Wednesday, July 29, 2015

And now for something completely different

My brother, dad, and I installed some pavers for my parents a couple weeks ago. In the past I've had a lot of floor installation jobs, but I've never done pavers. It's not too hard. Most of the work is prep.

First focus on getting level ground at the height you need. In our case, this meant that the pavers would end up flush with adjacent concrete. Account for a layer of sand, which in our case would be 3/4 inch. Focus on water flow if relevant--we wanted a slight tilt away from the house.

Rent a dirt compactor. Use your old skateboard to transport it from truck to work site (Figure 1).

Figure 1
Go around the area several times (Figure 2).

Figure 2

You will want your sand layer to be flat and appropriately level. A good way to do this is to get some pipes with the right diameter, then drag sand across them with a straight 2x4 (Figures 3-4).

Figure 3

This can be tricky if you have obstacles in the patio, like the tree above.

Figure 4

As you lay the pavers, you can fill in the holes left by the pipes. Lay the pavers straight down; if you have to drag them into position you will get sand between them and have a bad fit. Getting flush next to concrete may require some improvisation; in my case we had to bring the sand up a bit, which was fine since we want water flowing away from the house (actually, we laid them slightly higher than flush, to allow compacting).

Figure 5

The carts pictured in Figure 5 are by Racatac. I used them a lot when I installed carpet for a living; they are also good for tile and, obviously, pavers. These will make a huge difference for your back and knees. If you ever do a flooring job, buy or borrow some. For jobs like tile and pavers, you need a board like the one pictured so the cart wheels don't screw up individual bricks.

Figure 6


Figure 7

In the early part of the job, we kept the tiles square against the house, which forms a (somewhat) right angle for us. You can see in Figures 6 and 7 that we had to build a bridge to the sidewalk and lost the house on the right side due to a flower bed. Use a string to make a straight line. You may think you can lay bricks straight, but you can't.

Our biggest obstacle was the tree in the middle of the patio. We had to wrap the bricks around this and meet behind it, which always presents a challenge. Again, we used a string to keep lines straight (Figure 8).

Figure 8

Figure 9 shows things coming together.

Figure 9

My mom wanted round corners on the tree and flower beds. This is a part that takes a lot of time. You can do this with a tile saw, but it's cheaper and just as easy to use a grinder with a masonry blade (Figure 10). If the blade isn't large enough, you can score the bricks then break them (carefully).

Figure 10

Figure 11 shows the result.

Figure 11

Around flower beds, insert plastic border to hold bricks in place. This is harder than it looks (Figure 12).

Figure 12

The last step is to sweep fine sand over the bricks. This will fall into the cracks and act like grout, keeping the pavers as laid and preventing wobbling. It will take many, many coats to fill in all cracks. Spread, spray with water, allow to dry, repeat. Figures 13-15 show the process.

Figure 13


Figure 14


Figure 15

The grouting isn't quite finished, but it's just a matter of a few more coats.

Pavers look nice, but a key advantage over concrete is that they can be spot repaired. This particular patio has a tree in the middle that must be watered; as a result, the concrete that was there before was constantly settling and buckling. Repairing concrete is expensive; replacing a few pavers is cheap.



UPDATE: My dad finished the grouting and sealing; here's the finished product:

Figure 16












Thursday, July 2, 2015

Theory and empirics in cancer research

A couple years ago I read The Emperor of All Maladies, a fantastic book on the history of cancer research and treatment. I think a lot of economists would like this book because, among other things, it focuses on the differing roles of empirical and theoretical progress in a discipline that is constantly asked to serve the real world. In particular, both fields seem to display a constant tension between quick, "credible" fixes to problems and a deeper theoretical understanding of driving forces.

Reader beware--medicine and biology are way outside my wheelhouse, and it's been some time since I've read this book.

