Why can’t Africa get its shit together? That’s a question I’ve had for a while. Economically many of it’s countries rank near the bottom of the scale. I don’t subscribe to the racist notion that Africans genetically are predisposed to this. It’s certainly possible that there’s a cultural reason for it, much like the U.S. has been culturally prone to electing jingo-istic right-wing politicians for the last half century. For instance, because of tribal differences, it’s difficult for an African country to agree on a political system. Though India made many inroads to solving that problem. But it’s certainly possible it’s behind Africa’s problems.

Is racism a factor? Yes. Centuries of slave raids and colonialism doesn’t leave Africa in a good position. But it doesn’t explain everything. India, China, Latin America, and other places have been subject to racism as well, and they are doing better than Africa. Perhaps less racism, or less enduring, however. Haiti, populated by African descendants, also sits near the bottom of most economic rankings. I do think European and American racism works in somewhat of a ranked fashion, so I’m sure it plays a part.

More likely there’s a big economic reason. Economics posits that people choose an option that makes the optimum allocation of resources for themselves. Of course, over the decades the profession has discovered lots of exceptions to that rule, but the general rule explains a lot of human behavior.

One economic explanation for Africa’s chronic problems is that being resource rich is a war and corruption magnet, and so saddles Africa with the likes of Mobuto Sese Seko and Samuel Doe. These despots steal the bulk of the money and leave their citizens in a worse position than ever. But Africa is not homogeneously resource rich, so there’s still something missing from the equation.

Another possible economic reason is the lack of the rule of law and functioning government prevents economic development. While certainly true, Africa has had 60 years to develop these systems. Failure to develop them is more likely a symptom though. Asia has done it. South America has too. So what’s the underlying economic reason?

Dambisa Moyo proposes in Dead Aid that the underlying economic reason is the abundance of unaccountable international aid is the key to Africa’s failure. She’s a Harvard and Oxford educated economist who’s worked on African issues for the World Bank and Goldman Sachs. She’s Zambian by birth as well, which I’m sure is a major reason why her critique of aid has gotten some traction where others have failed to get notice for similar criticisms.

Her argument says that aid works like easy resources, giving corrupt governments and businesses the opportunity and reason to steal the money, and crowds out other sources of economic growth as well. In other words, the developed world doesn’t make anyone truly accountable for the money, so of course it’s taken. To have aid work, at a minimum either we’d need to run the aid ourselves, or we have to have anti-corruption conditions and the spigot turned off when they aren’t met. Moyo doesn’t think the former is a good idea (paternalistic, among other things) and the latter isn’t credible.

In other words, not only is aid not helping, it’s actually the cause of Africa’s economic problems. I don’t know how to evaluate the claim. Aid certainly hasn’t moved Africa on a par with other regions. But it could be ameliorating a real underlying cause. Economics doesn’t often allow for controlled experiments that would solve that confusion. Aid certainly hasn’t all gone to waste, either.

Moyo proposes four alternative sources of financing for development. First, international bonds. Second, foreign direct investment. Third, international trade. And fourth, micro-loans, remittances, and other banking improvements tailored for the poor. If, in fact, aid is the underlying cause of Africa’s problems, these might have some hope of changing the game. But I am skeptical. First, that these methods won’t have the same problems that aid does. And second, that they don’t have their own problems. And lastly, even if they won’t cause the same problems, I see no incentive for the African powerful to switch, if indeed their money-grubbing ways are the mechanism through which aid fails.

International bonds would work according to Moyo because lenders wouldn’t lend money in a second round if they didn’t get their funds repaid in a first round. Aid continues to be sent even if earlier rounds are squandered. This proposal I don’t understand. Here’s why I don’t think it would work. A bond issue gets stolen by a corrupt leader. No one is willing to issue bonds to the country again, and we are back to the point where we are now: either people starve or we send aid.

Her second proposal is foreign direct investment (F.D.I.). In other words, foreign companies buying shares of projects in African countries. I think this has a better chance of success, but I don’t think it will really make much difference. In order to secure scarce opportunities, these companies will need to kick back to corrupt political leaders. There’s no guarantee that the benefits will accrue to citizens of an African country. Look at Nigeria, where foreign oil companies are causing far more damage environmentally than they are benefiting locals economically. And there’s also the problem of nationalization, where the government, for corrupt or not corrupt reasons, simply takes over a foreign companies ownership. Without strong legal protections, this can happen easily. Without addressing those problems, I don’t see F.D.I. being the driver of economic growth. But it has potential benefits and may be a piece of the solution.

The third proposal is increased international trade. Comparative advantage results in large surpluses than benefit the citizenry. I see this as the best opportunity. However, as Moyo notes, there are many barriers to this. The first world would need to drop punitive tariffs. There’s more incentive for African countries to reduce barriers to each other, but there are more jurisdictions involved and they have much smaller economies. It’ll be a lot of diplomatic work to get that established there, and the benefits aren’t huge for each one. But if first world countries get in the act, it could have a huge effect. If.

Lastly, Moyo pushing banking services for the poor. Micro-loans. Removing barriers to remittances. Forms of deposit accounts geared toward small depositors to get local money moving through the economy instead of being hidden under mattresses. Again, while this has great potential, it has high transaction costs. In other words, since individual deposits and loans are small, it takes a lot of them to make a difference. And that takes a lot of bankers to make it work, who cost money and take time.

