Economists strike – what next?

One wonders about such things (and here). The most highly educated group in our society (university academics if you are still wondering) are threatening strike action for better pay.

The question in my mind is; will the economics departments be participating in such actions, and what is there reasoning?

The economic academics I know think that the university lifestyle, autonomy, and interesting research projects, mean that moderate pay is sufficient to attract good talent. After all, that’s what keeps them in the game – it’s not the money honey. Why then the need for more pay?

Surely if there was a problem attracting staff, universities could voluntarily offer higher salaries for some positions?

In the end, academics always have self interest to fall back on as a justification for participating in strikes. Although, they could just as easily benefit from the strike action and not bother participating – another self-interest motive at work.

Oh, the mystery.

Conspiracy!

I don’t take anything at face value. I give credit to conspiracy theories, as they often seem as plausible as the mainstream interpretation of events. Many times though, I simply don’t care, and even if I did, I couldn’t do much about correcting any misrepresentations of history.

I want to throw another one out there.

I have written before how implying causality between correlations of changing global surface temperature and increasing concentrations of carbon dioxide is statistical mumbo jumbo. But considering we know so little about whether the global climate will in fact ‘change’ (we still don’t know if that is for better or for worse) as a result of humanities combustion of fossil fuels, we seem to be taking quite radical actions. Households appear to want to do their part to prevent some hypothesised distant future even of low probability, while immediate and dire problems exists all around us (maybe more so in other parts of the world than the Lucky Country). So the question remains, how did such a fringe issue become so mainstream?

Today’s conspiracy theory is that a group of very powerful world business leaders (the big oil men) saw the imminent peak of fossil fuel production, and the resulting problems of a declining productive capacity of the economy. They wanted to get governments to act on this problem without having to admit that the problem existed. So, they utilised the fringe climate change movement, giving them a voice in mainstream circles. Any government actions implemented to curb climate change would conceal the peak of oil production for a little longer. Government research and subsidies may even assist in finding alternatives for big oil to invest in. All they while they can maintain that oil reserves are plentiful, keep confidence in their business and the share price high, while having governments unknowingly assist them to wean themselves off oil.

They use lines like “the stone age didn’t end because of a stone shortage” to show that change can happen voluntarily.

Anyway, that’s a nice one for today. I’ll leave you with this interesting comment from here.

I'm a bit of a conspiracy theory buff and one of my favorites is the meta-theory: all conspiracy theories that become popular are actually produced by the government to keep the paranoids occupied looking for aliens, bigfoot, and psychics instead of focusing on the more nefarious intrusions into civil and social rights. Meta-theory has a lot of benefits, such as that it explains why government explanations for things like Roswell are so terrible: a good explanation would leave only a few true believers, a bad explanation actually creates more believers in the conspiracy. As a final benefit, generating conspiracy theories as red herrings is cost-effective. A conspiracy theory works by arguing from the void/gaps. All the government need do is create a few vague clues and let the mind of the legions of paranoids do the rest of the work filling in the huge, ambiguous spaces. Why would anyone investigate mundane government corruption when there are aliens and psychics to research?

Information deficiencies in the job market

I am in the market for a new job. Here are some things I have noticed:

1. All jobs are exciting, and require people with enthusiasm.
2. All jobs are for an integral role in a team.
3. All jobs require you to work independently and as part of a team.

Here's a snapshot of the jargon.

...with a strong mission to provide outstanding services to our sunshine state. Undergoing an exciting diversification of its portfolio...

It all makes me pretty cynical. I mean, not all jobs can be that exiting! To make matters worse, many job advertisements emphasise the importance of experience. Even for a dish-pig or waiter, they seem to want a minimum of 2 years experience. Is there anything about washing dishes or carrying plates that can't be learnt in a week?

One job I saw suggested that the suitable candidate would have 5 years experience in a similar role. In my letter I wrote:

While I may not have 5 years experience in a similar role, I would suggest you are unlikely to find a proactive candidate given those requirements. Anyone who has spent 5 years in the same role, then applies for another similar one, in my mind, appears to be destined for mediocrity. If instead you seek a candidate with enthusiasm, analytical skills, and drive for constant improvement, then I may be quite suitable.

We’ll see how that application goes. I always wonder how you are meant to explain how great you will be for a job after reading a total of two paragraphs of non-sense. Maybe I'll offer a 'try before you buy' period in my next application. Surely that's in the best interests of all involved.

Where did we leave our common sense? Is it behind the new plasma screen?

This article raises the point that we have a tendency to eat more after exercise, negating the potential weight loss benefits. I don’t think this is breaking news. Nor does it actually mean that exercise won’t make you thin, as the title so controversially states. In fact, the following excerpt shows the ridiculous need to frame a discussion about how to address the compensating hunger from the exercise in emotive and controversial terms:

Exercise, in other words, isn’t necessarily helping us lose weight. It may even be making it harder.

Common sense tells us that diet and exercise are the ingredients to weight loss (and gain mind you – athletes are right into this diet and exercise equation). Eat less, exercise more, and you should lose weight. Eat more, exercise less, you should gain weight. And for those who want to gain muscle, heavy exercise and a high protein diet with plenty of calories. I heard a third hand story once that a famous Iron-man was asked in an interview whether he would consider writing a book about his particular views on health and fitness, and he replied along the following lines: “It would be a pretty short book”. It is after all, a simple equation.

Also, imagine that reality TV show where contestants lose weight. Are we to think now that they would have done a better job without all the exercise? Or that they could have really shed all that weight by sitting on their arse, but eating slightly less - really?

Anyway, I wonder where common sense has gone sometimes.

Child care subsidies and maternity Leave: New incentives and unintended consequences

The maternity leave debate was raised yesterday with an angle I had not thought about before, but being an economist, really should have. It suggests that maternity leave has the unintended consequence of encouraging women with young children to work rather than stay home with their children. Rather than bringing families together, it actually tears them apart. Let us examine this claim.

The article claims that more than 80% of children under 5 years of age attend formal day care in Sweden, where 12 months maternity leave is the norm. This figure must surely be closer to 100% of children aged 1-5, given that mothers (or fathers) are paid to stay home for the first year of their child’s life. In Australia, the number of children under 5 in formal day care is currently less than 40%, and much of that I would imagine is part time.

Both the pro and anti maternity leave debaters need to get straight the purpose of their policy. That way we can examine whether there are possible unintended consequences which can undermine the suggested outcomes.

For example, the pro-maternity side appear to want to reduce the cost of child rearing to working mothers. Fair enough. But the unintended outcome of a maternity leave is to decrease the costs of child rearing for working mothers, but not stay-at-home mums. The new incentive structure encourages mothers to choose work over staying home with youngsters.

Complementing maternity leave is the current child care benefit scheme. I have mentioned before how cheap child care can be after all the subsidies are considered – about $15/day/child. This policy increases the net benefits of working for mums, as the cost of working, in the form child care, is reduced. These subsidies provide incentives for mothers to return to work quickly after the birth of their children.

Sweden is the classic case study of the pro-maternity leave lobbyists, but I wonder if they have really examined the outcomes of Swedish policies in detail.

Consider this comment (all quotes from here): 

Policies such as childcare and parental leave have meant that the majority of Swedish women are employed in the labour market and remain there throughout their lives, with only minor interruptions after the birth of a child.

And: 

from 1990-1998 the percentage of women engaged in part-time work fluctuated between 43 and 47 percent, while since then it has decreased to between 33 and 36 percent.

It appears more kids in full time, rather than part time, child care is what you get.

The following graph is of the period following the introduction of 180 days parental leave, at 90% of previous salary, in 1974 in Sweden. This was extended to 9 months in 1978.

During the 1970s and 1980s, the state and the municipalities both covered approximately 45 per cent of the fees, leaving the remaining 10 per cent to be covered by parental fees.

Again, subsidising child care works, in that it increases the uptake of child care. Not subsidising it works too. Cost of childcare exploded in the 1990s, and

…by 1998, 17 per cent of the costs of childcare were being covered by parental fees

The graph above clearly shows this impact. But what of the 2000s boom? We have another policy change to explain that one.

In July 2001 the Swedish government expanded childcare to include children of parents who are unemployed and in January 2002 to include children of parents who are on parental leave looking after a sibling (Swedish National Agency for Education, 2003). In addition, in January 2003 all children aged 4-5 became entitled to 525 hours of free attendance in childcare per year.

