman, chair of the International Board for the Antarctic Treaty Summit.

But I wouldn’t make such strong claims so fast.

Geopolitics was not cast aside by the free love of the original Antarctic Treaty. The US does not recognise the territorial claims of other governments and reserves the right to assert claims. The USSR, and later Russia, made the same non-commitment to the Treaty. The success of the Antarctic treaties over the past fifty years was perhaps more the result of the low value of any commercial or strategic military operations in the Antarctic.

While the US has no current claim over territory, it has positioned its Amundsen-Scott research base at the South Pole so as to maintain a presence in all claimed territories (shown in the map below). The US may very well have secured a right to claim territory that existing claimants leave unoccupied.

We also know Australia does not have the capacity to visit the inland areas of its territorial claim. This may be problematic as the original Antarctic Treaty has a provision in Article XII allowing a contracting party to call a review of the operation of the treaty after thirty years. One could expect that our absence, or lack of presence, in our claimed territory puts us in a poor position for any future treaty negotiations that may establish new claims based on current activities.

The rise of new entrants into Antarctica is also concerning for existing territorial claimants.

Russia has seven stations in the AAT; China opened its second station last year; India will start construction on its first over summer; and South Korea is planning to set up a new station near the Easter sector by 2014.

With renewed interest from emerging global economic powers, and the ice sheets receding in some areas, mining the Antarctic is attraction a lot of attention (and here).

So it seems that the ingredients for conflict are slowly being added to the spicy Antarctic political stew (these concerns have been noted elsewhere). How one resolves these new interests in the mineral rights of Antarctica, with the interests of the existing parties to the Antarctic Treaty System, I am not sure. But let’s be clear. The US will not lose out in any future negotiations that allow further exploitation of the Antarctic. In a hypothetical future scenario where mining becomes allowable under the treaty system, does anyone really expect the US to respect the rights established by existing territorial claims? I don’t.

In the end, current Antarctic territorial claims are only valid as long as they are not challenged. So I ask the anarchists and libertarians, exactly how does one negotiate a territorial claim (or defend their property right) with an unmatchable armed force that happens to be a necessary military ally?

New paper: Developers pay developer charges

I have a new paper out — Developers pay developer charges in Cities: The International Journal of Urban Policy and Planning.

In this paper, I estimate the economic incidence of developer charges (taxes paid upon approval to use land for a higher value purpose) using a natural experiment in Queensland, Australia, where a surprise political announcement varied the charges. Using data on developer charges and dwelling prices during this ‘natural experiment’ period I estimate their economic incidence. The data clearly shows that the administrative incidence on the landowner (developer) happens to also be the economic incidence. An increase in the charge comes at no cost to the buyer of a new dwelling but instead decreases the land value by an equal amount.

The motivation for doing this analysis was an article in The Conversation that suggested the opposite — that the economic incidence was on the buyers of new dwellings, against all logic and reason. In fact, this research showed a significant correlation between developer charges and home prices at a ratio of 1:4. Erroneously interpreting this relationship as causal would mean that increasing charges by $1 would increase home prices by $4.

Can you see the nonsense here? If there really is a causal link property developers would be lobbying to massively increase charges in order to earn a 400% markup on them! In reality, the development industry has been lobbying hard to remove them.

In my paper, I demonstrate the problem with this causal interpretation, which arises because the variation in the developer charges is due to the way they are set by regulations. The regulations state that the charge per new dwelling of 2 bedrooms or less can be a maximum of $20,000. The charge for a 3 bedroom or larger dwelling can be a maximum of $28,000. Because councils have no incentive to charge less than this maximum this was the size of the charges in their data. The regression analysis merely showed that the average 3-bedroom or larger dwelling is 4 x $8,000, or $32,000, more than the average 2-bedroom or smaller dwelling (controlling for other quality and location factors).

Because my study covered a period where surprise political decisions varied the charges themselves for each dwelling type, my analysis shows no relationship. In fact, if you take out this surprise variation in my data and leave the charge at the fixed price for each size dwelling I can replicate the earlier results of a 1:4 correlation.

Why is this important?

This result is significant because the economics of property is almost the exact opposite of the economics taught in most modern university degrees, and bad economics is being used to justify bad policy. All too often I see the following implicit assumption about causality:

Cost of capital ⇒ Rental price of capital.

If you increase the cost of investing in capital, you increase the rental price of capital. That is the logic behind the idea that developer charges, or a land tax, can be passed on to users.

But this clearly makes no sense in the case of land. Land is costless to produce. It is obviously not costless to buy it from someone else, but ultimately, there is no prior investment that provides its value. It is merely a legal right to claim certain incomes associated with that location. So for land (and ownership rights in general), the direction of causality must be:

Rental price of capital ⇒ Cost of capital.

This is not a secret. It has been widely known for hundreds of years in the property valuation profession, which uses variations of the ‘residual value’ method to isolate the pure rental price of land and use it to determine the cost (price) of land.

So what?

Vested interests in the property industry continue to argue that shifting the tax base to land will increase the cost of housing — after all, they argue, the rental price is caused by the cost of land plus other costs, including taxes and charges.

We know this argument is bogus because it simply begs the question that if prices come from input costs, why does land have any value at all? All land rents should be zero.

And again, if the rental price of capital was the result of a summation of costs, the property industry would have nothing to fear from increasing developer charges, as they could pass on those costs in the price of new dwellings.

One step further

We can take this logic another step and see that because the economic incidence of land taxes (or development charges) is on the landowner, increasing these taxes can encourage more development sooner since it reduces the payoff from delaying investment in new housing.