Lastly, there’s the problem of making the switch to these new methods. Why would a corrupt leader pick a high cost bond with conditions over low cost aid that he can steal easily? Or give up control in F.D.I. when there’s low cost money in aid? And a non-corrupt government would be taking on a lot of risk to use high cost bonds for projects that don’t result in easy ways to pay them off. The only way the switch can happen is if aid is cut off on the other side. But that would entail an ugly period of transition, and it’s hard to watch people suffer in the mean time and do nothing. Moyo recognizes this to a certain extent. Her book’s intended audience (according to the last chapter) is actually the western world’s public. She thinks the only way to change the aid paradigm is by pressure from the West. Which seems pretty paternalistic to me, and that’s something she criticizes. But aside from that, the limit of our influence would be to cut off aid, if we could do that at all. We have little power with investors who would be needed to set up bonds, F.D.I. or micro-banking.

The short version of all this is I think Moyo might very well be on to something here. She’s not the first to make these proposals and I’m sure there’s some very serious study going on about them. But I don’t think her case is convincing, and definitely not convincing enough to make wholesale changes yet. Yet. I’m a big fan of controlled capitalism and using markets to steer the world to good ends. These very well could work, if someone works out the problems with them. You’ll need far more than a 150 page polemic to convince the people who need convincing.

A few other blogged reviews:

• Africa Can … End Poverty
• State of the Planet
• Zambian Economist
• Amy Reads
• Grumpy the Penguin

Title: Dead Aid: Why Aid Is Not Working and How There Is A Better Way For Africa
Author: Dambisa Moyo
Imprint / publisher: Farrar, Straus and Giroux / Macmillan
Format: Hardcover
Length: 154 p.
Publication date: 2009
ISBN-10: 0-374-13956-3
ISBN-13: 978-0-374-13956-8

There are two ideas in economics that have bothered me for a long time. The first, attributable to Adam Smith, is that an invisible hand guides capitalist markets to a socially optimal solution. The second is that markets, particularly the United States stock market, fully integrate all available information into the price of a security, which is the economically optimal price for that security. The latter, called the efficient market hypothesis, has dominated capitalist thinking in the U.S. for quite some time.

There are two underpinnings of capitalist economics. Scarcity and rationality. Goods are scarce, meaning we can’t use as much as we want of everything, whether it be time, money, air, food, entertainment, etc. We always have to make choices. The second is that people make their choices rationally; they act in their own best financial interest given all the information needed. I have no problem with scarcity. Rationality flies in the face of everything I’ve seen about people. And rationality is the underpinning of the two economic ideas above.

Adam Smith’s quote is actually referencing a pretty narrow piece of economics, not the broad Ayn Rand style statement about markets that so-called conservatives make it out to be. The classic refutation of that is the prisoner’s dilemma. Two actors in that case will, if they seek to maximize their own situation, cause the non-socially optimal solution to occur. But that’s hardly a general refutation. And in fact, I personally am convinced that the invisible hand is a good rule of thumb.

The efficient markets hypothesis in it’s rule of thumb format seems to me to be a good rule of thumb. Generally speaking, an individual cannot beat the market except through luck. But in it’s most strident form of taking into account all information, even non-public information, I call utter bullshit. But until now I didn’t have the background to say so.

The Myth of the Rational Market is an extensive history of the efficient market hypothesis, starting in the late 1800s and continuing all the way through 2008. It covers all the major players, explains the discoveries and theories that lead to the hypothesis, and explains how it came unraveled in the 1980s and beyond. As economics can be, sometimes it was a little hard to keep all the threads aligned in my head. Fox does a fairly admirable job of juggling them all, better than many economics texts I’ve read.

It’s rare for me to finish an economics book and feel better informed with information on issues that I actually discuss with friends. Okay, mostly I’m talking about wing-nut friends who like to post the market is always best tripe on Facebook or LiveJournal. Now I’ve got the evidence to say you’re an idiot.

And despite the book being flogged by a few people as about the financial market meltdown the last few years, it’s only tangentially related. It doesn’t hurt understanding of that crisis, but only the epilogue touches directly.

A few other blogged reviews:

• BoingBoing
• Steve Reads
• Concurring Opinions
• Wha’ Happen?

Title: The Myth of the Rational Market: A History of Risk, Reward, and Delusion on Wall Street
Author: Justin Fox
Imprint / publisher: HarperBusiness / HarperCollins
Format: Hardcover
Length: 382 p. (includes notes and index)
Publication date: 2009
ISBN-13: 978-0-06-059899-0

Spin-Free Economics isn’t.

That’s the short version of this review. Sorry, I couldn’t resist being clever. Probably more than a few other people thought of that little witticism too. So maybe I’m not really being that clever.

Behravesh’s premise is that politics has captured the public economic intellectuals. There is now a need for an impartial economist to arbitrate and determine which side is right on the key economics questions of today. That person is Nariman Behravesh!