It is time for the pro-maternity leave lobby to ask whether having almost all of our children aged 1-5 in full time child care is a desirable social outcome.

My gut instinct is no, but I have no reason for this position. My son is in family day care two days a week, and he started this at 18months of age. He enjoys it, and he learns to socialise with other kids. Since putting kids in child care is a voluntary action of parents, my inner economist says that it must be the best outcome in the circumstances. Of course, the circumstances are the direct result of government policy tweaking the incentive structure.

In the end, it appears maternity leave policies do not bring families closer together, but create a generation where parents and children become strangers.

What's with the news?

I thought some of you might be interested in the content you can find through the Courier Mail website’s front page:
• Sexy designs on Columbian catwalk – photo special
• Beauty and the beast – how Miss Universe narrowly escaped a captive crocodile
• The flying car is here!
• Get naked – best nude events, beaches and resorts
• Miranda Kerr caught topless again – photos inside
• Amazing animal escapes
• Beauty and the beast – picture special (bikini clad models holding exotic pets)
I just want to remind you that they also claim a readership of 620,000 each weekday. An economist will ask, is this degradation of news demand driven, or supply driven? Considering the vast flesh content of the internet, maybe it is demand driven. Anyway, I think I have now confirmed where not to go for news.

Insightful

I thought it might be time for a short break from the residential property market. Time, maybe, for a more philosophical glimpse at our world.

When election time comes around I often wonder what difference my vote will make. All the candidates seem to converge on the same policies 99% of the time, and often take advantage of irrelevant fringe issues to attract voters to their side. It appears then that much of the benefits from a democracy actually happen before votes are cast, as candidates seek to determine policies to satisfy the majority of people. Thus, we get the candidates and policies we deserve.

I will leave you with a quote from a very interesting piece.

... we also have to overcome our perception that elections are about the future course of our country. Actually, they are about picking managers who will oversee public policy as we move into the future...

UPDATE 2 - A chronic housing shortage: Myth or reality?

This is my final post on the housing shortage debate. After a little probing, I have isolated the single point that leads astray the data rich, but theory poor, residential property analysts. It is this. Housing shortage proponents believe that housing supply is not very responsive to price changes, or the jargon, supply in inelastic. As such, we can expect another house price spike as we wait for supply to catch up with expanding future housing demands.

I would like to think that today’s ABS release of building approvals data confirms my point, and makes a mockery of housing shortage predictions, such as those of Paul Braddick of ANZ. Braddick seems to acknowledge the housing shortage as some kind of inside joke when he writes:

If housing supply remains on its current trajectory, Australia will face a critical, and potentially intractable shortage of housing throughout the decade ahead that would force rents and house prices significantly higher and drive both rental and house purchase affordability/availability to extremely difficult levels. (my emphasis)

To look at the graph below, and make dire predictions based in extrapolating a one year trend in supply, in light of historical evidence, is probably one reason for the poor reputation of economists.

By the way, Braddick has claimed a shortage for some years, and in 2007 stated that buying a home was going to get much harder, and that we face supply constraints. Yet in the year following these claims prices dropped and affordability increased. I thought houses were like bananas. A supply constraint causes prices to rise, not fall. But if you make the same prediction for long enough it is bound to be right eventually.

Where is the theory in all these extrapolative forecasts? In Joye’s own words, his solution is to ‘elastify supply’, but how elastic is supply currently? And is there a problem with too much elasticity, which may accentuate the boom and bust cycle? Let’s not also forget the fact that supply is normally more elastic in the long run than in the short run anyway.

Why do we not see these types of conclusions from our top economists instead?

…the projections of demand, of supply and of the gap between them are simplistic and unlikely to be realised in the longer term. The housing market is dynamic, as is the economy as a whole, and the emergence of a major gap between effective demand and supply would stimulate market reactions affecting price (affordability) and aggregate supply.

There are my last thoughts before putting this debate to rest.

• Housing demand comprises rental and owner-occupier demand. Investor demand is simply a function of rental demand (income) and growth expectations, which may be partly driven by owner-occupier demand.
• The elasticity of supply of housing appears quite reasonable, but I have yet to find a good recent estimate for Australian housing. Even Joye and Co’s epic volume on home ownership, with a chapter on the elasticity of housing supply, fails to estimate the elasticity figure itself, and whether there has been some recent decline attributable to regulatory changes. In the UK it, the elasticity of supply of housing appears to be between 1 and 3. My own back of the envelope estimates using ABS weighted homes average price for capital cities (price), and dwelling units completed (quantity) result in a similar range of estimates (depending on whether monthly, yearly, or lagged).
• Although a Robertson/Keen type wager does not interest me so much, I am still prepared to offer a forecast. The growth in dwelling prices from July 2009 to July 2011 will be less than the growth in prices from July 2005 to July 2007. I know, it’s not particularly shocking, but it makes my point that the methods used to justify a housing shortage are flawed, and do feed into house prices.

UPDATE - A chronic housing shortage: Myth or reality?

I tried to contact Christopher Joye and Business Spectator to promote my previous post, which tried to unravel the mysterious reason for making dramatic claims of a chronic housing shortage.

I would like to think that today’s comment by Joye at Business Spectator is in some way connected with my own analysis, but doubt it. He does not address the concerns I raised of defining the term shortage, nor does he address why house prices declined during 2008, or why the rate of price growth is slowing. He does address a point that I have not made, about the large number of unoccupied dwellings in the census data, but I agree with his point about that data. Instead, I will have to take it as an expansion of his general argument.

To be clear, the argument is centred on the fact that building approvals are at all time lows, while population growth is at historical highs. Blind Freddy can see this.


In the long run population growth is the driver of underlying demand, but part of the cause of the recent burst in the population growth rate is the ‘baby bonus children’. They will not be a significant driver of demand for space for a couple of years yet. I also challenge the validity of simply extrapolation net migration trends, which would have missed the 1987 decline, and will miss any future declines. Maybe the shortage claim is that we currently do not have enough dwellings for future demand, and that there is some reason why we may not be able to supply these future dwellings. I’m sure we both agree that long run demand is a function of population, even after minor fluctuations in occupancy rates are considered. Population has grown in fits and starts before, and it will again - that surely is not the prime justification for claims of a shortage.

But we can first examine the obvious reason why building approvals, starts and completions are at a historical low. Joye’s own research shows that house prices declined through 2008, so there was little incentive for developers to bring stock to a falling market. Developers don’t count houses, they count profits. Could housing shortage proponents please explain to developers why they should have continued to build homes unprofitably when house prices were declining?

I understand Joye’s frustration in communicating his claim to the general populous, and I have no problems with being labelled neither an academic, economist or serious researcher; simply an independent pundit. My independence I feel is my strength. But neither does my independence imply a lack of academic rigour, seriousness of research or experience in property markets, for I like to think that is my forte.

But let me focus on the arguments at hand. The proponents of a housing shortage believe there is some kind of impediment to the future supply of housing, and in Joye’s own words they include: strict density restrictions; long building approval processes; a range of taxes and charges that stifle new development; insufficient infrastructure to liberate distant supply; and scarce new land in proximate urban areas.

Solution: elastify supply. Translation: build roads, rezone land for housing, decrease government fees to developers, and streamline the development and building approvals process – make it easier to build new homes.

But Joye’s own numbers show just how responsive the supply of residential property can be. Ignoring the GST induced slump in 2000, the graph below shows three previous periods where residential building activity slowed dramatically, only to bounce back within a couple of years. And these recoveries faced similar, if not worse, taxes, charges, and approvals processes.


The Queensland government has taken Joye’s ideas for elastifying supply on board with their SEQ Regional Plan. The plan complements the SEQ Infrastructure Plan, and together they achieve all of the solutions proposed by Joye. However, a Regional Plan delivering these same outcomes has been active in the State since 2005, and yet apparently, we still have a housing shortage.

There is a very good reason why this should be the case, and why Joye and Co.’s proposed solutions will not bring forward the construction of new dwellings. Let us examine each proposed solution in turn.

1. Density restrictions. If I understand this correctly, the claim is that if developers were allowed to build higher buildings, they would build more dwellings.