Consider the table below. It comes from my paper. I use it to demonstrate the changed incentives to delay or bring forward new housing development from increasing land taxes (which effectively decreases the net rental price of land).

The table shows three scenarios where the discount rate is 5%. In each scenario, the price in time one (t=1) reflects the expected rate of growth. The present value (PV) is the price at t=1 discounted at the 5% rate. Where that present value is higher than the current price, there is an incentive to delay sales, which feeds back into delayed construction [1].

If the rate of price growth is higher than the discount rate (the rate of return on the sale price available from investing it elsewhere) it makes sense to delay the sale to get the higher price (Scenario A). If the rate of price growth is low, there is an incentive to bring forward sales to get your money out of this property to put it somewhere else an get a higher return (Scenario C).




The property industry likes to promote the myth that they would never delay selling. Yet, when I worked for a major property developer during a price boom period, we did exactly that. The decision was made to close the sales office one Saturday because there were too many sales. These rapid sales meant that the price was too low and that delaying the sales would fetch a higher price (and a higher PV of that future price). So instead of selling the whole building in one day and starting construction, the prices were raised, and it took years afterward to sell the whole building and massively delayed construction.

The absolutely crucial lesson in from the Scenarios in this table that the imposition of a developer charge can turn Scenario A into Scenario C by reducing the net revenue from each future dwelling sale to a developer due to the charge. For example, if a charge of $10,000 is announced to be imposed in the next financial year in Scenario A, it becomes Scenario C in net terms, and the developer will prefer to bring forward planning applications to get a lower charge and incur sales in the current period.

Increase taxes on land to get more construction, not less!

To be clear, this is not some crazy idea I just invented. This is the standard result of real options theory, and it applies equally to increasing costs to landowners and decreasing their future development options. Here’s a 1985 paper from the AER making the point.

… the initiation of height restrictions, perhaps for the purpose of limiting growth in an area, may lead to an increase in building activity in the area because of the consequent decrease in uncertainty…

Imposing height restrictions can turn Scenario A, where future revenues (price x number of dwellings) are higher because of the option for increased density, to Scenario C, where future revenues are lower because the number of dwellings able to be built on the site is fixed. This brings forward sales and construction.

In sum

My new paper is a small contribution that demonstrates the well-established economics of property markets, but which flies in the face of conventional theory. Understanding land and property markets helps to understand how backward the standard economic understanding of ‘capital’ really is.

fn [1]. Another thing many economists get wrong about the property market is they ignore the fact that most sales come before construction, not after. This means that when people just say “increase supply” they don’t realise that market incentives mean this will never happen — supply only responds to demand. Only a housing developer without a profit motive would increase supply at a rate that would depress local prices, and yet we hear nothing from the ‘supply-siders’ about the creation of a public housing company that could do just that.

Facts don't matter

Review of Win Bigly: Persuasion in a World Where Facts Don’t Matter

I can save you $13 and summarise this book for you — a rich white guy from New York dating a model half his age who didn’t travel outside of North America till age 59 finds Donald Trump persuasive.

There is more to it than that. But according to Win Bigly’s author Scott Adams, the first piece of information about a topic matters when it comes to persuading. It’s called Anchoring.

On its surface Win Bigly is a lesson in the art of persuasion. Adams uses his experience blogging about the total misreading of Trump’s election persuasion by the established media as a backdrop to his own lessons in persuasion. He also provides a language to help understand and communicate persuasion techniques — The High-Ground Manoeuvre, Two Ways To Win and No Way to Lose, Setting The Table, Visual Persuasion. It’s all good stuff. To anyone who has an interest in cognitive science (not many of us), and skills in objectivity (even fewer of us), a lot of the book is a well-packaged presentation of established material paired with Adams’ persuasion hunches. For everyone else, you will find a lot of new and interesting stuff in there.

I probably enjoyed the book more because I have some views in common with Adams that few seem to share. For example, for years I have been bamboozled by people who have a love of facts yet continually try to persuade with facts. The facts are clear on this — facts don’t persuade. So why ignore this if you are a fact-lover? One of Adams’ main points, as you might have guessed from the title, is exactly this.

I also wrote about the misreading of Trump here. And of Brexit here. So I clearly do identify with Adams, which gives him a headstart in his persuasion.

But while I agree with much of his analysis of Trump’s persuasion methods, Adams persuaded me that he is, like many (most?), a bit of selfish bloke with a chip on his shoulder. This explains my opening sentence.

You see, despite repeated humble-brags throughout the book, ‘good guy’ Adams ends by changing the tone and being a dick about Clinton’s proposed estate tax, responding to it as follows.

This was personal. I started life with almost nothing and worked seven days a week for decades to build the wealth I have now. I wasn’t in the mood to let the government decide what happens to my money when I die.
...
But once Clinton announced her plans to use government force to rob me on my deathbed, it was war.

He also recites the nonsense double taxation myth favoured by one-percenters. Maybe it is good persuasion if your audience is other rich people or those who believe they will be rich when they die. To me, an expert in economics and taxation, it is idiotic and stupid. Inheritance taxes make the world better and fairer. These views starkly reveal a naivety and selfishness. It shows me that for all the interesting things in the book that I agree with, a lot of Adams’ filter of the world seems to be him identifying as a rich guy with German heritage and conservative tendencies who wanted Trump to win to validate that. He was very lucky to get his prediction right. As he admits.