If you've known someone with cancer, there's a good chance that the treatment consisted of some combination of chemotherapy, radiation, and surgery. In a sense these are very brute force ways to treat the problem, and as you might have noticed that the collateral damage can be massive. For the most part, the brute force approach to treating cancer comes to us from an empirical (actually experimental) tradition.

For a long time, surgery was the preferred method of treating cancer. The tricky thing is that simply cutting out a visible tumor doesn't always eliminate cancer from the body. This fact, discovered empirically, led to improvements in surgical technique but also to some extreme practices among some doctors. William Halsted performed "radical mastectomies" which left breast cancer patients with severed collarbones and gaping holes in their bodies. "Halsted and his disciples would rather evacuate the contents of the body than be faced with cancer recurrences" (65). This was part of a broader milieu in the world of surgery. "By 1898, it had transformed into a profession booming with self-confidence" (66).

Over the short term, these extreme surgical methods seemed to work reasonably well. But they reflected a woefully incomplete understanding of cancer. They could often cure the problem in women with small, local cancer activity, but at the cost of destroying the body without cause. On the other hand, cancer that had metasticized throught the body was not eliminated with the surgery. The approach did not save nearly as many lives as its proponents hoped, and it left a lot of people tragically disfigured.

Radiation was a more precise approach allowing specific targets (see page 75). It could often work well for localized tumors, saving many lives. Sometimes, though, it could actually cause cancer. And in any case, the collateral damage can still be huge, leaving patients "scarred, blinded, and scalded." It destroys cells indiscriminately.

Chemotherapy has roots in experiments with cloth dyes in the 1800s (85) and mustard gas in WWI (87). In the 1940s, treatments with combinations of chemicals were employed in increasingly well-designed experiments. This is chemotherapy, and while it's more advanced than surgery it is similar in that it employs brute force methods with huge collateral damage. Its advancement was driven by experiment rather than a growing understanding of cancer. Treating each specific cancer was just a matter of finding the right combination of toxins. The approach could lengthen lives, but sometimes by only a few months (208) (and sometimes for much longer!). Collateral damage was often huge. Much of cancer research funding went toward these experiments as opposed to deeper research:

They wanted a Manhattan Project for cancer. Increasingly, they felt that it was no longer necessary to wait for fundamental questions about cancer to be solved before launching an all-out attack on the problem (121). 

This approach had some success in treating cancer, with high costs (page 330 reviews cancer treatment's results to the mid-1980s). So there was some backlash:

As the armada of cytotoxic therapy readied itself for even more aggressive battles against cancer, a few dissenting voices began to be heard along its peripheries. These voices were connected by two common themes. 
First, the dissidents argued that indiscriminate chemotherapy, the unloading of barrel after barrel of poisonous drugs, could not be the only strategy by which to attack cancer. Contrary to prevailing dogma, cancer cells possessed unique and specific vulnerabilities that rendered them particularly sensitive to certain chemicals that had little impact on normal cells. 
Second, such chemicals could only be discovered by uncovering the deep biology of every cancer cell. Cancer-specific therapies existed, but they could only be known from the bottom up, i.e., from solving the basic biological riddles of each form of cancer, rather than from the top down, by maximizing cytotoxic chemotherapy or by discovering cellular poisons empirically.

This biology-based approach gained some traction, and there were some major breakthroughs in the 1980s that identified cancer-causing mechanisms at the molecular level. There has been a lot of progress since then. Understanding cancer better has made us better at early detection, which has significantly reduced mortality. More chemotherapy has played a role too. One cancer researcher looks back at a pioneer of experimental cancer treatment, Sidney Farber (from the 1940s), and writes,

Farber's generation had tried to target cancer cells empirically, but had failed because the mechanistic understanding of cancer was so poor. Farber had had the right idea, but at the wrong time. (433)

The author concludes that "an integrated approach" is needed (457). The case of breast cancer is particularly illustrative of this point (402).