There’s several problems with putting Behravesh into that position though. First, his economics have no creativity. This book is all about pushing the conventional wisdom of the economics profession. Indeed, early on he notes that economists are in largely in agreement on all the issues he notes in the book. Which would be well and good if agreement meant that these people were right. If economists are so smart, how did they as a profession miss the housing bubble? Some economists saw it, but by and large the group did not. So much for conventional wisdom. In some matters, such as on free trade generally, they are undoubtedly right. But on others, the jury is still out.

Second, Behravesh argues his cases very poorly. The book shows lots of correlations but very rarely demonstrates causation. Asia has adopted technology. Asia’s economies do well. Africa has not adopted technology. Africa’s economies don’t do well. Therefore Africa needs to adopted technology in order for it’s economies to do well. While that has a certain logical appeal, that’s correlation, not causation. Both items may be symptoms of something else, or completely random. The things he writes make sense but making sense doesn’t mean they are true.

Third, Behravesh documents his arguments and positions poorly. There are no footnotes or endnotes. Behravesh simply includes a list of sources in the back for each chapter with some short discussion of what can be found at each source. But he doesn’t tie together his actual claims with specific sources.

Fourth, some of Behravesh’s claims didn’t match up with what I found. For instance, he claimed the Canadian health care system is plagued by long unacceptable waits, worse than the U.S. But that doesn’t match up with what I found in this report from Statistics Canada or this study in the New England Journal of Medicine. Longer waits, but not unacceptably longer, generally.

Bottom line: don’t rely on Spin-Free Economics for unbiased truth. Like everyone, Behravesh has his prejudices, and they affect what he writes.

Title: Spin-Free Economics: A No-Nonsense, Nonpartisan Guide to Today’s Global Economic Debates
Author: Nariman Behravesh
Imprint / publisher:
Format: McGraw-Hill
Length: 334 p.
Publication date: 2009
ISBN-10: 0-07-154903-X
ISBN-13: 978-0-07-154903-5
Subject: International economic relations
Subject: International finance
Subject: Globalization — Economic aspects
Subject: Economic development
LC classification: HF1359 .B42 2009

If you check out Alyssa Katz’ blog, you’ll see that the author of Our Lot obviously reads a lot of economics blogs. I hoped the book would distill a lot of information about the real estate bubble and it’s associated economics and make it understandable to an average person. The jacket copy promises that the book helps … understand what really happened, how it affected our homes and communities, and how we can move on to a future we’ll want to live in. On those promises, the book succeeded partially on the second item and fails pretty badly on the others. The book does contain scores of sad tales of real estate villainy and loss. Horrible as these are, they bury the nuggets of real information rather than illustrate them.

What was economic situation that precipitated the financial meltdown over the last couple of years culminating with bailouts and handouts to the rich last fall? From the mid 1990s through 2006 real estate prices outpaced inflation and comparable housing rents driven by speculation, government incentives, fraud, and wishful thinking. Like any Ponzi scheme, the only way to keep things afloat is to bring in new people willing to pay ever-higher prices. When the game of musical chairs ends, the people holding title lose it and possibly lose more. This explanation does appear in Our Lot but it’s buried.

There are many villains in the real estate bubble. Some of them are featured. But the book often failed to explain why these actors were bad, and almost always failed to paint a complete picture of the crime. What is most often omitted is that the victims usually were witting accomplices who just weren’t as smart as other perpetrators. Investors thought they could make a quick buck and got burned. The tale of woe includes a foreclosure at the end, but doesn’t delineate between gains they thought they would make and actual losses.

Another service that Katz could have done but didn’t would be to better explain how the individual scams worked. I’m thinking particularly about chapter six, entitled Crime Spree, which covered the loosely defined crime of mortgage fraud. In other words, people that tried to scam usually lax lenders. The centerpiece is the case of Phillip Hill, who paid William McGill and Renee Donewar to buy houses and condos with Hill’s money as down payments after which the latter two would assign the properties back to Hill. The loans were for inflated amounts. But how Hill extracted the inflated money from the loans Katz never explained. And never explained what he did with the money. She explained that the general modus operandi was have a front home improvement company get paid for work it never did. I’ve re-read this portion a couple of times and still can’t tell if that’s how Hill did it. All I can tell is that the loans were inflated. Instead I learned how Hill was such an asshole that he took control of a homeowners association because he owned so many of the houses on paper. And he collected their homeowner’s dues and perhaps kept that money. But that doesn’t add up to the $100 million in fraudulent loans Katz describes.

That’s a big failing of Our Lot: the constant referencing of irrelevant minutia like Hill’s takeover of a homeowners association. On page 105, the book describes how home builder Jeff Spitzer’s fluffy mustache and golden shock of hair had not yet turned white. Phillip Hill had been hired to play a temple builder for the opening ceremony at the 1996 Olympics on page 133. There’s lots and lots of that stuff.

Katz would have been better served by a standard high school paper structure. Tell us the broad outlines, then in further paragraphs get more and more detailed and provide the supporting information. Finally, explain the implications of the information before summing up. Or something like that. But stop jumping all over the place and don’t put details in the middle of higher level explanations.