But through what mechanism is this claim achieved. Let us use an example to show how rezoning to increasing building height restrictions benefits only current land holders, and does not improve the supply of dwellings.

A great case study is near my own home, where former industrial land near the city is a target for gentrification by the local government. The land has been rezoned for residential, and the building height restriction has been increased periodically from 5 to 7 to 10 storeys in the past 5 years. Yet there remains just a trickle of new apartment buildings.

The reason is simple. As the height limit is raised, the land itself gains value. Any developer looking to enter into the area would have to now pay the current owner an even greater price for the land, leaving their rate of return on the development similar in every case (the 5, 7 and 10 storey cases). Rezoning, while in some instances is required to change uses, and to allow for natural growth to proceed, still remains a gift to the land owner.

2. Long building approvals process. The argument is that supply responses to price changes are delayed due to arduous approvals processes.

In general, I agree that the approvals process for residential dwellings is in some cases arduous and time consuming. However, the fact that planning and building approvals remain current for a period of time allows developers to speculate with early approvals, without committing to construction until prices appear stable enough.

Even if the cost and time taken for approvals is reduced though innovative management by local governments, the argument of benefits going to current owners of developable land, as in increase in value reflective of the reduction in development risk, applies.

3. Taxes and charges stifle new development.

This is the same argument for rezoning and the building approvals process. Reduced development costs are returned to land values.

4. Insufficient infrastructure to liberate distant supply; and scarce new land in proximate urban areas. These arguments assume that developable land is unavailable due to current planning restrictions.

This argument is one of the more popular ones in the property industry. If I just stated here that there is plenty of land currently zoned for residential development, both within existing suburban areas, and in new outer suburb developments, I would be hit with a request to show some evidence. So here it is for South East Queensland.

Springfield, to the west of Brisbane is only 13% developed. It has an area of 2,860Ha, and a target population of 86,000 people, with house and land packages available now. Coomera, north of the Gold Coast, has been rezoned for a new satellite city, and has very good highway access to both Brisbane and the Coast. Land is zoned for housing for an estimated 60,000 people. Sippy Downs, west of the Sunshine Coast has a new plan promoting development around the University of the Sunshine Coast. Not to mention infill projects such as Portside in Hamilton, and the ongoing transformation of Teneriffe, South Bank, and South Brisbane into dense residential areas.

Of course, I have repeatedly mentioned, the benefits from rezoning go to current land holders. For a development industry with large parcels of land bought for long term speculation, this is a simple gift.

At the end of all this reasoning we end up at the same point as before. We all agree that there has been a recent jump in population growth rates, which will lead to medium term stability in house prices, and a recovery in residential construction. However, some things remain uncertain, like why Australia’s leading expert on residential property markets can claim something as radical as a chronic housing shortage based on extrapolating trends in data without resorting to theoretical foundations; and why all levels of government are buying into ineffective solutions to a non-existent problem.

A chronic housing shortage: Myth or reality?

What I really want for me and my young family is a nice big house, well located, with a shed, in a quiet street, with shops close by, and parks all around. Damn the housing shortage!

But let us be serious for a minute. If you are going to claim a housing shortage, a chronic one at that, you will need some pretty solid economic justification.

This article is targeted squarely at the claims of protagonists Christopher Joye and Jason Anderson. I do this not to provoke, but to share ideas and present some theoretical arguments. I read Joye’s columns in Business Spectator, and am a fan of his general rigour and respect for evidence. But for some reason, he repeatedly claims that Australia suffers a chronic housing shortage. Maybe it is just his enthusiasm coming through, but surely to make such a claim he would need to define both chronic and shortage. Setting the definition of shortage aside for a moment, I think we can first ignore the use of the term chronic, as it implies long-lasting and ongoing. Maybe this term is used to make the point that Joye foresees the scale of future housing shortages to be quite severe.

Anderson makes these same claims, and challenges those who deny a housing shortage to explain to me why it is that in the 2008 calendar year we had the strongest rental growth in nominal terms for more than 20 years and in real terms for more than 30 years. He further claims his analysis revealed a housing shortage in 2006, and proposed that this would result in large increases in rent. While the rent rises did in fact happen, Joye’s own RP Data-Rismark Hedonic Index shows that house prices in capital cities have only just recovered their losses to return to the levels of early 2008. Are we to believe that a chronic housing shortage resulted in a decline in prices of 4%? If we adjust this index into real terms, that is a significant reduction (although I’m not certain whether this is already factored into the index). In any case the house price index in the figure below has grown at an average rate of 5.6% pa since Jan 2007. Over the period, the weighted average inflation in capital cities was 3.4% for 2007/08 and 3.1% for 2008/09.



Joye also makes the following claims as he tries to make the case for a chronic housing shortage, and I quote:
1. House prices have only just recovered their 2008 losses.
2. The rate of house price growth is not accelerating – in fact, it is decelerating. 3. Australia has had very low rates of appreciation –currently and since 2003.
4. Indeed, Australian house price growth since the end of 2003 has been well below household disposable income growth and nominal GDP.

I still can’t see the chronic housing shortage.

This article is also aimed at the antagonist Kris Sayce, who wrote an interesting piece that attempted to challenge the claims of Joye, Anderson and others. One of his key foci is the research that quantifies the shortfall of dwellings, which to me misses the point entirely. Dwelling counting, like job counting, is meaningless to an economist without regard to the profile of demand and supply and subsequently the price. These figures, as far as I am concerned, are a communication tool for planners and politicians; for those who get lost in more abstract economic concepts.

But Sayce does finally focus on the issue at hand – supply, demand, and price. He makes the poignant point that house prices during a bubble (if you want to call it that, however mild) begin to carry a growth premium. People begin paying a premium on the price for the expected future capital growth. The elimination of this growth premium may explain the decline in prices observed over 2008.

But this article is not about discrediting the two main protagonists, nor is it about supporting Sayce and the pool of antagonists, of which Steve Keen is probably the most extreme. In the end, I think we all agree (apart from Steve) that an upswing in residential property prices is certain, but I think we disagree on the timing and the severity of the boom.

Let us turn then to the details, which I believe get lost or forgotten in discussions of this nature. First, we need to define shortage in some meaningful way. Second, we need to examine the reason for the disconnection between rents and prices to answer Anderson’s question. And third, we need to consider the role of expectations and behaviour in response to broader economic circumstances.

First, shortage, or scarcity, of resources is THE economic problem. Most economists believe that prices are the best way for resources to be rationed amongst competing demands. In the residential property market, prices really do reflect a point where the supply and demand curves meet at a given point in time. Either the term shortage is used as a proxy for high prices relative to some subjective normal price level, or there must be some barrier that is stopping the market from functioning; some barrier that makes buyers unable to participate even though they have the financial means.

I await a meaningful definition of housing shortage from Messrs Joye and Anderson.

Second, the response to Jason Anderson’s challenge of explaining the dramatic rental increases in 2008 is deceptively simply. Any individual, family or other residing group, face two options for housing: renting or buying. The trend observed over the past 7 years or so has been an early rise in house prices, with a less substantial increases in rent, and a late fall, or plateau, in house prices, and an increase in rents. Buying and renting each have their benefits. If on aggregate, people tended to see buying as preferable in the early part of the decade, having seen significant price increases, and factoring in this growth premium to their decision, we would get the pattern observed. If in recent years, that growth premium has been lost, and job uncertainty has increased, people may feel like renting is relatively more attractive. Hence, we have seen significant rental gains since the end of 2007, but flat or decreasing house prices. At some point, rents will increase to the point where buying seems an attractive option again.

To clarify, the demand for housing is the sum of the demand for rental accommodation and owner-occupied accommodation.

Third, there is plenty going on in the economy more broadly that will impact the housing situation; lingering uncertainty (about a W-shaped recovery), expected interest rate rises, and a new generation entering housing with different attitudes.

Uncertainty is, in my opinion, going to hold back price growth for residential dwellings for some time yet. While there is much media attention to those who claim the end of the recession, but there are still warnings about a W-shaped recovery. Too much exuberance too early in global stock markets could be a big mistake, and another big fall would postpone a sound recovery. While this may make residential property appear a more stable investment, I suspect the net effect will still be a reduction in demand from both investors and owner-occupiers.