So basically we spent a century treating cancer with methods discovered through experiment, with results that range from tragic to pretty good (the book reviews some studies). In a sense the approach served us pretty well, providing ways to treat a terrible disease without having to invest a lot of time and money in knowing a lot about it. Then we focused more on understanding the disease, which gave us pretty good progress. At any given point in time, focusing more on basic research may have denied effective treatment to existing patients, but it may have sped the process of finding better approaches.

I don't really have any big conclusions other than to say that I think the conflict between theory and empirics is complicated and may be unavoidable, particularly in the case of economics. The "credibility revolution" is a huge step forward for the field with its ability to provide quick answers to policy questions. But what does it tell us about a $15 minimum wage? Nothing, really. But theory is a messier business, and it can result in a lot of wasted effort. So neither the theorists or the empiricists are in a position to feel overly important. We need both, and sometimes one will make progress faster than the other.

This book is a really good read with a lot of other insights relevant to economics (page 211 rings a bell, for example); recommended.

Wednesday, June 10, 2015

Dire predictions about firm failure

John Chambers made a prediction that CBS News journalists find really noteworthy:

In one of his last appearances as Cisco (CSCO) CEO, John Chambers offered a stark view of the future for many businesses. He estimated that 40 percent of them wouldn't exist in 10 years because of the rapidly changing technological landscape. 

The article proceeds to pile on, with quotes from eminent scholars:

"He is right in ... characterizing the nature of transformative change that's talking place in the economy," said Rahul Kapoor, assistant professor of management at the Wharton School of Business at the University of Pennsylvania.

Of course, the "transformative change" that we're talking about is actually going on all the time; please read your Schumpeter.

The annual firm failure rate in the US ranges from 8 to 10 percent. We can't quite get a 10-year exit rate without microdata, but we can get a rough, ballpark example from the BDS. Suppose I do the following: count how many firms exist in a given year, count how many firms aged 11+ exist 11 years later, then divide things appropriately. This won't capture the actual failure rate due to things like M&A, but it should give us a magnitude to work from. Figure 1 plots this 10-year exit rate (click for larger image). Interpret as follows: the line at year t gives the percent of year-t firms that won't exist in year t+11.

Figure 1


This rate ranges from 50 to 60 percent, and it has been falling. Chambers may get the prediction right, but if so, it will be because the next ten years will be less "transformative" than the last 30. If the 40 percent figure is cause for alarm, that's only because it would mean the US economy has become even less dynamic (which seems plausible given current trends [pdf]); and even then it's unclear whether we should worry. These numbers are nice because they remind us that young firms make a big contribution to labor markets. (Caveat: as I mentioned above, some of this is M&A, so these data provide an upper bound).

I want to be fair to Chambers: it's possible that, contrary to CBSN's interpretation of his comment, he was actually referring to large, established firms that we generally don't think of as being at high risk of failure. So it's useful to think of these numbers in employment-weighted terms. That is, what will be the employment of firms in existence in year t when we get to year t+11, and how does that compare to year t employment of those firms? Figure 2 plots 10-year exit rates on an employment-weighted basis (click for larger image).

Figure 2


You can see that this rate ranges from 10 to 20 percent, but really it was 10 percent until the Great Recession. 

A similar way to interpret Chambers is to focus only on established firms, and ignore startups. Figure 3 plots 10-year exit rates when we only look at firms age 5 and above (unweighted; click for larger image).

Figure 3


These numbers range from less than 5 to about 15 percent, with a big rise associated with the Great Recession. So in this sense, Chambers' prediction is noteworthy. If employment among today's older firms falls by 40 percent over the next decade, that would be a pretty big deal and require a lot of reallocation. In some senses this could be a plausible prediction: you can see that the Great Recession really moved this number, and we know that said recession was not cleansing in a productivity sense, so our current stock of firms could be a bit weaker than we're used to. But I am going to take a risky stand and predict that 40 percent is an overestimate for this quantity. What is likely to move these numbers that much is a huge recession, not ongoing technological progress, and you can see what even a recession the size of our last one does.