It’s not all bad. From what I can tell, the information that’s there is all correct. It does give a good feel for all sorts of chicanery. The mortgage fraud perpetrated by Phillip Hill that I previously mentioned, the reader will get a good idea of the scale of the fraud perpetrated by the guy and how many people he affected. Chapter 2 shows a pretty good progression of the relaxation of regulation and how government relied on home ownership to prop up part of the economy over the years. The book gives the reader a good idea of the relaxation of lending standards that would be necessary to bring in more buyers. Lower standards meant more people who wouldn’t be able to pay the money back. It’s spread out over too many individual stories, but it’s there.

But I wouldn’t recommend the book. And that’s coming from someone who agrees with Katz’ politics for the most part.

A couple other blogged reviews:

• FT’s Books
• Jeff Kelly Lowenstein’s Blog

Title: Our Lot: How Real Estate Came to Own Us
Author: Alyssa Katz
Cover creator: Natalie Slocum (designer)
Imprint / publisher: Bloomsbury
Format: Hardcover
Length: 228 p.
Publication date: June 2009
ISBN-10: 1-59691-479-3
ISBN-13: 978-1-59691-479-7
Subject: Real estate business — United States — Marketing
Subject: Real estate business — United States — Managing
LC classification: HD1375.K348 2009

Thomas Schelling might be my new favorite economist, but the book used enough math to make my eyes glaze over. Although probably not intentional, the book thoroughly debunks the the idea that the invisible hand of the market always guides society to a socially good result. In particular, Schelling explains how somewhat innocuous racial preferences can lead to almost totally segregated neighborhoods.

I don’t often include long passages from books, but I think this one is necessary:

The result is often characterized by the statement that the market works. By market is meant the entire complex of institutions within which people buy and sell and hire and are hired and borrow and lend and trade and contract and shop around to find bargains. A lot may be wrong with the deductive reasoning of economists, but when they state the conclusion carefully and modestly they have a point. The free market may not do much, or anything, to distribute opportunities and resources among people the way you or I might like them distributed, and it may not lead people to like the activities we wish they liked or want to consume the the things we wish they wanted to consume; it may encourage individualist rather than group values and it may fail to protect people against their own shortsightedness and self-indulgence. It may lead to asymmetrical personal relationships between employee and employer, lender and borrower, and attach too much status to material attainments. The market may even perform disastrously where inflation and depression are concerned. Still, within these serious limitations, it does remarkably well in coordinating or harmonizing or integrating the efforts of self-serving individuals and organizations.

Schelling goes on to write that quite a number of activities operate almost entirely outside the purview of the market and so cannot even be expected to receive market-like benefits or treatment: the languages we choose to speak, who we marry, who we live near, what games we like to play, etc. Although these things affect our economic status, that nexus between them is small enough that other preferences dominate. Those preferences are the subject of the book.

Schelling describes our preferences and how we act on them as part of a feedback loop. In other words, it’s game theory. We make our choices based on what other people do, and what we expect them to do. In making such choices, we affect our own circumstances and those of others. In most cases, we don’t consider the effect we have on others as part of the equation. In some cases, we can’t. This externality means that many of these situations are forms of the prisoner’s dilemma. The optimal individual solution leads to suboptimal group results.

Early on, the book explains some of the kinds of models that can be used to work through the circumstances. Key among many of the models is the notion of a critical mass. If enough other people are doing something, we will make the same choice. No one wants to be the only person at a club. So we go to a club only if we expect enough other people to be there to make it enjoyable. (We usually don’t consider the impact of staying home on the club or other possible patrons.) In the case of segregation, behavior could be due to similar effects. Minorities moving into a previously all white neighborhood may induce hard core white racists to leave. The overall percentage of whites to blacks is thus reduced perhaps below the tolerance level of the next group of whites, who then leave, further reducing the ratio. The cycle repeats itself. At some point, even the fairly tolerant whites who merely don’t want to be outnumbered 10 to 1 will leave, leaving a segregated neighborhood in their wake.

A number of the models relate to foretelling the future. Self-fulfilling prophecies is one class of these. Perhaps whites believe that blacks cannot run businesses. The expectation leads them to avoiding hiring blacks, who then never get the experience to run businesses. The expectation creates the situation where it’s true (assuming whites own all the businesses, which at one point in our history was predominantly the case). Other models include self-displacing prophecies (such as when everyone tries to tip just a little bit above average), self-negating prophecies (if we believe a place will be to crowded, we stay home), self-equilibrating expectations (everyone brought chips to the picnic last time, so I bring salad next time), and self-confirming signals (people expect diet soda to be in grey colored bottles, so soda companies start putting diet soda in grey bottles to indicate it’s diet).

After going through those and other models, explaining how they work generally, later chapters get into specifics, including a lot of math. Chapter four is devoted entirely to mixing races and sexes, starting off with some trivial observations. Mathematically, if race is divided into white and non-white, only one group can be numerically superior. Both groups might be tolerant of the other, but wish to live in a neighborhood where their own race is the majority. In that case, the only stable mix is complete segregation. If a group merely prefers not to be a severe minority (say no less than 25% of the local population), the initial mix has a great effect on the final result. A neighborhood that is 40% black would remain viable. But one that is 24% black would result in total segregation. Blacks would move to neighborhoods where they feel more comfortable. The optimal solution might be to induce a few white families to leave to ensure a mixed race neighborhood, but the mechanics force a slow black evacuation.