Maybe one reason that I have had this reaction is that unlike most readers of Win Bigly I am simultaneously reading The Great Leveler: Violence and the history of inequality from the Stone Age to the twenty-first century. But that’s another story.

The book is worth a read if you want to better understand the Trump phenomena. It may persuade you to drop some of your beliefs in “facts” that don’t really stand up to scrutiny. But for all the insight in the book, I guess I was disappointed to see that even those most alert to our tendency to believe in myths, or facts that suit our own interests, are driven by their own myths.

Postscript
One thing I have always found strange is how rich conservatives who ‘worked hard for their money’ want their children to never have to by leaving massive inheritances. At the same time, many will promote how noble the experience of poverty and hard work is for everyone else’s children. Such reasoning ignores the fact that plenty of people have usually worked harder for less money — after all if Scott Adams went on strike no one would declare it a State emergency. Apparently, you get what you deserve in life because you work hard for it, unless, of course, you are born into the right family. Life isn’t fair. But that doesn’t mean we shouldn’t make it fairer if we can.

Evolutionary market competition

One of the best models of competitive markets in an economy is an evolutionary one that embeds the ideas that cooperation and competition operating at different levels. The basic ingredients of the evolutionary approach are:

• Variation - A process that varies inheritable traits at any reproducible unit (organism, tribe/colony, cell).
• Selection - A process whereby the environmental conditions determine the reproductive success of a reproducible unit.
• The result is a process of adaptation.
• A firm (or any organisation) can be considered a reproducible unit.
• The market and society as the environment which determines success and reproduction
• Relative success matters for reproduction (firm growth and continued existence) rather than an absolute success.
• Success depends on the local environment at each point time - there is no timeless correct way to do things, and there are environmental niches (sometimes temporary).
• The success of markets in delivering efficient output is, therefore, the result of within-firm cooperation, and between-firm competition.
• Without market level selection pressure, firms can become internally competitive, losing efficiency.

These ideas might make more sense with an example.

The core approach 
Imagine that within a firm every interaction amongst employees can be either cooperative, which results in improved production efficiency, or competitive, which helps one of the individual employees (conditional on the other being cooperative), but reduces the overall efficiency of the firm.

It might be as simple as employees wasting resources blaming others for failures rather than working together to get an efficient outcome, or it could be as competitive and nasty as sabotaging the work of others in the firm to make yourself look good, which might be good for the individual, but bad for the company.

Perhaps the example of Amazon can help get your mind around this idea:

At Amazon, workers are encouraged to tear apart one another’s ideas in meetings, toil long and late (emails arrive past midnight, followed by text messages asking why they were not answered), and held to standards that the company boasts are “unreasonably high.”
The internal phone directory instructs colleagues on how to send secret feedback to one another’s bosses. Employees say it is frequently used to sabotage others. (Source)

The table below shows the stylised conflict between individual choices to cooperation or compete within a firm. For two people (A and B) who randomly meet within a firm, they can both cooperate and earn an individual payoff of 10 each (top left cell with A, B individual payoffs listed), giving the firm an overall payoff of 20. Or, one person can ‘defect’ while the other cooperates, giving that person a payoff of 15, but only a payoff of 0 for the cooperator, and an overall firm payoff of 15, which is lower than if people were cooperating. And the bottom right cell shows the payoffs if both people are competitive (the defect from cooperation), giving each a lower payoff of 5, and the firm a payoff of 10 (the sum of both people’s payoff).

Clearly, the best thing within a firm is for all interactions to be cooperative to get the highest total firm payoff, but there remains an incentive for each individual within the firm to occasionally defect and get a higher personal payoff.

Now, let’s think about market competition operating at a firm level. With more competition, would we expect the evolution of market to result in the success of more competitive individuals?

The diagram below shows a serious of three selection stages over rows from time one to time three. Each small table is an environmental or market niche, and each colour represents a single firm. So in the top row there are four firms (blue, green, yellow and orange).

Each small table shows in column N the number of cooperators or defectors within the firm. So in the top row blue table, there are 20 cooperators and no defectors in the firm. The next column, P, shows the average payoff to each person from random interactions amongst other firm staff. In the top row of the blue table the average personal payoff is 10 because all 20 staff are cooperators and every interaction with another cooperator in the firm gives a payoff of 10. The total firm (or group) payoff is in column G and is 200 in this instance (20 people getting a payoff of 10 each).

The next firm in the top row in green has within it 15 cooperating staff, and 5 defectors. The average personal payoff for the cooperators in that firm is 7.5 because they have a 1 in 4 chance of dealing with a defector, and a 3 in 4 chance of dealing with another cooperator. The defectors have a higher personal payoff of 12.5 for the same reason.

Moving across the top row, the yellow firm has 10 cooperators and 10 defectors. This firm is a nasty place to be, and half the time the firm is busy with staff blaming each other and not producing efficiently. The payoff (or total efficiency) for the firm is much lower, at a total of 150.

The last orange firm is mostly defectors, perhaps an extreme version of our Amazon example. The total payoff for this firm is just 125.

Outside these tables on the right side is a column N, which is the sum total of the number of people who are cooperators or defectors in each time period. In time one there are 50 cooperators amongst the firms (20 in blue, 15 in green, 10 in yellow, and 5 in orange), and 30 defectors.

Moving from time one to time two, or going down a row, is a selection stage in the competitive evolutionary game of market competition amongst firms. That is, only the most efficient firms survive, and the least efficient die off from lack of customers from their poor value products made inefficiently. In fact, in this example, the most efficient firm expands to take up the market niche left by the firm that dies off.