In any case, the way Chambers stated the prediction, and the way the journalists reported it, betrays a serious lack of familiarity with the pace of pedestrian reallocation that occurs in the US economy. Economic transformation is not a big, discrete event; it is a continual process. Journalists reporting on stories like this would do their viewers a big service by providing some quantitative context.


Sunday, May 24, 2015

Beating dead horses

The econ twittersphere has erupted in response to a provocative (but very blog-like) essay by the great Paul Romer, published in the Papers & Proceedings at AER. Romer is annoyed that certain old freshwater econ guys use math in an annoying way. Romer follows up here; Tony Yates has some thoughts here. Noah Smith, always up for a good bashing of said old guys, opines here, making the same points he usually makes (to wit: those silly freshwater guys just build models in which government can't be good, physicists and engineers have physics and engineering models that perform better empirically, here are some examples of silly things predicted by some DSGE models, etc.).

In recent years, guys like Noah have made very clear that they don't like bare bones RBC and that they don't like certain old guys in macroeconomics. But during these years, while the blogosphere has obsessed over this stuff, macroeconomists have been doing a ton of interesting work for which the blog debate is an uninteresting sideshow.

I've said this before and I will say it again: Whatever one might think of the contributions of the certain old guys to macroeconomics, the field has moved lightyears beyond that stuff. Nobody is using bare-bones RBC. The "freshwater vs saltwater" distinction is a redundant taxonomy--as best I can tell, it's really about Calvo pricing vs. flexible price models, while the sticky price assumption is just one of hundreds of ways that people add frictions to the RBC model. If you use the water-based terms instead of just describing specific frictions, you're just facilitating mood affiliation.

Few, if any, of the people writing models with flexible prices (but other frictions) would say that nominal frictions don't matter. It's just that nominal stickiness is one among many ways in which the real world deviates from bare-bones RBC, and every model must assume away something, and sometimes nominal stickiness is that something for good reason (meanwhile, a lot of good Calvo pricing papers ignore important financial sector frictions, not to mention heterogeneity and tons of other stuff, and that's ok). Sure, you can always find an absurd element of any model, as Noah does with relish in his post. But we're stuck with a world in which no model can explain everything, and in any case a paper that's good at some things and bad at others is an opportunity for another paper that's good at a few more things and bad at slightly fewer things. That's the nature of the discipline. It will always be easy to make the discipline look silly to outsiders who haven't confronted the magnitude of the problems we face.

Let me also say this: if there is anyone out there who criticizes the absurd oversimplification that is the representative agent model* but also criticizes mathiness, here's a newsflash: deviations from rep agent require hard math and/or nasty computation. The Mian and Sufi critique requires models in which agents differ at least along a wealth distribution. The Geanakoplos stuff requires hard math. So be careful how you use the term "mathiness" (I think Romer is using it in a reasonably precise way, and a lot of people are misinterpreting him and using it too broadly). More realistic models are going to require harder math, though I agree completely with both Romer and Roger Farmer that adding more math isn't always productive.

So while the blogosphere keeps restating 1970s fights, practicing macroeconomists are doing a lot of really interesting research that makes the freshwater/saltwater taxonomy irrelevant or at least useless. Bashing caricatures of the economics profession is a great way to get followers and sell books, but it doesn't advance the discipline.


UPDATE: This post is more snarky than I intended or am comfortable with. I think Noah and I are actually closer on this than it would seem from this text and the comments below. My basic point is that I hope people do not use the blogosphere as a sufficient statistic for what is going on in modern macroeconomics.

*I actually think rep agent is remarkably useful, particularly compared to how much it costs.

Saturday, May 9, 2015

Mobilizing and upgrading idle, depreciated capital

Here's a Bloomberg article:

Real estate buyers seeking money to renovate and flip U.S. houses are getting help from some of the world’s biggest investment firms. 
Colony Capital Inc., Blackstone Group LP and Cerberus Capital Management are among the companies that have started making bridge loans to investors who buy homes to sell them quickly for a profit. 