Then Schelling really starts getting into the math. Neighborhoods aren’t uniform. Preferences of individuals differ. Some percentage of people might be okay with any percentage of people not like them. Other are fine with 25%. Some with 75%. This can be graphed. If the preferences can be graphed on opposing axes. The intersection will show in what direction migration will happen (absent outside influence) and what population mixtures will be stable given the groups’ preferences. With some sets of assumptions and preferences, integrated neighborhoods are more likely. Moving from extremely segregated (which is stable, but not preferable) may take very concerted action, even when everyone involved would be fine with an integrated neighborhood. The individual incentives do not provide a path to get from A to B. Some of the steps along the way, if everyone is free to make individual choices, lead back to segregated neighborhoods.

I found it all very enlightening. Minorities may not want either segregated neighborhoods, nor gentrified ones. This shows why achieving acceptable mixes is so difficult. The market isn’t the operative factor driving living arrangements. And you can’t assume people won’t live in integrated places based on the fact they live in segregated ones naturally. There isn’t a natural market mechanism that moves them to a place they would consider optimal, even on an individual basis.

Schelling covers a lot of other situations as well, such as mixing groups by continuous characteristics like age or income rather than dichotomous ones (like is or isn’t white), mechanisms in place when a dichotomous choice can be made (such as choosing the sex for one’s children). I won’t get into those here, as the discussion of segregation in the book would be enough on it’s own to pique my interest.

This edition of the book closes with Schelling’s Nobel Prize lecture. (Technically, the Nobel Prize in Economics is not a Nobel Prize, but I’ll save the bulk of my pedanticism for some other time.) To accept a Nobel Prize, a winner is required to give a lecture. Schelling’s lecture at first glance seems to have little bearing on economics. In it he recounts the history of the world’s aversion to using nuclear weapons. Read next to the rest of the book, it’s much clearer. Breaking the taboo is just as much a game of expectations on the part of world leaders as more prosaic considerations of whether to show up to a party in formal wear when one doesn’t know if a party is formal or not. I think it’s a fine example of the world-changing nature of games.

Other blogged reviews:

• Stephen Laniel’s Unspecified Bunker
• Explanada

Title: Micromotives and Macrobehavior
Author: Thomas C. Shelling
Cover creator: John Lamb (photographe)
Series: Fels Lectures on Public Policy Analysis
Imprint / publisher: W. W. Norton
Format: Paperback
Length: 270 p. (includes index)
Publication date: 2006 (originally 1978)
ISBN-10: 0-393-32946-1
ISBN-13: 978-0-393-32946-9
Subject: Policy sciences
Subject: Choice (Psychology)
Subject: Social choice
Subject: Collective behavior
Subject: Social problems
LC classification: H61.S355 1978

The Myth of the Rational Voter is partially a book explaining economist Bryan Caplan’s economic model for voting, and partially it’s a polemic arguing for elitist views regarding the intelligence of the average U.S. citizen. As a super-smart citizen with just enough information to be dangerous, I’m partial to the argument. Caplan’s model and argument are internally consistent, but I don’t think he’s founded his erector set theory on as firm a ground as he describes. Whether it’s all true or not can only be seen by further research or events.

The model that Caplan espouses is fairly simple actually. Belief should be considered economically like any good such as leisure time or oranges. Belief, or irrationality, is the acceptance of suppositions as fact without reasonable evidence for so doing. Beliefs may be correct (e.g., one should not defy the law of gravity), or immaterial economically (e.g., god is a trinity). As the cost of being irrational goes up, people will consume less irrationality. If the cost of oranges goes up, I’ll buy fewer oranges. Since one vote has so little chance of affecting an election, a voter will consume as much irrationality as makes him comfortable with his view of the world. Because so much of a person’s beliefs aren’t true, particularly economically, we are getting economic programs that run contrary to established economic theory. In other words, we have shitty government because we vote stupidly, and we vote stupidly because a vote has little chance of affecting the outcome.

The polemic is a typical elitist libertarian one. Economists are smarter than your average bear. People vote anti-economist. We get bad economic policies because we don’t follow what the economists tell us to. Therefore we should take power out of the hands of people to some degree. Institute a poll tax. Institute education requirements. Reduce voter turnout. Or at the very least, remove as much of business and economic policy from political control as is possible. Let people’s individual choices be paramount and the market will move us to a socially optimal outcome.

As much as I like the ideas, there’s a lot of picking apart to do. First off, the premise that people are voting irrationally is not necessarily true. Caplan’s evidence is that the general public disagrees with economists on economic policies such as trade, foreign aid, and the like. For the general public to be irrational, the economists have to be right. Caplan’s evidence that the economists are right is a large chapter highlighting data from a survey. Caplan manipulates the data to remove the bias from such things as economic class from economists positions. After adjustment, the position is closer to the economist position rather than the position of the general public. Therefore, the economists must be more right than the public. Ta-da!

What’s obviously missing is whether or not the economists are right. The problem is that a lot of economics isn’t testable or at least not tested with the rigor that one would find in physics. Merely removing bias does not prove correctness. I can think of at least one recent item where the economic profession generally got it wrong: the existence of a housing bubble in the United States from 1998 through 2006/2007. So pardon me if I’m not convinced that that because economists say that protectionism is bad that it is bad. I’m generally pro-free-trade, but I need better convincing than that logic.