More closely related to the residential property market, the likelihood of interest rate rises next year will be holding back many moves from the rental to the buying market. Coupling this with a potential W-shaped recovery, and the potential for greater job disruptions should that occur, I would hesitate to call a house price boom until after 2010.

Taking the focus back to the home seeking individual or family, how do these uncertainties change their accommodation decision? For starters, it delays the decision to go from renter to owner. It also delays the decision to even become a renter. Young adults will choose to stay much longer with their folks. Importantly, and this is often overlooked, it may increase the occupancy rates in an effort to consolidate space and increase savings. For example, Grandma may move in with her children’s family and rent her own house. Or families may take boarders in their spare rooms, and group households may decide that rents can be shared better by having someone occupy the spare room. All of these points describe my network of young professional friends – the next generation of home buyers.

This brings me to my final point. The next generation of home buyers have different values to the Baby Boomers, or even Generation X. Generation Y travels, they see a mortgage as a burden, and the opportunity costs of homeownership to be very high. In my own case, the difference in costs for me to own the house I currently occupy, or to rent, are about $20,000 per year. The Generation Y attitude is to see the choices as
a. Buy a house and commit to continuous work for a lengthy period of time with little opportunity for saving or an extravagant lifestyle, or
b. Rent, stay mobile, and use the $20,000 difference on a year long trip to South East Asia, or a spend 6 months motorcycling through South America, Che Guevera style. And do this year in, year out.

My own prediction is that the housing market, in terms of prices, will remain fairly stable for the next year, while rents may continue rising at a slower pace. Should a second economic slump occur next year, governments of all levels have incentive to prop up prices temporarily, prolonging the plateau. It is likely to be another year until increasing rents and prices combine to provide the incentive, and the certainty, for developers to bring housing stock to the market. The recent population growth also points to the fact that housing will remain a reliable investment in the medium term, as the current ‘baby bonus children’ grow out of their bassinets.

I often wonder where the incentives lie for making such dramatic claims about the housing market. The obvious reason is that making claims that hit the middle ground are not particularly newsworthy. A second obvious reason is that maintaining confidence in the market is very important, and claims such as this do dilute the uncertainties discussed above. But really, developers are savvy operators, and many have large financial and land reserves, leaving them ready to build and profit when the market is ready. There is no need for alarm.

In good company on a W-shaped recovery

These blog entries are my ideas. I have them, then I write them down. And when I find my ideas are being taken up by others (most likely independently), or my predictions prove accurate, I like to take some credit by posting a little reminder.

It seems my prediction of a second share market crash is now shared by a number of prominent economists. I'm not certain whether their predictions are based on oil supply considerations, but that is the fundamental basis for my own.

If we could get economic forecasting like this, where a two week range was proposed for a Chinese stock market crash, and was off the mark by only a week, economics would gain some serious social status.

Should

It’s weird word, and one that I hear much too often from the environmentalists in my social circle. We should care for the environment, we should turn off the lights, we should drive less, we should eat organic food, we should should should should. Where does it end?

And isn’t it amazing how many people are happy to should you without a solid principle upon which to base their assertion.

I had a guy once pull up next to me on his push-bike at traffic lights after he saw me roll through the previous red light. He told me I should obey the lights, and clothed his statement in the authority of his role as a bike shop attendant who hears drivers complain about cyclists flaunting road rules. “No worries” seemed like the most polite palm off I could manage, considering I felt like telling him to mind his own business and wishing he’d get knocked off his bike.

That afternoon, returning home along the same stretch of road, I followed another cyclist who happened to run a red light. I stopped, as there was traffic coming. But I caught up to him a couple of intersections later. I didn’t think there was anything to say, he was acting as I would expect a cyclist to act but it was the same guy who gave me an earful in the morning! Want a hypocritical bastard.

I wasn’t in the mood for confrontation (I rarely am) so I just said g’day, and rode on my way. I hope he felt like a tool, because it must have been fairly obvious I’d seen him run the light.

I thought originally his should proposition was that we should all obey road rules. But by evening, it looked like his should proposition is that we should look after our personal safety before road rules, but make sure everyone else is doing the 'right thing'.

But it brings me to my point about should. Where does the authority to should someone come from? Most of the greenies get their best information from the hippie papers, and unwashed websites, and very few would understand an academic journal should they ever learn how to find one. A loose translation of should is “let me tell you how to behave” – but that wouldn’t go down so well.

But the real problem is that the ‘should-ers’ generally have the best intentions. They genuinely believe what they say, and that they are on some kind of mission to rescue the world from the ‘unshould’; those who independently determine their behaviour.

I should resolve never to should anyone again. My wife would appreciate that.

Close the Gap

I’ve wanted to write about the Federal Government’s Close the Gap campaign for quite a while. But I am going to use this opportunity to raise a much bigger issue that underpins the campaign, and other calls for equality, such as women’s salaries, gay rights, and racial equality to name a few. That issue is fairness.

When I hear of calls for equality, I always ask, why would you expect equality? I never hear calls for more white guys in basketball or more black guys in swimming. I never hear cries of outrage when women in sport never seem to make the speeds, heights, of distances of the men; or even fury over gay fellows being far more fashionable than the rest of us straight guys. It is just plain UNFAIR!

So why do we suddenly decide that equal outcomes are important when it comes to other things?

For a start, we can only observe outcomes, not opportunities. What most of use really want are equal opportunities. But how can we know? When we look at nationwide data we can’t know how many women chose to work less, chose not to continue their education, or chose to do more housework?

Let’s take a closer look at the Close the Gap campaign. For starters, why would we expect life expectancy of a single race, to be the same as the average life expectancy of all other race in our society combined? And what about mixed race people? Are they an average of the racial heritage in their bloodline?

I’m pretty sure the data is out there for a real comparison which would isolate race from a number of other factors that are likely to have a large impact on life expectancy, such as alcohol and tobacco consumption, hours of exercise per week, occupation, family history of illness, location and so on. Somehow my instinct tells me that it’s highly unlikely that after all these factors are considered, that race has any impact on life expectancy.

“Why, but of course not!”

That’s the response I would expect from Close the Gap advocates.

“Of course it’s not race exactly that is the cause of shorter life expectancies (because if it is, there’s not much anyone can do about it), it’s all those other factors that are more prevalent amongst Aboriginal people.”

So? They also prevail to varying degrees in people from all races. This campaign is ONLY about improving conditions for Aboriginal people. Closing the gap gets a lot more difficult if you are helping the other races as well. How is that fair? If we were really to be fair we would ignore race altogether. Not one single policy should require the identification of race. Our new campaign would be called Let's Live Longer, but I don't think it would appeal to our emotions so much.

But when it comes to government social programs, fairness appears all the rage. Those people who oppose markets in human organs probably epitomise misdirected notions of fairness. They imagine for example, that a world in which kidneys must be donated, and where 1,000 people (these are arbitrary figures) die each year awaiting a donor organ, is better that a world where kidneys are bought from willing donors and where only 100 people die waiting for a kidney - based on the notion of fairness. They cry that rich people will have an advantage over poor people for access to kidneys. True. But that's no different from the markets for food, clothing or housing. The point is that donors will be able to accept rewards, thus encouraging donations. And every extra kidney will go to someone, rich or poor. The fair scenario in this case treats people differently, while the unfair case treats them all the same. It's the kind of backward logic that bugs me all too often.

But before I move on from the racist livespan campaign and unfair view of life saving surgery, I will reiterate that we can still only observe outcomes, not opportunities. If more Aboriginal people choose to live in shanty towns in the desert, choose not to seek medical attention, choose to abuse alcohol and smoke like a chimney, than who are we to intervene?

My gut instinct tells me that the remote location of many Aboriginal people is a key factor, which itself captures level education, access to health services, diet, exercise, and probably drug abuse. But does that mean that we should supply all the modern services available in the big smoke at every little tin-pot shanty town in the desert? No way.

Anyway, that’s enough about very popular but completely racist campaign; on to the ever-popular issue of equal pay for women. Again, we have an opportunity vs outcome problem here. Did you know that tall people earn more on average as well? I want equal pay for short people!

I won’t continue. I feel frustrated by the absurdity.

Health costs revisited

In July 2008 I wrote how preventative health care, such as screening and early treatments, actually increase the total cost to society for medical treatments.