So when we move to the second row in time two, the least efficient orange firm has died off, and the most efficient blue firm has expanded to satisfy that market niche.

But notice this. When we add up the total cooperators and defectors working in all the firms in the market at time two, there are now 65 cooperators (15 extra), and 15 defectors (15 less), compared to time one. That is, competition at the firm level has led to the selection of the most internally cooperate firms to survive, not the most internally competitive. Going down one more row shows the new relatively least efficient yellow firm also dies off. Thus, what works at one point in time does not work at all points in time, and success in this game is only relative to others in the market environment.

The economic lesson from this simple example is that competition is good when it provides a selection mechanism that favours cooperative and efficient groups (or firms) that enable total production to expand. Variations that improve efficiency and cooperation within firms will, over time, be selected for by consumer choices in the market.

Within-firm competition with external costs
Let us now think about larger firms that have multiple departments making multiple products with a variety of different customers. We can also think of large bureaucracies in general, including government departments. Perhaps the above example has led you to think that competition within company departments might be a good way to select for the best ones. Unfortunately, this approach has a huge incentive problem, as the relative success of one department might be due to passing off costs to, or sabotaging, another. Thus, within-firm competition that results in an evolutionary selection process is very risky, and it is well known that 'silos' in firms can results in conflict between what is best for each silo, and what is best for the firm.

Unfortunately on most occasions, silos encourage behaviours that are beneficial to the occupants of the silo, but are often not in the best interest of the overall business or its customers. It also plays into the hands of corporate politics, since silos help to keep things private. And we all know that in office politics information is power.
 A recent survey from the American Management Association showed that 83% of executives said that silos existed in their companies and that 97% think they have a negative effect. (Source)

I capture the idea of sabotage, or passing on external costs to other departments, in the table below. Here the company has two departments (each small table), and within each department there is a choice to cooperate on either project A, which provides that department with a payoff of 20, or project B, which provides a payoff to that department of 10. However, project A comes with an external cost to the other department of 15.

For each department it is better to cooperate on A, giving them 20 each, but also inflicting an external cost of 15 each. The overall company payoff is just 10 in this situation. However, if the departments each cooperate internally on B, the overall firm payoff is double, at 20, as there are no other externalised costs.

Thus, for large organisations, the emergence of silos that are blind to the situation of other parts of the company may end up with a choice of projects and investments that are not overall optimal and efficient. Companies that find ways to ensure they maintain this inter-departmental efficiency as they grow are those that the market will select for.

Notice that this problem is a much more serious one in governments where there is no government-level selection pressure. At best there is an occasional change of government in a democracy, but rarely does this provide strong incentives to change operational processes all that much.

Indeed, the incentive to sabotage other groups and inflict costs on them also arise with market competition in general, and as such, provides a strong basis for competition laws and intervention where negative externalities from the activities of certain firms exist.

Muir’s chickens
The lesson here about market competition acting as a selection mechanism to favour firms that have high within-group cooperation is radically displayed in the experiments of William Muir, who bred chickens and either selected for a) the most productive individual egg-laying chicken, or b) the most productive cage of egg-laying chickens (in each cage were 9 chickens).

The results drive home the message of group selection is a process that increases the number of cooperators and total efficiency.

The first method favored the nastiest hens who achieved their productivity by suppressing the productivity of other hens. After six generations, Muir had produced a nation of psychopaths, who plucked and murdered each other in their incessant attacks. No wonder egg productivity plummeted!
In the second approach, he selected the most productive groups and because they were already a group that worked well together, they included peaceful and cooperative hens. (Source)

Egg production by the cooperative cages increase 160% over just a few generations. More detail here.

How to stop corruption in town planning

I spoke this week at the Australian Public Sector Anti-Corruption Conference in Sydney about how to tackle corruption in councils and in town planning generally.

My main proposal is to not focus on political donations, disclosures, or electoral procedures, but instead to remove the economic payoffs available from being corrupt. In other words, remove the honeypot and you will get rid of the flies.

In town planning, the honeypot is the $11 billion worth of new property rights granted through the planning system to selected landowners across Australia each year.

If councils didn't have this power to make millionaires out of some landowners there would be no reason to lobby them in the first place. So why not simply charge the market price for new property rights made available through the planning scheme? No more honeypot. No more flies.

Below is the paper I discussed. What I didn't discuss in detail was a politically viable implementation. After all, some landholders have recently bought development sites and paid a price to the previous landholder that reflected their assumption that their planning application would be costless (or come with just a small administrative cost). That is, the previous landowner has already been paid for the new rights from the planning system that they were given for free.

To ensure that these recent purchasers do not pay twice for the same new property rights - once to the previous owner, then again to the council or state government - there can be a short phase-in period of a year or so where development applications made during that period operate under previous rules. This will bring forward a lot of development by landholders who have recently bought development sites since there is now a huge cost to delaying development and construction. Their chance to develop under previous rules is not taken away at all. The time frame is simply shortened.

So it is win-win all around. Charging for new property rights is economically efficient and captures pure economic rents. It removes the honeypot that political mates swarm around. And its introduction will increase housing supply by bringing forward development that would otherwise be delayed by private developers seeking to drip feed new developments into the market to maximise returns.

Get my full conference paper here.

Decent criticisms of economics? Here are 111 of them.

1 like = 1 criticism of mainstream economics

— Unnerving Economics (@UnlearningEcon) October 17, 2017

Courtesy of a lengthy Twitter thread following the above tweet by @UnlearningEconomics, here are 111 criticisms of economics. Most are spot on. My personal favourites are 42, 51, 58, 66, 80, 87, 92, and 106.