Secondly, I’m confused about his model. His model explanation is essentially that people’s irrationality during voting when graphed looks like a demand curve. In other words, if it costs someone money to be irrational they are likely to be more rational. We can treat a person’s preferences over his beliefs as if they were his preferences over consumption goods. The graphs look alike, so the underlying functions are the same. And because there’s no cost in voting, we’re really irrational. What bothers me about this analysis is that these aren’t scarce goods. When using scarce goods (or things like entertainment that can be translated into the scarce good time), the individuals must economize because they only have so much. The costs are a function of scarcity. But there’s an infinite supply of belief. The costs in this case are not a function of scarcity. I’m not sure this makes a difference, but it could. The known plotted points in the two graphs resemble each other, but because I’m not sure the underlying cost functions are the same, I’m not sure things hold at the edges. Like where the cost is zero as in voting.

There’s also no data to back up this model. It occurs to me that some implications of this idea ought to be testable. Closer elections have higher cost should result in better economic policies because the chances of having an effect are greater. Also, places where education (corresponding to rationality) is greater should have better economic policies. Randomly, there should be places where there is more rational voting and thus better policies. Caplan presents no such data. So I have to assume he didn’t find it at the time he wrote this book. Without empirical data, implementing his policy prescriptions in the hopes that it will improve things seems premature.

The thing that bothers me most about the whole book is it really feels to me like Caplan latched onto the model because it supported his libertarian tendency. Not consciously of course. It could easily be something that he believes because it fits his comfortable worldview, much as he accuses his irrational voters of the same thing. I have no idea where that meta road could take this and it hurts my head to go that way.

All that nit-picking aside, I have no evidence to counter any of this. I just have questions. The model seems cogent to me. One of the things that I glom onto is using prices as indicators, which this does with regard to voting. I understand things like determining how scarce drugs are by watching whether street prices for drugs are going up or down. Attaching a cost to voting and using that to evaluate resonates with me.

As for Caplan’s writing, I am not really sure what his intended audience is. Occasionally he drops into a wonkish mode where I got glassy-eyed. In plenty of spots he seems to be targeting other economists, admonishing them that they are irrationally assuming voting rationality. He writes non-technically enough that I can follow most of he argument. This is not the latest in the popular economics genre, however. Political economy is squarely within the realm of established economics.

Other blogged reviews:

• Obstinate Observations
• Walter Block (from the Caplan isn’t libertarian enough camp)
• Marginal Revolution (from a colleague of Caplan, so take it with some salt)
• Bibliographing

Title: The Myth of the Rational Voter: Why Democracies Choose Bad Policies
Author: Bryan Caplan
Cover creator: Frank Mahood
Imprint / publisher: Princeton University Press
Format: Hardcover
Length: 276 p. (includes 70 pages of endnotes, references and index)
Publication date: 2007
ISBN-10: 0-691-12942-8
ISBN-13: 978-0-691-12942-6
Subject: Economic policy
Subject: Democracy
Subject: Political sociology
Subject: Representative government and representation
Subject: Rationalism
LC classification: HD87.C36 2006

On the whole a solid book, but Tim Harford’s chapters on micro-economic behavior and game theory are far stronger than the pro-trade arguments he makes in later chapters on improving the lot of poor people around the world. I generally tend to agree with a pro-trade stance, but straw man arguments and bait-and-switch explanations aren’t going to convince anyone except the already convinced.

The Undercover Economist is another in the increasingly popular category of popular economics. I probably should stop buying and reading them because all the ones I keep reading overlap. I don’t need another exposition on externalities, nor another general high-level defense of globalization. The material on externalities was pretty good though, even if I’ve heard that stuff before.

The book contains a fair amount of new-to-me information despite it’s survey nature. While I was familiar with price discrimination, Harford’s chapter on the topic exposed to me a lot of different ways by which businesses achieve the technique. The author also introduced a technique to counter unfairness from Kenneth Arrow where you give the disadvantaged a head start, perhaps with lump sum payments. The idea intrigues me, though it seems somewhat impractical at solving many issues of justice with a crude application. I want to read more on the topic if I ever find time. A last area I learned a bunch on from Harford is on game theory, particularly his chapter on the auctions of radio spectrum in the U.S., New Zealand, and the U.K. I’m not sure how practical my new knowledge is, but it seems a lot less abstract and complicated than my previous exposure to game theory. (Even in the more complicated forms, game theory is something I’ve wanted to know more about for a while.)

There were some parts that irritated me quite a bit though. Harford spends quite a bit of time discussing price discrimination with regard to medicines generally coming out in favor of it. And in other places he generally argues against government intervention in markets. And yet, there’s no acknowledgment that patent and copyright monopolies are just that: large government intervention. There’s good arguments to be made that they are on balance an economic good. But price discrimination in pills is 100% the result of patent monopolies.