Now, there is some more evidence in my corner. The US Congressional Budget Office is now on my side, with plenty of research to support the claim that preventative medicine adds cost to the health care system, rather than reducing costs.

Who would have thought that my original ideas (I had not read any of the studies that this letter refers to) would reflect reality!

I stated it like this:

What has happened is that improvements in medical treatments have enabled us to live longer lives, and because of much of the preventative treatments, we die less suddenly then ever, increasing these 'death postponing' medical costs. Because we can diagnose more problems, we can visit doctors more readily, and we treat more medical conditions then ever. Thus, it is because of the very efficiency and effectiveness of medical technology that our demand for it has grown, both during our lives, and in our ‘prolonged death’.

And the CBO summarise one study like this:

The researchers found that those steps would substantially reduce the projected number of heart attacks and strokes that occurred but would also increase total spending on medical care because the ultimate savings would offset only about 10 percent of the costs of the preventive services, on average.

Remember, we all die. If you prevent someone from having a heart attack, although you may prolong their life, they will die from something else, and most likely, they will need further medical treatment for that ailment.

And now the economics blogosphere has picked it up here.

Predictions

We all know that predicting is very difficult, especially about the future. Google tells my I should attribute that saying to the Danish physicist Neils Bohr, who won the Nobel Prize for physics in 1922, but I’m sure even he borrowed if from someone, because we are all in essence simply human prediction machines.

For the speculators out there, here are mine:

1.Oil will rise again. Maybe we’ll get to $200/barrel this time. Other raw materials will follow the boom.

2.We will have another crash in prices – shares, commodities, and possibly housing will come along for the ride this time.

3.People will point the finger in all directions except to the finite oil supply. Only the lone fighter on this blog will point out that we are in an adjustment period where we are going to have the change the way we do many things. But we will adapt, and we will look back at all the scaremongering and wonder why anyone thought it would be a difficult transition.

4.They say it’s all in the timing, but I am least confident about this point. The next crash will happen after Sept 2010, but before Dec 2012.

5.The crash is unlikely to be as sudden next time, although I wouldn’t rule out a surprisingly fast price free fall. I would expect some more restrained reactions by market actors after the 08/09 experience.

6.There is money to make in the next 12 months, but it might be wise to take profits when you can, phasing down exposure to financial stocks and commodities late next year.

7.For Capricorns, next year is a good time to focus on love, but also to gain control of your finances.

All but number 7 I reckon have merit. I just want to post this now so that if I am proven correct, I take credit for having amazing insight. If my predictions prove wrong, I’ll find reasons why and try and pass the blame. Although number 7 is a certainty!

Aussie husbands fair – not world’s worst

Many things piss me off. One of them is when the media misinterprets technical material, be it scientific, legal, economic or anything else they can find that appears to have a populist twist.

I recommend for those who hate scientific research being totally abused by the media to pay attention to Ben Goldacre’s blog here.

For those who hate it when the media tells of a British economist who finds that Aussie blokes are the worst husbands, please read on.

Within a day of what I suspect was an innocent media release, I could google aussie bloke worst husband and get 107,000 hits. Most news sites, including all the major Aussie TV networks, and print newspaper sites, even local papers, had their articles flashing on their front page, but with 90% of the article text in common.

The same research was also used to claim that Amercians make the best husbands. I am now waiting for a Today Tonight special on the secret lives of Aussie husbands!

I will bet my house on the fact that not a single reporter read the original research paper, and if they did, had no clue what it meant. If you read it, you will see that it is a dense and technical document. That's apparently an excuse not to fact check in news reporting these days. A simple email to any university economics department in the country would have resulted in a good analysis of the findings, and some interesting broader social implications. I know a number of professors who love that kind of thing.

So, what did the now infamous paper actually find? Let me use Sanz’s own words:
Empirical results support the predictions of a house-hold formation model where less egalitarian social norms decrease the supply of men in the household market by increasing a man's cost of providing household labor. Both men and women living in more egalitarian countries have, everything else equal, a higher probability of forming a household. Furthermore, consistent with the theory, individual attitudes run opposite to social norms for the case of women. Whereas ceteris paribus a more egalitarian woman has a lower probability of forming a household, a woman living in a more egalitarian country has, everything else equal, a higher probability of forming a household.

To translate:
1. Societies with a culture of egalitarianism (equality) have higher rates of cohabitation or marriage, than less egalitarian societies.
2. The more egalitarian a women, the lower her chance of finding a mate
3. The more egalitarian a man, the higher his chance of coupling up.

What we don’t know is who is the best or worst husband. There is no difference between married and cohabitating males in the survey data, so that claim of relevance to marriage is bunkum.

But we do finally find details on housework, from a survey conducted in 1994 and 2002. Australian respondents (both men and women) stated that women always or usually do the laundry, cooking and shopping, 74%, 66%, and 60% of the time respectively. That seems reasonable to me for a society wide average, when you consider the average man’s ability to shop or cook! And it’s a lot better than Japan, where women apparently do laundry, cooking and shopping 94%, 94% and 80% of the time!

If we weight these chores equally into a housework index, we find Australia is actually 8th out of the 12 countries in the survey. The European countries only beat us because their men do more shopping! And surprisingly (because it makes at least one media report appear legitimate), US men do the most housework when measured this way!

The main results of the study should not surprise anyone. A man finds a woman more attractive when he believes she will contribute more to the household, while a woman finds a man more attractive when she thinks he will contribute more to the household. But is that news? At least the lucky author now has some attention on their work.

UPDATE
Another 24hours of media circulation brings the Google hits up to 1,310,000 for the phrase aussie husband worst. Still the only website that actually reports what the original research actually reveals is this one.

It was also a topic of discussion in '7pm', the new chat show on channel Ten, last night. Must be a slow news day!

Random and poorly linked observations

Can Generation Y, those twenty-somethings often labelled by baby-boomers as bludgers who had everything dished out to them, actually take credit for the ‘soft-landing’ of the current recession (can we call it that yet)?

I say this after a weekend catching up with friends. Some had been involuntarily retired from their previous jobs, but being tech savvy, were on the books for temp work within hours, and within days had started new jobs. That friction economists love to talk about when discussing unemployment seems non-existent. So my friends continued to earn and spend just as they had before. I wonder if those older generations (whatever you want to call them) would adjust so quickly.

And what of the healthcare system? Are we stuck with a baby-boomer health system in a Gen Y world?

Recent debates have been streaming in from both Australia and the US about reforming the ‘health care system’. It makes me wonder two things that are rarely discussed:

1. What exactly is the boundary of the system?
2. Wouldn’t a system designed to prevent death always seem to be poorly performing?

There have been great comments from the blogosphere about US health reform. In particular, the fact that much health care actually resides outside ‘the system’ – panadol, vitamins (if you believe they actually have health benefits), bandages, etc – you know, stuff a pharmacy sells. If we had concerns about the widespread, affordable supply of these goods, what we we do about the 'allied health system'.

I think what is clear is that while regulation of quality, labelling, etc. is important, regulation of the distribution of services may be overstepping the mark and lead to poor services.

If you want my opinion, there is nothing wrong with healthcare in this country as far as I can see. We have the option of private health cover, and are penalised for not taking it up if our incomes are particularly high. If we don’t have private cover we should expect a baseline of care and nothing more. Even then, the poor are still looked after. Many of you wouldn’t know this, but you can get a doctor to visit you at home, 24 hours a day, and bulk bill. We’ve used this service a couple of times. To me this is medical utopia!

So, since we’ve now solved the ‘health crisis’ by revealing that, in fact, there is no crisis, we can move on other things. Like child care.

Why is it that government feels the need to subsidise the costs of child care? I took my young son for the first time to child care yesterday and for $50 you can have him looked after and fed for 10 hours. But with the child care subsidies, it works out more like $20! So, when weighing up the alternatives of my wife staying home to look after our son, my mother looking after him, and child care, it gives a huge advantage to the latter. Should I be king for a day, this is one of many subsidies I would scrap that appears to be encouraging fragmented families, and the culture of children being raised by ‘the system’.

Finally, I would like to announce that today 29th July 2009 is the official 1st January 2000 of climate change. That date represents the date that we all realised that the millennium bug, Y2K, was actually just symbol of repressed fears being expressed en masse. I feel that climate change is simply an outlet for our caring side in the apparently uncaring world we live in. While I have spent the past few years examining the mechanisms for action to reduce GHG emissions, I am coming to the conclusion that there are many other immediate problems that should be the focus of attention.