1. Too many unobservable parameters that change every time they are 'measured'
2. The functions are all smooth, when everything interesting that happens in a capitalist economy is not
3. Defends unrealistic assumptions on the basis that they can make good predictions. Almost never makes good predictions.
4. Embeds libertarianism, consumerism and capitalism into models without questioning them
5. Excessively 'thin' conception of the environment as amenable to cost-benefit analysis, no acknowledgement of how ecosystems work
6. Obscene levels of professional arrogance
7. Bizarre obsession with optimisation models. Guys, there's other kinds of maths
8. Use of the word 'proof' for things that are either trivial or don't technically count as 'proofs'
9. Textbooks/classes that teach model first, reality second (or never)
10. Bizarre obsession with linear regression. Guys, there's other kinds of statistics
11. Literally no case of an acknowledgement that a model/theory is flat out wrong and should be completely discarded
12. No real concept of the social. Putting 'identity' in a utility function doesn't count
13. Ridiculously hierarchical journal system that stifles creativity
14. Articles that are way too long, despite pretension that maths allows one to be concise
15. Virtually no conception of power, exploitation, conflict
16. Possibly worst of all, has undue levels of influence on policy despite its huge shortcomings
17. Huge problem with under-representation of women and POC
18. Research largely centred on the USA and other western countries, who need it least
19. At best, only pays much attention to pressing social issues *after* a catastrophe
20. Is the source of 'you just don't understand economics', repeated ad nauseum by academics and internet knuckle-draggers alike
21. Defines itself by a methodology instead of the object of study
22. Is taught as ‘economics’, so that students don’t even realise they are only learning one perspective
23. In practice, has generally favoured the powerful through its influence on policy
24. Is rife with aggregation problems, and pretends they don’t exist
25. Absorbs concepts used by critics/non-mainstream economics, watering them down to the point of being unrecognisable
26. Spends large amounts of time, pages, volumes, on issues which are basically trivial
27. Related: has little conception of its own history. Has been reinventing the wheel (but with maths!) for a long time
28. Insists on approaching history largely through the use of statistics, preferring even bad statistics to the qualitative
29. Makes its students more selfish (don’t @ me)
30. Uses maths to represent quantities which don’t have measurable, scientific units
31. A lot of statistical results are essentially obtained through p-hacking. (Though this isn’t specific to econ)
32. Little in the way of professional ethics or duty
33. Irritating habit of defining all criticisms as someone else’s problem. “That’s sociology!” Or “I’m not even a macroeconomist!”
34. Overuse of equilibrium & comparative statics, little conception of how things actually change
35. Crises are not exogenous shocks
36. Dear microeconomists. Why do I care what people do in laboratory gambles? Besides, Gigerenzer did it better.
37. Behavioural economics: making economic man more realistic by having him solve more complex utility functions
38. Also behavioural economics: ‘nudging’ people to be more ‘rational’, because economists clearly have that idea down
39. Game theory weirdly convinces it’s practitioners it’s applicable almost everywhere when it’s applicable almost nowhere
40. Preference satisfaction & efficiency/output are the focal points of almost every model. The normative implications are rarely laid bare
41. Calibration. Wtf
42. Large areas of undergraduate economics are the same as books from hundreds of years ago, with no empirical reason for why
43. The EMH is either the most trivial or most ridiculous theory I’ve ever seen, depending on who is arguing for it
44. On the whole, mainstream textbooks and economists STILL don’t get why banks work
45. Rational expectations is blatantly absurd to even the most casual observer
46. Models are invented too fast, and used before they are fully understood (my latest medium post is about this)
47. Prices simply do not play the coordinating role attributed to them by mainstream economists in many markets
48. Abuse of labels like ‘dynamic’ ‘imperfect information’ or ‘bounded rationality’, when the models do not truly reflect these ideas
49. With the way it’s taught, people who learn it often cannot think any other way. It is difficult to do even if you want to
50. The ‘law’ of demand and supply is quite clearly no such thing. Counterexamples are easy to find
51. The certainty with which comparative advantage is propagated as an argument for free trade is proportional to its utter inapplicability
52. No appreciation of the social economy. I bet most economists don’t even know what it is
53. In general, workplace dynamics are absent (except in terms of contract efficiency)
54. ‘Intuitive’, ‘plausible’. What the hell do these mean and why are they in every econ paper?
55. The spectrum auctions were  flawed, please stop going on about them
56. The ‘empirical revolution’ aka we’ve got clever statistical methods and look at them no not over there the shiny bit here
57. Randomised control trials, because we like experimenting on poor people-how else do we determine which experiments on poor people work?
58. Instrumental variables, because the best way to deal with unverifiable assumptions about endogeneity is to introduce another one
59. Regression discontinuity design, because that thing that’s obvious from looking at one graph needs an entire paper
60. Subjective well-being research has yet to tell us anything we didn’t already know
61. Utility as a concept has always been circular. Revealed preference doesn’t help, it just makes it more obvious