The title of the article (likely not chosen by the author) is heavy on mood affiliation: "House flippers are back together with Wall St. What could possibly go wrong?"

Lately I've watched a few episodes of Flip or Flop, an HGTV show (on Netflix) that follows a couple who flip houses for a living. The show takes a fair amount of artistic license (producers: you can't portray your stars as living on the financial edge if they drive a custom Escalade), but it is a nice illustration of what flipping can do for the economy.

The houses are typically in pretty bad shape. Many of them were foreclosures. They have been sitting empty for some time. In some cases, the previous residents stole things or poured concrete down drains. Generally they are unlivable (well, by modern American middle class standards). The flippers buy the houses, do very nice renovations on them, then put them on the market within a month or two.

This is really good! Idle capital is a waste. Houses with concrete in their drains don't do us any good. Depreciation is bad. These people are making large additions to the US capital stock, so it's efficient to allocate resources to them (with all the usual caveats about overborrowing externalities, potential policy distortions, etc.). The economy needs this stuff; hence:

Home flippers are benefiting from rising prices, limited new construction and a shortage of inventory on the market.

And it makes sense for big, risk-neutral firms to play this game (see my brief conversation with Lucas Goodman about this).

There's also this:

The new lenders are focused on more experienced investors, many of whom have have established companies, rather than the amateurs that proliferated during the housing boom a decade ago. Today’s flippers are more sophisticated after the crash weeded out most of the weaker investors, Lewis said.

Friday, May 1, 2015

Why manufacturing?

From Dietz Vollrath:

One of my continuing questions about research in economic growth is why it insists on remaining so focused on manufacturing to the exclusion of the other 70-95% of economic activity in most economies. 

He mentions work by Chad Syverson and others. It's true--much of the productivity literature focuses on manufacturing.

Why do we persist in focusing on this particular subset of industries, sectors, and firms? I think one of the main reasons is that our data collection is skewed towards manufacturing, and we end up with a “lamppost” problem.

That is almost certainly the main reason. I guarantee that the people using the microdata would love to be able to carefully study productivity outside of manufacturing. Vollrath describes how industry code schemes are heavily tilted toward detail in manufacturing. Read his post; it's very instructive. (And hey--he's not the only one who blogs industry codes!). I think the switch from SIC to NAICS was a huge improvement on this, though the problem hasn't disappeared.

It's not just about industry codes. The big microdata sources are typically limited to employment information for businesses outside of manufacturing, i.e., there's no capital. And the lack of coverage has persistent consequences. Recent improvements to the data often aren't easy to roll back to earlier years, which means it's hard to study the time series.

The other issue, though, is that even our primary productivity concept--TFP--is really designed for a manufacturing world. The Census Bureau actually has survey microdata for firms in retail and services. But how do we measure capital in those industries? What other inputs are important? This is a much bigger problem than simple lack of coverage. (Obviously, there is a literature).

The further you get from producing widgets with machines, the harder it is to map the TFP concept to the real world. And that's just at the firm (or establishment) level! Facing this challenge in the microdata colors one's views of the TFP concept at the macro level. There is no clean mapping from micro to macro; go down this rabbit hole if you won't take my word for it. Aggregate TFP isn't actually a thing, even if it's still a useful fiction.

Wednesday, April 29, 2015

BED: 7.2 million jobs created, 6.6 million destroyed in Q3 2014

From the BLS:

From June 2014 to September 2014, gross job gains from opening and expanding private sector establishments were 7.2 million, a decrease of 259,000 jobs from the previous quarter, the U.S. Bureau of Labor Statistics reported today. Over this period, gross job losses from closing and contracting private sector establishments were 6.6 million, an increase of 115,000 jobs from the previous quarter. 