A departing thought (from here):

NYTM: Have you ever seen “American Idol”?

Arlo Guthrie: No, I have never watched it. But I’m thankful we’re living in a world where we can actually afford to waste your time. What a great thing that is.

Until next time.

Complexity

It's been a long time between discussions on this blog- probably because I am yet to have any unique insights worthy of internet fame since my last post. Instead, I'll direct your attention to the website of Michael Crichton, deceased author, writer of Jurrasic Park and other such things. After spending hours reading his essays and speeches on the website, I feel he must have been a very insightful man, and worthy of mention on this blog. A must read is his speech on complexity.

Solar island challenge

The debate about the environmental benefits of solar power is not dead. This short story is intended to raise serious issues about how we can evaluate the environmental degradation attributable to any choice of technological alternatives.

There are two identical islands, untouched my humans. As part of a real life experiment a group of participants is sent to each island and given the following instructions:

You are to produce 1,000kWh of 240v AC power and send it along a copper wire provided at each island. This wire leads to a remote sensing facility where your electricity output will be measured.
You must generate this electricity with the minimum environmental disturbance.
Your island does not produce any other goods, so all resource use will be attributed to the electricity you generate.

The first group, the ‘Nasties’, agreed that using coal to fire turbines, which would in turn drive a shaft through some coiled copper wiring, would be the simplest and quickest way to go.

The other group, the ‘Greenies’, decided that love child of the green movement, solar electricity from photovoltaic panels, was the obvious way to go.

Neither group faced any knowledge barriers. Each group was full of technical experts who understood all the aspects of metallurgy, pottery, mining, engineering, even agriculture and plant breeding.

They both began their plans in earnest while their impact on the environment was observed via satellite from a remote location.

Both groups need to first establish a reliable water supply, build some shelter, search for edible plants that could be farmed, and manufacture some tools. By the end of the first week, both islands saw a striking transformation in a protected cove as the groups built shelter, cleared land, gather food, planted seeds, and diverted springs. Both groups were confident they would use the least resources on the electricity challenge.

Once water, food and shelter were reliably established, the next major step was to manufacture tools. The island was not short of rich metal ores, and each group began building clay furnaces to extract the metals, which would be used for both tools and later for their own choice of electricity generation.

A few months on, and both islands are occupied by a happy, productive workforce. Each individual member is spending every waking moment contributing to the electricity project. There is no such thing as recreation!

Kilns have been running for some time, and tools have been cast from the metals, such as axe, shovel and pick heads, which are now being used to by the ‘Nasties’ to mine coal. The Nasties feel close to the end of their project. Once they have extracted some more copper for wires, some steel for building pressure vessels and shafts, they will see victory!

The Greenies across the ocean are facing some tough decisions. While they can make fairly impure metals with their furnace, they must be further refined if they are to become part of a photovoltaic panel. Also, the group realises they need a low impact way of growing pure crystal silicon blocks that can be later sawed into wafer thin pieces if they are going to finish their project soon.

The Nasties have cast their pressure vessel, with intake and outlet holes. They have filled the vessel with water, and have joined the inlet and outtake with a long cooling tube. The strands of copper that were roughly beaten and rolled into wire have been built to a crude alternator on the shaft that leads out of the turbine, which itself is a rudimentary contraption on the side of the pressure vessel.

As the winter approaches, the pattern of habitation on the two islands is clearly diverging. The Nasties have a simple network of tracks between their protected domestic dwellings on the lee side of the island, and the coal and ore reserves to the east. A small area of land that was cleared during their first week was yielding native crops that were feeding the group. They have a built their makeshift powerstation just metres from the exposed copper wire that disappears through thick plastic tubing into the ocean. A steady stream of workers brings more coal and ore and they realise that quality of their metals needs to be improved, before the turbine will generate power.

But the Nasties are confident. They had generated some power. A boat had arrived that brought a multimeter so that they could refine their generator to produce the required electricity. After current was detected on the wire, and the device was sent to both islands to assist in the final refinement.

The Greenies thought the delivery of such a device was a little premature. They had been trying to use as little coal as possible, but soon realised that to generate the 2000 degrees Celsius necessary to extract silicon from sand, which is much higher than they need to extract the metals, they would need lots more coal, and a better insulated furnace.

The pattern of habitation on the Greenies island grew rapidly around their original settlement. They were in a period of growth, expanding their abilities to extract metal, and silicon, and expanding their mining to include sand. They worked hard both physically, and intellectually, with their greatest minds devoted to establishing more efficient methods of silicon extraction and growing.

It was exactly 10 months after their first footsteps on the island that the Nasties had met their electricity generating goal. Another boat arrived this time to collect them and observe the environmental conditions on the island. While there was obvious disturbance around the settlement, and cleared tracks leading to ore deposits, as well as smaller tracks that were used when foraging for wild food, most of the island remained untouched. The observers estimated the total consumption of timber, coal, and mineral ores by the Nasties.

We will stop the story there. The point here is that we would need such an experiment if we were ever to really know the environmental impact attributable to single consumption decision. My gut feeling is that the Nasties would have an easy time of outdoing the Greenies at their own game.

Of course, there are plenty of issues with the design of this type of experiment in the first place - what's the major one?

The joys of politics

I recently wrote about the theoretical arguments surrounding fiscal stimulus by governments (here). Anna Bligh in her election campaign promised to 'create' 100,000 jobs in her next term. We know that these actions and promises are all rubbish, so why to we accept it? Why not vote for the guy who is reasonable? Or is it that reasonable people avoid politics and we have to vote for the best of the worst.

I want to bring your attention to comments by economics super-professor Greg Mankiw about the US stimulus bill. Apparently the US government has promised to monitor the effects of the bill and report periodically on the number of jobs created.

It is an absolute mystery as to what these guys will actually do. My cynical side might suggest they will simply pluck numbers from the air. Then possibly vote on what number would by not too high, not too low, but just right, as far as the public perception of their validity goes. They may even dabble in economic tricks.

These are the joys of politics.

Political renovation rescue

Economists are often deluded into believing that their years of diligent research into how government intervention can maximise the wellbeing of the populous may one day result in tangible gains to wellbeing. I must apologise. I am about to shatter the one way mirror currently shielding economists from reality.

A workable economic theory, once in the hands of a politician of any significance, stature, or importance, from local councillors to world leaders, will be utilised as a weapon for vote winning amongst a well studied, segregated and predictable bunch of right-wing, left-wing, religious, environmentalist voters who are easily convinced that ‘full of shit’ equates to knowledgeable and caring.

Let me take a Channel 9 reality TV analogy further than it should ever be taken. Imagine your lovable host Damie Jurie is wearing a toolbelt, complete with hammer and tape measure, talking the talk about fixing trusses to A-frames using through-bolts and nail-plates. The public immediately thinks he actually knows how to use those tools on his belt, and when he does so, we would trust that he does it right.

But if the tool is actually cost-benefit analysis, and the Damie Jurie is actually your favourite rhyming Prime Minister, Treasurer, Mayor, Premier, or any such figure, when they apply the economic tool that they are so fond of, the public has no expertise with which to criticise its application. If we saw Jurie using a hammer to drive in a screw we would be alarmed, question his intelligence as well as his sexuality, and change the channel, if not before we have circulated a series of new Damie Jurie jokes by email. But our politicians can get away with nonsensical applications of technical economic tools because we are ignorant about how they are best used - and they know it.

As a public sector economist I have been shocked at the prominent disinterest in economic models that attempt to capture flow-on effects of policy. Politicians like to know the economic benefits of policies to their target group. But if you live across the road from a working family, especially if they are farmers, and worse if they are a vocal minority group, the cost burden you face will be completely ignored in the ‘cost-benefit’ or impact analysis of their proposed policy.