62. Functional forms are only chosen for tractability reasons, and every popular functional form has counterfactual implications
63. Excessive use of mathematical notation in explicit detail for god knows what reason. Makes it seem more scientific, I guess?
64. Similar love of graphs as apparently making ideas that are obviously wrong seem right. Laffer, Kuznets, environmental Kuznets, etc.
65. Convergence, as implied by the Solow model, is obviously wrong. 'Conditional convergence' just makes it unfalsifiable
66. Total Factor Productivity is an artefact of accounting, it doesn't measure productivity
67. Pareto optimality/efficiency are close to useless concepts, unverifiable and unobtainable in the real world
68. The market for lemons is so clearly wrong I'm not sure how it's so popular. The original referee rejections were right
69. Specific version of #27, but worth saying: I can't believe what the mainstream has done to Keynes. Sorry mate
70. Abuse of the term 'fallacy', which means an *objective* error in logic, to mean 'doesn't fit my little story about hotdogs'
71. Virtually ignores household work, care work, and anything else that isn't directly counted in GDP
72. Regional inequality buries GDP as a measure of national welfare. The UK is a case in point, the US isn't much better
73. Overly complicated statistical models hide assumptions and obscure more transparent relationships in descriptive data
74. The concept of 'marginal' anything is completely alien to most people, firms, governments, I don't know why it's used
75. The 'but there is a paper that does X' defence. 1. It will never be part of 99% of the mainstream 2. It's probably a crap attempt anyway
76. Kaldor-Hicks compensation is such a poorly thought out idea. People who've lost their jobs don't want 'transfers', they want jobs
77. 'Heterogeneity' in macroeconomics means 'people differ by one or two parameters', which is limited heterogeneity, to say the least
78. 'Models help us be logical and scientific'
79. EU was invented when mathematicians didn't know the difference between time averages & ensemble averages. Now they do, so get rid of it.
80. Markets don't clear, and they don't 'try' to clear. Businesses deliberately keep stocks to deal with uncertainty/change
81. Idea that maths is necessary for being logical has 2 issues (1) maths isn't always (Godel) & (2) words can obviously be logical
82. The basis of public choice theory - that political actors are selfish - has been convincingly falsified
83. Coase's theory of firms is either so vague as to be useless or wrong, otherwise all activity would be subsumed under a single firm
84. Where are the activist economists? Global slavery, meat-eating, the environment, are all both huge economic and huge moral issues
85. Has any economist ever been dismissed from the profession/respectability for doing terrible things? Scholes, Schleifer, etc.
86. Regulation policy is insufficiently systemic, overly focused on individual firms. Huge problem in the run-up to the crisis (see VAR)
87. There is generally little in the way of legal and institutional understanding when economists discuss policy
88. The overarching idea that 'competition is good' ignores the many cases where it is negative (such as arms races)
89. Unnecessary level of deference to existing models/literature, regardless of how wrong it is
90. Repetitive education. No I do not want to learn oligopoly theory 5 times
91. Lack of habitual use of case studies, survey methods, interviews, and other non-statistical research methods
92. Too much use of downloadable statistics without really knowing where they came from and their limitations
93. Time series, with the exception of finance, has data which verge on useless
94. The Lucas critique is a devastating critique of mainstream economics. Too bad it's somehow been interpreted as support for it.
95. Economists got Brexit wrong, and they barely even understand how. Hint: 'but our forecasts were right!' isn't the point
96. Econometrics "assumes independent, identically distributed populations when modelling unique & interdependent individuals" HT @BruceMcF
97. Excessive conviction in 'human capital' as a way to solve social problems and inequality
98. Any discipline which not only produces but *rewards* people like Robert Barro, Ed Prescott and Eugene Fama clearly has problems
99. It is common to see accounting identities interpreted as causal, probably due to economists mistaking them for equilibrium conditions
100. The causality paradigm in applied micro has completely overreached. Many social phenomena do not have 'causes'
101. 'Yes, we know this idea is wrong but we use it as a benchmark'
102. Inflation targeting (esp. CPI) played a huge role in blinding policymakers to the brewing financial crisis. No idea why it's still used
103. Monetarism is the single most ridiculous and most repeatedly falsified doctrine to have ever made it into policy. Still it lives on.
104. Becker-esque economic imperialism is so obviously counterfactual it's hard to believe it ever had a place in the discipline
105. Well-worn, but yes-it *is* sad/strange that economists invented their own 'Nobel'
106. The idea that the 'supply side' and 'demand side' are independent is wrong, and a source of (very) bad policy
107. Economists are largely responsible for Uber's surge pricing policy. 'nuff said
108. Major disciplinary institutions like the AEA were formed during in the red scare, hugely biasing them. These biases persist.
109. The Chicago School of anti-trust has taken over the discipline and competition authorities, doing irreparable damage
110. Ideas like 'government intervention' and 'externalities' only make sense if you assume the status quo is neutral. Which it isn't.
111. OK one more. Economic forecasts are really bad. Everyone knows it so why do we carry on making them??