The second major section that irritated me is his defense of globalizing trade policies. The problem here is that Harford’s arguments are quite sloppy. In one place he shows a graph that compares foreign investment in China with reductions in Chinese air pollution as an argument that foreign investment reduces air pollution. The two correlate quite well. But correlation is not causation as any stats wizard will tell you! In another place Harford writes that tariffs increase a country’s political isolation which increases it’s political stability (in the case of repressive government I guess) which increases the power of the ruling elite. His point being that the political elite may be using high tariffs to the detriment of their citizens but helping themselves. Except then every example he gives is not of high tariffs but of externally imposed sanctions (mostly from the U.S.): Cuba, Iraq, Myanmar, and North Korea. Then he moves on as if the point has been proven. It’s crap like that that fails to win over converts to globalization, though it’s subtle enough that I’m not sure many would recognize the source of their unease about the argument.

If you haven’t been reading the rash of popular economics books that have hit the market in the last few years, this is a pretty decent one to pick up. If you have, I suggest skipping it and looking deeper into particular economics topics that interest you.

Title: The Undercover Economist: Exposing Why the Rich Are Rich, the Poor Are Poor — and Why You Can Never Buy a Decent Used Car!
Author: Tim Harford
Cover creator: Kathleen M. Lynch (designer) / Lou Brooks (artist)
Imprint / publisher: Oxford University Press
Format: Hardcover
Length: 276 p. (includes endnotes and index)
Publication date: November 2005
ISBN-10: 0-19-518977-9
Subject: Economic history, 1990-
Subject: Economics
Subject: Consumer education
LC classification: HC59.15.H35 2005

I’ve been reading Dean Baker’s stuff for a long time, first when he wrote Economic Reporting Review and Beat the Press since he moved to a blog format. He’s an economist with a liberal economics think tank. This book is less an economics treatise than a political polemic with an economic bent.

Baker’s premise for the book is that conservatives have characterized the political economy debates in the United States as government versus the market, with conservatives be pro-market and liberals being pro-government. This characterization puts liberals on their heels in the political arena. Baker’s argument is that the conservative vision depends as much or more on government intervention in the market than the liberal vision does.

The book is pretty convincing in making that argument. Examples include deliberate trade policy geared toward the wealthy, small business incentives, and intellectual property laws that create property rights out of thin air. Baker does a bang-up job poking holes in the conservative myths as well as pointing out many of the problems with our governments economic policies.

Where he falls down somewhat is in his arguments for alternatives. Perhaps this is just a little bit of the devil you do know versus the devil you don’t in my case. For instance, one of his proposed changes to copyright law includes a voucher system. Give everyone in the U.S. a $75 voucher to be used toward the support of an artist, provided the artist’s work is placed in the public domain. Baker’s argument is that a flood of creativity would ensue. The first thing that comes to my mind though is a large number of non-artists gaming the system. For instance, my buddy loses his job so my circle of friends bands together and send our vouchers my buddy’s way, despite his lack of artistic creation. Baker is certainly right to want reform of the system, and his ideas might even form the basis for the way to do it. But I’m not entirely convinced.

Lastly, I wish he had titled the book differently. It’s an attempt to change the debate. The issue I have is that the nanny state means something fairly particular as used by most intellectual conservatives. It means the government acting as a nanny to protect a person from themselves. Hence blocking the sale of trans-fats because people would become obese. In the book the term is used more generally to indicate government action. Some of the items in the book are in fact instances of the government protecting the rich from the own stupidity (the chapter on bankruptcy for instance). A lot of them are just actions of big government geared to benefit the friend of conservative, not necessarily to protect them from their own bad decisions.

Will Baker succeed in changing the debate? I doubt it. To do so he needs to get someone with media exposure to start espousing his ideas. That’s at the minimum. I haven’t seen the Democratic Party really have that kind of chutzpah.

Title: The conservative nanny state: how the wealthy use the government to stay rich and get richer
Author: Dean Baker
Imprint / publisher: Center for Economic and Policy Research
Format: Electronic book
Length: 113 p.
Publication date: 2006
ISBN-13: 978-1-4116-9395-1

Astute visitors will have noticed that I’ve had Ben Bernanke’s Essays on the Great Depression on my Now Reading list for over two months. I’ve been slowly working my way through this book, but with the new year fast approaching I think it’s time I gave up. This one not so much because the material isn’t interesting, but because I am not up to the material.

I picked up the book last year, before he was even appointed to be chairman of the Federal Reserve. Some economics writer listed the tome in a bibliography of a their own book. I can’t remember who specifically. I suspect it was N. Gregory Mankiw but I could be totally wrong and I don’t have that book handy to check.

This is not to say that I haven’t gotten anything from the book. I have. But this is not what I was expecting. I thought the book would be more essay-like. Instad, it is reprints of some of Bernanke’s academic papers. Very very heavy with graphs and tables and equations and jargon that is well beyond me.

The big thing I did get out of this is the correction of some misimpressions I had. I’d always thought that the Great Depression affected the United States primarily. Incorrect. The economic phenomenon occurred worldwide. I also thought that the public works projects initiated by Franklin Roosevelt hadn’t done much, but that our entry into World War II boosted us out of the economic slowdown. But according to Bernanke, the primary cause of the Depression was adherence to the gold standard by the U.S. and western European governments along with some poor policies by United States central bankers. As countries dropped off the gold standard between 1931 and 1936, they began recovering from the Depression. In other words, the key determinant of recovery was not World War II, but instead abandonment of the gold standard.