Imagine my surprise when Federal Government documents explaining how to develop a project plan for a water buyback scheme explicitly state the any flow-on effect should be ignored. It may well have said

‘We need to sell this policy to the ignorant public, please use the most confusing economic terminology to make us look like that ever popular Jurie fellow. Please don’t explain how we’re taxing the general public and putting money directly into the pockets of an arbitrarily selected group of vocal farmers. And while you’re at it, make it look like we care about climate change’

Now, that may be a little cynical. Or maybe it’s extremely cynical. But to intentionally ignore these effects makes the whole thing look like a sales pitch. This time it is to the farming communities in the Murray-darling Basin. Who knows who will get the handouts next time (try working mothers), but gee I wish I was a farmer.

How about an example of the distorted analysis expected in the public sector. A recent ABARE report attempted to quantify the loss from a 10% reduction in water available in the Murray-Darling basin. They used an input-output matrix as one tool (that does not consider flow-on effects to any particular degree). They found about a 6% reduction in total production from the MDB region as a whole. But when using a CGE model (which iterates flow-on effects until a new equilibrium is met) they found that national production decreased a mere 0.04%! Given there are no statistical tests on this outputs of this model one has to wonder whether that is actually distinguishable from zero, or whether it is just a rounding error!

This rant has left me no closer to changing the world for the better. I comfort myself knowing that our political system is the best of the worst. We live in an imperfect world, and this type of vote manipulation, pork barrelling and bribery is a small price to pay for the freedoms we take for granted. I also think about the automatic stabiliser inherent in government, knowing that my salary is an important component of containing the excessive fluctuations of markets, and then give myself a pat on the back for being a great stabiliser!

But at least I feel better for getting it all out of my system. I’m off to buy a farm. Can you help me build a shed Damie?

Randomness, risk and uncertainty: How do we know what we don’t know?

Being a habitual sceptic (and an economist), the insights offered by Nassim Nicholas Taleb in The Black Swan have struck a chord. I have never found a receptive audience in academia for my dislike of the assumptions of the characteristics of randomness that determine the probability density function (amongst other assumptions) in most statistical analysis – especially in social phenomenon. But finally I have a wing man.

The general attitude I face is that if we don’t make these (sometime radical) assumptions, we can’t do any analysis of the data, and draw any conclusions. My response is; what use are conclusions based on flawed assumptions?

The book poses the challenge to think rationally about probabilities, and the impact of improbable events. In particular, Taleb challenges us to acknowledge the limits of knowledge. Real risks and randomness come from the unknown unknowns.

He uses an example of casino to explain the difference between known risks that occur in a world he calls mediocrastan, and the wild unknowns and events from the world of extremistan. The mediocristan risks are those involving the gambling itself. Each individual bet has a risk that is essentially Gaussian, so with a large number of bets taking place, and limits on the size of each bet, these risks are eliminated.

Taleb suggests that most of our concerns about risk, and the high impacts of improbable events, are from the world of extremistan, where complex systems result in variations at all scales. The point is that in extremistan, large variations and extreme events WILL HAPPEN, and much more often than we think. Such large complex systems include financial markets, the global economy, and the climate.

While attending a statistical conference at a Las Vegas casino, Taleb discovered that the four largest losses incurred by the casino did not involve the gambling itself (whether cheating or otherwise). The first was when a tiger performing in a stage act maimed one of the performers. The next was when a disgruntled contractor who became injured on job threatened to blow up the casino with dynamite because he was insulted by the settlement offered. The third was when an employee failed to mail paperwork to the Internal Revenue Service for a number of years, which ended in a monstrous fine. And finally, the casino owner’s daughter was kidnapped and held ransom, which forced the owner to dip into casino funds.

These events are Black Swans. Unpredictable, outside the scope of expectations, and have massive consequences.

He makes a number of interesting points that I want to share. These are particularly relevant in current environmental debates. For example, where I work we try to estimate the environmental impacts from changes to stream flow in rivers. The number of assumptions in unbelievable, and any output from this type of modelling has to be taken with a grain of salt. It is merely some background information that either confirms or challenges the experiences on the ground. When I write about the economic impacts of changing water regimes I repeatedly make the point of acknowledging the unknowns and the limitations of my analysis. Can you imagine the complexity of climate models, and the staggering number of assumption built into them? One wonders whether climate scientists understand statistics at all.

The first point of interest may be familiar for those who are statistically inclined. It is the statistical regress argument and it is a cause for concern. It goes as follows:

Say you need past data to discover whether the probability distribution is Gaussian, fractal, or something else. You will need to establish whether you have enough data to back up your claim. How do we know when we have enough data? From the distribution – a distribution tells you whether you have enough data to “build confidence” about what you are inferring. If it is a Gaussian bell curve, then a few points will suffice. And how do you know if the distribution is Gaussian? Well, from the data. So we need the data to tells us what the probability distribution is, and a probability distribution to tell us how much data we need. This causes a severe regress argument.

Given that our data samples for global temperatures are extremely limited, climate scientists face this problem at the outset.

Another interesting point is how the nature of Black Swan events, and the resulting silent evidence distort our interpretation of history. Any act that aims to prevent a Black Swan event goes unnoticed because its success can never be observed. Imagine there is a bureaucrat who decides to implement aviation rules in August 2001 that would have prevented the September 11 events in New York. We could never judge the success of these measures in preventing terrorist attacks, and the bureaucrat would never gained any credit for the measures. Possibly, due to the complexity, cost and frustration of travellers, he would have had to overturn the rules in 2002. He would be labelled as someone whose best skill is to waste time and money. Learning from history is very, very distorted due to silent evidence. I can imagine in the not too distant future that the history book will explain how we should have seen an event like September 11 coming, due to such things as ‘rising tensions between terrorist groups and the US’, but they would simply be wrong. The crashing planes were the sign of rising tension!

Another great insight is the problem of induction. He uses an analogy of a melting ice cube. If we know the shape of the ice-cube, we can fairly well predict the size of the puddle of water when it melts. But, if we have the puddle of water as our source of information, there is not much we can say about the shape of the ice-cube. In economics we constantly go about measuring puddles of water, and through flawed statistics, try and make outrageous claims about the shape of the ice-cube. The herd mentality of the global economics profession and media seem to have induced that overzealous lending in a few sub-prime locations in the US has led the whole world into a massive recession. My question is, the given how many other more significant events were happening around the globe during this time, how can anyone be so sure of that the ice-cube was shaped like a few bad loans, and not like a oil shock? Or why was the cause not simply a unique combination of unforeseeable events? This same question can be applied to climate change. If we agree that the climate is changing (which itself is questionable due to the previous two reasons), how can we isolate a single cause in a complex system?

I will stop now because I don’t really think I can do justice to the ideas of Taleb and his philosophical predecessors here. I just want to reiterate that we know a lot less than we think we know.

My main concern is that for someone who preaches a precautionary approach to making claims of knowledge, Taleb is a devoutly religious man who has used arguments such as ‘religion has not killed so many people as the concept of the nation state’. So, if religion is the root cause of, say, 10 million premature deaths, while fighting for or defending a nation state (which coincidently have often been religious states) has killed, say, 20million people prematurely, does this mean that religion is good for society? Taking this argument elsewhere and we get such things as ‘murder kills 100 people annually, but motor vehicle accidents kill 300 people’. For a guy who we are meant to believe has a solid grasp of logic, reason, argument, and science, this seems a rather appalling justification for his beliefs. But of course, nobody is perfect, and we need to judge each argument on its merits.

Tagcrowd - heard of it?

I recently ran across a very interesting website called Tagcrowd. It counts word frequency in text and presents a neat cloud of words that provides a good visual summary. I did it with my whole blog and got the following result. Seems to sum it up nicely.

Can governments be more innovative than private enterprise?

I have had some interesting thoughts lately regarding the trends towards the privatisation of infrastructure and the user pays principle which underpins this trend. My theory suggests that private infrastructure based on user pays principles locks society into a particular path of development which becomes increasingly self-reinforcing, thus excluding innovative solutions to transport, communications, energy and water supply.

Let me explain in more detail.

Consider two countries, A and B. Previous governments of country A have spent the past century investing heavily in a rail network for both passengers and freight, while country B has spent the past century ignoring rail and building roads as the major land transport system.

Now imagine that a technology, X, is developed that can massively increase the efficiency of rail transport, but not road transport. Think along the lines of mag-lev trains or some such thing.

Now both country A and B believe that this technology is superior to their current land transport system and aim to develop a network based on private investment. Country A already has the land, the stations, and the infrastructure in place, while country B has none of it. One would expect that the compared with country B, country A is more likely to find potential private investment for such a project given the likely lower costs but equal benefits.