Corruption fighter joins contest for South Brisbane

Corruption fighter and Game of Mates author Dr Cameron Murray has thrown his hat into the ring to challenge Deputy Premier Jackie Trad for the hotly contested South Brisbane seat at the upcoming Queensland election.

University of Queensland economics lecturer and corruption fighter Dr Cameron Murray will be contesting the seat of South Brisbane as an Independent candidate.

After the release of his book earlier this year on political favouritism in Australia, entitled Game of Mates: How favours bleed the nation, Dr Murray decided it was time to take the next step and try and enter politics to clean it up.

“People are sick of professional politicians working in the interests of their mates rather than the hard-working public,” said Dr Murray. “Across the state, people have been telling me they want a fresh approach, free of corruption and big-party backroom deals, and that needs real people with experience from outside of politics to put their hand up and offer a sensible alternative.”

“I have been working for years now with community groups and anti-corruption campaigners, including Rob Pyne, the independent Cairns MP who has exposed corruption across Queensland councils. Being an independent elected member of parliament would allow me to continue this work and leverage that position to really help clean up Queensland politics.

“One issue I am passionate about is better planning. Communities across the State are being ignored while their cities, suburbs and towns are radically changed to benefit a small set of well-connected property developers. Drawing from lessons in Australia and abroad I will push for a range of effective policies, including selling new development rights to developers and enacting citizen juries to decide on local planning schemes. These will rescue ratepayers who are now subsidising overdevelopment, and provide true democratic input into these highly valuable decisions that are unfortunately being corrupted by political mates.

“I also believe that our current crop of politicians has forgotten about the basics. I would focus at every chance on maintaining the high quality of life we enjoy in Queensland. For that we need secure jobs in a diverse economy, not just relying on the booms and busts of mining and housing cycles. We need affordable housing for first home buyers and renters. And of course, we need a sustainable environment that preserves our rare natural gifts for future generations.

“I look forward to offering a sensible alternative in this election and bringing fresh economic thinking to Queensland politics,” said Dr Murray.

A Bitcoin Bet

I have yet to hear reasoned arguments about why Bitcoin should be considered a currency. Nor have the perceived advantages over existing currencies and their settlement systems ever really been properly elucidated.

Somehow that does not stop people believing that Bitcoin is a currency. In many cases, people argue that it is even better than existing national currencies without even knowing about the security and settlement features of the current payment systems used across the world. Perhaps this is why the benefits of crypto-currencies are never made clear, and all you get is hand-waving about governments debasing their currency, being anonymous, or some such thing.

Bitcoin is a financial roulette wheel, spinning on ideology, and attracting suckers with every turn. It has none of the core features of a currency, which means it will never be used as one.

Professor Jason Potts, a founder of Crypto Economics, seems for some reason to think otherwise. On Facebook, I suggested to a mutual friend that I was willing to bet that Bitcoin will never be used as a currency, by which I mean as the unit in which goods and services are priced and as the medium for settling payments.

I said:

I have yet to hear why Bitcoin or any other cryptocurrency functions better than current monetary and payment systems, except nonsense anarchist handwaving about being 'distributed', and something about 'trust', which is no longer even the case with a small set of Chinese organisations essentially taking over Bitcoin mining, and the trust problem being totally misinterpreted...

Jason decided that a bet was interesting and would take me up on it if I decided terms. After a little back and forth the following terms were agreed to.

I [Cameron] will lose the bet if, as at 19 September 2022, Bitcoin (meaning Bitcoin or any other cryptocurrency not backed by a national banking institution) meets all of the following criteria. 

1. Bitcoin can be used to buy groceries in a physical store in my suburb where prices are posted in Bitcoin and not simply converted from AUD pricing periodically.

2. More than three listed companies in Australia pay salaries in Bitcoin (or have an option to), and advertise their salary rates in Bitcoin (i.e. you do not just get paid AUD converted at the going exchange rate each time).

3. At least one OECD country accepts Bitcoin for income tax payments and will calculate tax obligations in Bitcoin (not convert from the local currency to Bitcoin). 

4. Jason Potts is being paid in Bitcoin at a fixed Bitcoin price (not simply converting an AUD salary to Bitcoin). 

Loser pays the winner AUD 100 at an event the loser organises in their city that involves lively discussions, debates, and socialising.

I see a huge number of problems with Bitcoin and want to outline some of them here in the context of this bet. Some of the main ones are:

Money-ness
It is not clear what the advantage of a blockchain tracking all transactions is. My view is that this comes from a fundamental misunderstanding of money. Money is a not an object, or token. It is not a gold coin. It is a common accounting system.

This is why we price in the national currency. There is nothing stopping any company setting their prices in all manner of things — gold, iron, US dollars, or other units. But we don’t. Because we want to integrate into the common system of accounting that our suppliers and customers use, and one where it makes financial sense to can keep relatively stable and predictable pricing, in addition to easy payment.

Every online store that I have found that accepts Bitcoins does not price in Bitcoins. It prices in the national currency, and allows you to pay using Bitcoin. An Australian service that allows you to ‘get paid in Bitcoin’ prefers to be paid themselves in Aussie Dollars for that service.

Indeed, the fundamental misunderstanding of money is evident at some of these retailers. For example, when Mission Market announced they would start accepting Bitcoin, they noted the following:

Unlike credit cards, Bitcoin payments are not sent through a labyrinthine network of banks and processors, meaning that transactions can be completed faster and more cheaply than conventional electronic transactions. Bitcoin retains many of the useful features of cash while offering more security. And because Bitcoin has a finite supply and is not issued by a central bank such as the Federal Reserve, its purchasing power cannot be eroded through excessive money creation. [my emphasis]

Here again, we get the ‘money as object’ myth rearing its head. Payments are not ‘sent’. They are accounted for. The ‘finite supply’ again reinforces this idea.

Now, this same myth is true in much of economics. The quantity theory of money talks about the supply of money very much as a token. This is why the theory fails routinely. Properly considering the nature of money, the theory would not apply to some quantity stock measure, but would instead apply to the rate of expansion of current money accounts used for transactions of newly-produced real goods and services. But that is a fight for another day. 

The last main problem for Bitcoin in terms 'money-ness' is that if its value keeps rising no one will want to use it for transactions when an alternative currency that isn't rising in value is available. That's just Gresham's Law. And of course, if the value doesn't keep rising, it is not clear why anyone would want Bitcoin as a means of payment, and its value will likely converge to zero. 