Title: Essays on the great depression
Author: Ben S. Bernanke
Imprint / publisher: Princeton University Press
Format: Paperback
Length: 310 p. (includes index)
Publication date: 2004
ISBN-10: 0-691-11820-5
ISBN-13: 978-0-691-11820-8
Subject: Depressions — 1929 — United States
Subject: Depressions — 1929
LC classification: HB3717 1929 .B365 2000

Just as I was moving several weeks ago I got a call from my stock broker. He worked for a major brokerage and was leaving to form his own one-man investment advisory service. He wanted me to move my account with him. This scenario is fairly common in the investment world, at least in the so-call high net worth portfolios. I used to date a girl who worked for an investment advisory company as an assistant. The bulk of her frustrations (at least as she related them to me) were all about advisers who joined the company and their skills with regard to getting their former clients to become clients at the firm for which she worked.

I personally like my broker, but I’ve got a pretty fundamental difference with him about portfolio management. I don’t know to what extent he believes in the underlying theory, but I often got calls from him that I should probably sell or buy a security because it had reached it’s support or resistance level. These are terms used by so-called technical analysts, which should more properly be called trend analysis according to John Allen Paulos. A large segment of investment advisers out there follow this model. The classic mantra for the stock market is to buy low and sell high. Technical analysis is all about watching the stock price and using some mathematical rules about the stock price to determine when the price is low and when the price is high. Pretty much the only input to these rules is the stock price.

There’s some value to the technique, but in a worst case scenario of a flat but volatile market, a person will lose money due to all the transaction costs associated with buying and selling. More generally, technical analysis may not be much different in its results from investing in a broad-based Standard and Poor’s 500 index fund.

My philosophy is generally to invest in broad-based index funds spread out across a number of asset classes. Then you sit on it for a long time and occasionally re-adjust things to get it back to your overall percentages if some part gains a lot or loses a lot of money (throwing off your percentages). But I also like the idea of watching macro-economic trends, and using some percentage of my portfolio to make bets on those trends. For instance, I’ve watched the explosive growth in emerging markets (a.k.a. developing countries making the transition from the third world to the first world) and years ago decided that a portion of my portfolio needed to be invested there. Or earlier this year seeing the coming housing market meltdown, I put some of that money into a fund that shorts financial companies. Basically, betting that over the next year banks overall will take a lot of losses from bad mortgage investments.

Anyway, to refresh my thoughts regarding whether I should jump to the new firm or not, I decided to pull out A Mathematician Plays the Stock Market and read through it again. Mostly I focused on his chapters on technical analysis, fundamental analysis, and sections on the efficient market hypothesis.

The efficient market hypothesis is a theory that fascinates me. The hypothesis is that the prices on the stock market reflect all information about each stock. To illustrate, say the newspaper reports that the F.D.A. has approved a new drug by GlaxoSmithKline (G.S.K.). That would be good for G.S.K., right? And you’d want to invest in their stock, right? Perhaps not. The hypothesis is that almost immediately investors are going to start paying more for the stock. Meaning that if you go buy it now, the higher price offsets any extra money you’d make because of the drug approval.

Paulos repeats a joke though that shows that a market can’t be 100% efficient. Two efficient market theorists pass a $100 bill laying on the street, but don’t pick it up. Why not? If the $100 was real, someone (the market) would have already picked it up.

The implications of the theory to a common investor such as I am is that (if the theory is true) everything I do in the stock market is essentially gambling. It’s all luck. I am just flipping a coin as to whether I am going to do better than the broad market, or worse, with each individual bet I make. It doesn’t mean I can’t do better. It just means that I might as well not bother with almost any strategy at all. Picking stocks at random will have about the same effect.

Now, there are strategies that can lock people into certain paths. They essentially reduce the betting involved. But making it less random also means that you move in lockstep with other people pretty much.

One thing Paulos also writes about this hypothesis is that if everyone believes it, it can’t be true. In order for it to happen, there has to be a number of people snapping up tidbits of information to move the price of a stock. But if everyone believes the theory, they won’t bother, and the price never moves in accordance with new information.

My one big beef with the book is that a lot of it seems like argument by analogy. Here’s one thing about the stock market that looks a lot like something from mathematics. In other words, correlation. But just because two things are correlated doesn’t mean there’s a connection. In the future that past correlation may fall apart. It’s a point that Paulos brings up with regard to other aspects. But I’m not sure he sees it with regard to his own words. On the other hand, he may know more and know that there is an underlying causal connection, but just isn’t bothering to explain it because this is a book for non-mathematicians. For our purposes, showing the correlation may be sufficient.

Title: A mathematician plays the stock market
Author: John Allen Paulos
Imprint / publisher: Basic Books / Perseus
Format: Hardcover
Length: 216 p. (includes index)
Publication date: 2003
ISBN-10: 0-465-05480-3
Subject: Investments — Psychological aspects
Subject: Stock exchanges — Psychological aspects
Subject: Stock exchanges — Mathematical models
Subject: Investment analysis
Subject: Stocks
LC classification: HG4515.15.P38 2003