Thus due to historical capital investment, country A continues along a rail based path towards the most efficient outcome available with technology X, while country B continues along a road based path and will never reach technology X through private investment alone and will remain 'stuck' with a less efficient land transport network. This is the problem of path dependence, a situation encountered in both evolutionary theory and economics –“the cheapest manufacturing method may not be achievable by “evolutionary steps” but may require a complete change in method”.

The question then arises that if country B is ‘stuck’ on a more costly trajectory of land transport development, how does it become ‘unstuck’. This is where I believe governments can intervene to make the decision to become unstuck by directing investment into the superior new infrastructure. Rather than the user pays principle of privatisation, the government can justify funding such scheme due to benefits to the user, but also benefits to non-users in society.

For example, if a rail line is established along a popular road corridor, both the rail users and the road users benefit - the rail users from cheaper transportation, and the road users from less congestion. Unless a private enterprise can charge the road users for the rail line, a publicly funded outcome is far superior.

The inability for private infrastructure owners to capture external benefits limits their opportunity to innovate and provide broad social benefits.

Governments on the other hand can consider all external benefits and consciously ‘invest’ a region out of their current development trajectory on the basis of providing indirect social benefits.

The problem then is getting a government to even perceive these potential social benefits, let alone act on them.

The other problem is that if governments do ‘invest’ a region out a of a particular development path, they are now stuck in the new path, unless they invest heavily once again. For example, Brisbane ditched trams back in the 1960s, and successive governments ever since have been considering getting them back. But each change in trajectory is more expensive than the last.

So what then should a government do to maximise social welfare? Should they just stick to the path they are on and hope that future technologies are advantageous, or should they embrace innovation and change the development path?

On Andrew Bolt

I must say that until recently I have had little exposure to the writings of Andrew Bolt. A short snippet of him on telly once seemed to highlight for me that this guy was a headline grabbing voice of the extreme ‘right-wing’ (whatever that is anyway) political agenda. However in the past few days I have been reading his blog, and now finally have read his book Still not sorry. And I must say, although he can fall into the trap of making illogical assertions, just as can the left on many occasions, he writes quite a bit of commonsense that seems to raise much less publicity. His book provides snippets of his basic opinion on particular issues, so let me please take the time to highlight this commonsense on various issues.

1. Australia is divided into the ‘elites’ who get much of the air time, and whose opinions are out of step with the average Aussie. The elites believe that people need such things as racial sensitivity training, and as a group give a disproportionately loud voice to left wing agendas. The majority of us think things are pretty good and we just like to get on with enjoying life.

I must say that the more exposure I’m having to many academic and intellectual types trying to make a difference to policy, the more I am beginning to see the total disconnection with reality of many of these said ‘intellectuals’.

2. Australia is a great country, and we shouldn’t sacrifice our fundamental freedoms and opportunities for fringe issues of minority interest groups.

Many of the problems we face in Australia today are, in comparison to the rest of the world and to recent history, very trivial. Economic research is a good guide. These days economists can theorise about happiness coefficients, gender implications of armed conflict. If there were real issues to tackle, economists would not get sidetracked like this. Compared to historical standards we are living in a utopia. The message from Andrew Bolt is that we should get some perspective and be thankful for the opportunities provided to us in our society.

3. Racism is not the issue it is made out to be, and we could do much better if we didn’t promote policy based on race, gender or any other ‘ist’ feature.

Along these lines, there has been further frustration for me this week. The Wild Rivers Act allows the government to protect the natural flow of waters courses if they meet certain criteria for being natural environments. No problems there, it is the type of policy I think delivers tangible benefits. But Indigenous leader Noel Pearson had now started complaining that the legislation will lock up land from development, taking away opportunities for local indigenous communities. But most indigenous groups surveyed by the department found widespread support. So what is the real opinion of indigenous people in the Cape?

I think our mistake here is to segregate people by race. Can’t they just be two opinions of groups in the Cape? Why should race imply a set opinion about a policy?

In France it has been illegal for quite some time to classify people by race. The government does not even collect statistics about racial identity (since gathering that data is illegal). This, I believe, should be the target for us. If we can’t classify people by race, we can’t write racist policies.

The French elite are typical targets of Bolts critique. They say such things as, ‘Every time we want to study the divisions of society we are accused of dividing society’. That is exactly the point.

Bolt also stole my idea about irrational women in positions of power – about 7 years before I had it! I have recently attended a workshop with Australian academics and experts on environmental economic assessment, and was shocked at the illogical and often conflicting theories that underpin sociology – a discipline, that from my experience, is populated with highly ‘educated’ middle aged women who believe in astrology and alternative medicine. Are these ‘elites’ the people we want advising our decision makers?

4. Help people help themselves.

Bolt also repeatedly claims that handouts are not long term solutions to poverty. There is nothing controversial here. While we as a society have decided that in times of need people who cannot support themselves will be supported by the rest of us, no one believes that this support CAUSES, or provides incentives to, those who are provided with it to begin to look after themselves again. Economists know that such support inadvertently provides incentives to not return to work. So why should we continue to throw good money after bad in supporting communities such as Palm Island?

Where Bolt gets himself into strife is when he allows himself to effortlessly drop his evidence-based critical line of argument and get down in the gutter, spruiking pro-Howard pro-liberal rhetoric, when there are obvious flaws in both Green and LIberal sides of the argument. He lets fly with ‘facts’ without citations, which actually quite bugs me, as it is easy enough to find ‘reliable’ evidence both ways in the world of grey that is politics.

What does it mean to 'save a life'?

I have been reading some great articles about poor science journalism, and gross misrepresentation of the facts. These articles got me thinking about what it actually means when a new drug, vaccine, surgery, or other medical intervention has the possibility of ‘saving thousands of lives’. What exactly does the phrase ‘save a life’ mean?

My starting point for this analysis is that everyone dies. Therefore, we cannot save someone from death; at best we can postpone death – from being the direct result of condition X, to being the result of some unknown future event.

The question is further complicated if we consider the flow on effects from death. For example, a child (A) may die from disease X, but the flow on effect from this one death is the birth of another child (B) by the couple, who would not have chosen not to have that child (B), had the first child (A) not died young.

So here we have a theoretical conundrum. In the previous case if child A had be ‘saved’ by a new drug or surgery, child B would never had been born. Imagine then comparing two hypothetical scenarios:

Scenario 1 -
Child A is ‘saved’ by a new drug or surgery.
Child B is never born
Child A lives until the age of 60.

Scenario 2 –
Child A is not saved and dies
Child B is born
Child B lives until the age of 90

If we consider a year of life to have an equal value amongst all individuals, we can say that Scenario 2 provides more life. The net effect of the drug/surgery is to postpone the death of Child A by, say 55 years, and eliminate the chance of Child B being born. Scenario 1 provides 35 years less combined life years than Scenario 2.

In a more general sense, do we need some death to create life?

Another hypothetical can let us examine this question. Imagine a new drug is invented that, for example, promotes tissue repair, and the life expectancy of the population rises dramatically over just a few years. Does this prolonged life of existing generations come at the expense of future generations? If the birth rate did not slow as a reaction to this, population growth would also see a dramatic spike in population growth.

We can think about the ambiguity of ‘save a life’ more when we consider treatments for the elderly. If a drug cures one life threatening disease in an 80 year old, and they die a year later from a different disease, did the drug still ‘save a life’? Again, I would say that we can just postpone death. In this case, the drug postponed death by one year.

But if the same drug could be used on a child, it may postpone death by quite a number of years. Does it then ‘save a life’?

Economists know that a very large chunk of government health expenditure goes to treatments in the last 30 days of someone’s life. All we can derive from this is that we are getting some very poor ‘life returns’ on our health investments. It is a much better investment in terms of ‘life returns’ to fund medical care for the young.

I guess my point is that if we don’t think about saving lives, but rather about postponing death, we get a much better perspective on the effectiveness, and usefulness of various medical claims. We also need to consider that postponing death is not inherently a good thing for society as a whole, although it often is for the individual person whose life is prolonged. I hope anti-abortion and anti-euthanasia activists can think deeply about these issues before launching their next hysterical propaganda campaign.