I like this data series, with some caveats.* If you're not familiar with this series, note that gross flows are large relative to net flows. Roughly speaking, think of the Great Recession as involving about 8.5 million net job losses. Entering and expanding business establishments create at least half that many jobs even in terrible quarters, but a recession is characterized by even larger numbers of jobs being destroyed by shrinking or closing establishments. So gross flows are large relative to net flows.

I like to slice the data by extensive margin (opening or closing business establishments) and intensive margin (expanding or contracting existing establishments). Figure 1 reports the flows of employment associated with opening and closing establishments, and Figure 2 reports actual numbers of establishments that opened or closed (click for larger images).

Figure 1

Figure 2

The last time I blogged this series was the 1q2014 release, and that release didn't look great. But, confirming the usual cautions, that release did not seem to mark a new trend. Reallocation from the extensive margin is moving sideways, more or less, with year-over-year job gains from openings slightly down and losses from closings barely changed.

Next, the intensive margin. Figure 3 reports employment flows from expanding and contracting establishments, and Figure 4 reports establishment counts for these categories (click for larger images).

Figure 3

Figure 4

On the intensive margin, reallocation seems to be sticking to its gentle upward trend since the Great Recession. Both jobs created and jobs destroyed on the intensive margin are slightly up year over year.

So there isn't a lot going on along the establishment entry margin, with things pretty much moving sideways (which means fairly constant positive net job creation from entry). Reallocation associated with growth or contraction of existing establishments is steadily rising and may soon approach pre-Great Recession levels.

Now some usual thoughts: gross flows give us an idea of where jobs are being created and destroyed, which fleshes out the net job numbers that are more popular (and timely). More broadly, these data help dissuade us from always thinking in representative agent terms, which is what the net numbers incline people to do. It's tempting to think that net numbers tell us about the experience of most businesses, but in reality there is a lot of heterogeneity among firms, and reallocation proceeds at a high pace.

Some previous BED posts are here.


*The BED are quarterly data provided from the BLS based on state UI data. They are released with a lag of about 8 months. Like the BDS (the dataset I usually use here), the BED basically covers the universe of private nonfarm employers; unlike the BDS, the BED is available at higher frequency and is released more quickly. BED has other drawbacks compared to the BDS, such as a more limited ability to track firms.

The BLS effectively expanded the sample definition in the first quarter of 2013. The 2013q1 observation was the most obviously affected, as it reported all establishments that were added to the sample as establishment openings. For openings data, I have replaced the 2013q1 observation with the average of 2012q4 and 2013q2. I haven't dug into the data enough to know whether users can manually correct for this over the longer run.

It is also important to note that these numbers are seasonally adjusted, and any guess at net numbers based on the difference between two seasonally adjusted series is very, very rough. Non-SA numbers are available on the BLS website.

These numbers track business establishments, which are different from firms. Costco is a firm; your local Costco store is an establishment. Most firms consist of only one establishment. The BED is not ideal for tracking firms, as it has limited ability to correctly link establishments to the firm level.

Monday, April 20, 2015

Thinking about family firms

The Economist has a really nice special report on family firms in the April 18th issue. I think this is a fascinating topic. I don't know the literature on this well, but I'd like to. Here's a literature survey from a recent working paper by Mullins and Schoar:

These studies document that family firms, on average, tend to be smaller than non-family firms, have lower performance, weaker governance structures, and are often concentrated in older, more regulated industries (e.g. Morck, Strangeland, and Yeung, 2000, and Claessens et al., 2000, 2002; Faccio and Lang, 2002; Anderson and Reeb, 2003; Bertrand and Schoar, 2006). Attention has also focused on the importance to firm outcomes of the CEO position (e.g. Bennedsen et al., 2010, 2012) and on the individual characteristics and styles of CEOs (e.g. Bertrand and Schoar, 2003; Malmendier and Tate, 2008; Schoar and Zuo, 2011).