Governments
Since money is a common accounting system, those who make the rules of money — government, central banks, and private banks — can exercise a great deal of power via this system. As we see now in China, those holding this power do not want it threatened. If a private crypto-currency did evolve into a more widely accepted alternative monetary system, it would be immediately crushed politically.

Trust
One of the arguments in favour of Bitcoin is that you don’t need to trust a banking system to settle a payment, nor identify yourself. Instead, you trust a different system. Surely in normal commercial arrangements, the very choice to use Bitcoin rather than established currencies would be a signal of a lack of trust on the part of a transaction partner.

Imagine you are a new retailer in a market and approach a wholesaler about purchasing a variety of goods. You ask to pay in Bitcoin. What would their response be? Would it increase their trust that you will pay your bills, or decrease it?

Perhaps this is why Bitcoin’s main commercial use has been in black markets.

And indeed, the main advantages of using Bitcoin — the anonymity of your transaction partner in digital payments — seem to be the very reasons that governments would want to crack down, particularly if it is widely used to avoid tax.

Technical limits
Around $180 billion worth of non-cash payments are settled each day in Australia. This excludes a great number of within-bank settlements between account holders, and all cash payments in the economy. Since cash payments are about 30% of all payments, and accounting for some within-bank settlements, the total daily payments could be closer to $300 billion.

I have no idea how Bitcoin or any other crypto-currency could handle that sort of settlement need in a timely manner. That’s over $200 million per minute. And yet, the Bitcoin system can only settle about 3 to 7 transactions per second. Mmmm…

Compare this to, say, VISA, the credit card payments company. They alone settle over 56,000 transactions per second during peak times.

Also, the cost of settling Bitcoin transactions is growing. To buy a coffee in Bitcoin today takes over 10 minutes and costs a few dollars for the transaction.

My view
If Bitcoin wants to be more “currency like” it will have to start centralising and becoming a lot more like existing currencies. It will have to change its structure to allow the balance sheets of the system to grow extremely rapidly as the market for them grows. In effect, it will have to become more like existing currencies. Which will then beg the question -- why change to a new private currency that works fundamentally the same as the existing one?

Finding Australia's "missing million"

I am responding here to Aidan Morrison's brilliant deep dive into the ABS population statistics entitled "The Missing Million: Is Australia's migration rate actually high?".

1. The ABS always strings together their data after series breaks. It is really bad in the economic data where the whole concept of what they are trying to measure can change (like the 1998 CPI revision). You could do a similar deep dive into every ABS dataset and finish with more questions than answers. 


2. Many people who use the data (including most of those people in your example) know there is a series break in 2006. But as you have shown, it doesn’t really make much of a difference in the end. The divergence with the raw arrivals/departures data that started in the early 2000s remains. The new 12/16 rule applies symmetrically to those who leave and arrive, and although the ABS notes that it increases the NOM estimate during their 2003-06 test period, this was kind of the point. They were classifying many arrivals as short-term (i.e. not in ERP) when they stayed more than 12 out of 16 months, but not consecutively. This applies to much of the international student cohort, of which there are now over 600,000, compared to 200,000 in 2001.  


3. My point is, the discrepancy you point out between your physically present population (PPP) and the estimated resident population (ERP) is not primarily because of this change in methodology in 2006. The difference is simply the number of residents currently abroad, short term, at any point in time, minus short term visitors (under the new definitions of short-term). The census also won’t catch the million residents who are abroad that night. 
And while short term departures are growing, the number abroad at any point in time will grow as well.

4. The new methodology means that the ERP is higher than the old methodology because it makes sense to count people who reside in Australia more than 12 out of 16 months as residents who need the type of long-term facilities that residents need. In my view, ERP is the more important concept economically than physical bodies on the ground on any day. It also matches more closely the way these things are measured internationally. 


5. So if the whole issue boils down to net short-term movements what is causing the change since 2001-02? From ABS 3401 we see that this is mostly from the rise in short-term resident departures for holidays!


Also, mostly these trips are for less than a couple of months. 



We can see that the increasingly popular destinations are NZ (big boost in 2003-04), Indonesia (likely Bali) and the US. Less so to China or India, as many might expect.


I would guess that retirees are a big portion of the post-2002 short term departures boom (a lot of baby boomers started retiring 10 years ago). There are plenty of anecdotes to back this up. And it’s now a hot button political issue that pensioners are getting the pension while on cruises and travelling abroad.

The data also shows that the number of people over 65 travelling abroad has tripled in the 10 years to 2015-16, with a relative decline in the share of short-term resident departures coming from people aged 30-60.

The other point to note is that both the baby boomers and their children (the baby-boomer echo) were, in the past ten years, at the stage of life where they are more likely to travel abroad.

We can see below that what data we have shows that people over age 60 have been a larger share of short-term departures recently, with people aged 30-60 being a declining share of the total.

6. Which brings us full circle. The 2006 methodology change meant that some inward immigration which was previously considered short-term, like international students, is now considered long term (i.e. residents), while there has been a rise in short-term departures from baby-boomers and their children holidaying in Bali!

Should we subtract retirees on holidays in Indonesia and on cruise ships from our resident population figures? I suspect not. Do their holidays mean that inbound residents residing more than 12 out of 16 months don't need to be considered in terms of housing and infrastructure needs? Probably not.

Overall, after a lot of thinking on this topic, I suspect that the ABS data, although imperfect, and although hiding a series break, is probably the ‘better’ metric to use in planning and economic analysis.