Mueller and Philippon argue that "family firms are particularly effective at coping with difficult labor relations" because they can provide a more credible implicit contract; it would be interesting to study job flows specifically at family vs. non-family, controlling for size and age. In any case, I'm already obsessed with the fact that private firms are different from public firms; these data on family firms give me another thing to obsess over.

Recent literature also finds that transfer of control from founders to heirs can be hard on a firm, though transferring control to professional CEOs is less costly. The tricky problem, of course, is that selection effects might mean that founding CEOs are high ability, but there is less reason to assume that their heirs will be. From The Economist:

The biggest problem for family companies is the distinct possibility that the children or grandchildren of business founders may not match the founder for either brains or character. Warren Buffett, a veteran investor, once compared family succession to “choosing the 2020 Olympic team by picking the eldest sons of the gold-medal winners in the 2000 Olympics”. A family grandee says that the biggest barrier to keeping the family show on the road is the “growing sloth of family members”. And CEOs who bear the family name are far more difficult to sack than hired hands, even if they turn out to be useless. 

Why do I find this interesting? I think a lot about young firms and entrepreneurs generally, and how they matter for macroeconomics. One way to model questions in entrepreneurship is to follow Quadrini (2000) and separate the entrepreneurial sector from the "corporate" sector (where entrepreneurs are special in that they are linked to households); this is a nice modeling approach that I use in my research. But firms that start out as entrepreneurs or family affairs don't always stay that way forever, and there may be interesting things going on during the transition to more "mature" ways of doing business.

When thinking about the macroeconomic role of family firms it's important to get the weights right. From a macro perspective, simply looking at what percent of firms are family firms will give us an exaggerated sense of how much they matter (remember: most firms are small, but most people work at large firms). Says The Economist, "Family businesses make up more than 90% of the world’s companies. Many of them are small corner shops." I think you could replace "many" with "nearly all".

What I would really like to see are figures on the share of employment or revenue accounted for by family firms. The Economist doesn't give us that, but they do cite a BCG study finding that family firms account for 33 percent of U.S. firms with revenue over $1 billion. That's a lot--more than I would have expected! It's not just Cargill and Koch. Some of these firms are publicly traded; many of them are not--a reminder that a lot of activity does not show up in SEC filings.

More broadly, this stuff about family firms is a reminder that management matters.

Friday, April 17, 2015

The Starks are dumb, and other thoughts

The great Jim Tankersley has an article arguing that people should learn from A Song of Ice and Fire when thinking about the business cycle. It includes a quote from your humble savings scold. I want to expand on this a little.  

!!!Some spoilers from the books may follow.!!!

Winter in Westeros is a major recession; in particular, it is a real business cycle (RBC) recession as it decimates agricultural productivity when agriculture is the largest and most important industry. In some (or most?) parts of the country, agricultural output falls to something close to zero.

I always think of two major mistakes the Westerosi are making with respect to their business cycle. First, they are not saving enough. Second, they are not sufficiently focused on technology.

The lack of evidence of saving is by far the most striking economic fact from ASOIF. An important point to remember is that Westeros is in some ways a planned economy. Medieval economics is far outside my wheelhouse; but what we can say is that a large share of Westerosi resources are allocated by planners, with huge resources going toward making war. These planners are typically really bad at taking precautionary actions with respect to the coming winter. While various indicators are suggesting that winter is imminent, we have the major houses fighting over a crown. Not only does warmaking require significant resources, but these people also seem to enjoy literally burning fields while they're at it.

This is really puzzling behavior from heads of houses who seem to care a lot about the future of their brand. It seems like these people should be making huge efforts to store food. The only reason to buy weapons is to protect your storehouses. The only reason to build castles is to protect your storehouses. The only reason to mine gold is to buy food, buy food storage technology, or buy castles and weapons to protect your storehouses. And so on.

The Starks, whom a lot of readers are inclined to like, really look bad in this context. They have the most to lose from Winter--they are the first to enter and the last to exit winter, and their winter is likely the hardest. So why is Ned accepting a job in King's Landing when he should be scrambling to prepare his jurisdiction for winter? Even worse, why does Robb leave home to pursue a revenge war whose ostensible purpose is to gain independence from a monarch who won't even matter when winter comes? This is seriously reckless and irresponsible behavior.

As summer drags on and on, the Starks' time should be increasingly occupied by building huge greenhouses and building huge walls around them (Eric Crampton has noted the greenhouse issue). There's really no excuse to focus on anything else, unless it's figuring out a diplomatic solution to the Wildling issue or, depending on your priors, fortifying the Wall against the Others. When Robert Baratheon shows up to hire Ned as Hand, Ned should be laughing him out of the North. "Me, come to King's Landing when my people will be the first to suffer in winter?! No way." And at the very least, he goes only on the condition that he's going to play Joseph of Egypt (or Andrés Velasco) and make the realm's famine preparation agenda his top priority. If he does that, he gives Catelyn and Robb strict instructions to carry on his work preparing the North. No silly excursions south when our people aren't ready.

So the Starks are idiots. Most of the other houses are too. Frankly, Tywin Lannister seems far too smart to waste time and resources on the war when he should be sending cartloads of gold to Highgarden in exchange for food (Matt Yglesias has touched on this before). And even if you do go to war, you don't go around gratuitously burning other peoples' fields. When winter comes, you want other people to have food too (so you can take it, or at least so they don't come to your door).

Maybe you end up saving too much. But, as I mentioned to Jim, that just means you'll have a chance to buy other house's assets at fire sale prices during winter. You may come out of winter with not only a full belly but also a new fleet of Iron Islanders' ships and a portfolio of Lannister gold mines.

We do see a few people taking things seriously. I don't know if we hear it explicitly, but it seems very likely that the Manderlys are on top of this. They seem to have a pretty long game generally. Wyman stays home and lets his sons fight the war, and we later learn that while home he's been focusing on a lot of long-game preparations. We also learn from the new Winds of Winter Sansa chapter that Littlefinger is getting things ready too (of course, as Master of Coin he really should have been focused on this at the realm level instead of selling royal debt the whole time).

One other thing. My friend Jack has this to say:

The savings problem is precisely why the Lannister-Tyrell schism of A Feast for Crows and A Dance with Dragons is so important.

The Tyrells came into the War of Five Kings very late so they still have much of their military, agricultural, and economic might, and Cersei just alienated them by having Margaery thrown in jail for adultery and treason. This is happening at the same time that Winter Is Coming and Aegon is taking castles in the Stormlands.

So Martin is likely to do something with this in coming books. I hope he takes it seriously. So far, I have a hard time making sense of the behavior of some of these houses.


UPDATE: Matthew Klein notes, "the food isn't grown in the North. If anything he should have focused on evacuating his subjects down to Dorne." Good point. Getting out of the North seems like a decent priority.

Tuesday, April 7, 2015

Public earnings buying private firms

A few weeks ago there was a story that caught my interest, and I'm just now getting time to blog about it. The amazingly entertaining and informative Matt Levine pointed us to the NYT story:

Big money managers including Fidelity Investments, T. Rowe Price and BlackRock have all struck deals worth billions of dollars to acquire shares of these private companies that are then pooled into mutual funds that go into the 401(k)’s and individual retirement accounts of many Americans. With private tech companies growing faster than companies on the stock market, the money managers are aiming to get a piece of the action.

I think this is a cool story for two reasons. First, I've complained before about the inability of small investors to own young, non-public companies in a diversified way. Unless you're an accredited investor, you can't really get into venture capital or private equity (and even if you could, then you'd have to pay huge management fees). The only way for me to own non-public firms is to start one, and then I won't be diversified. But we know that private firms are different from public firms, so holding a diversified basket of public firms isn't really owning the whole economy (by the way, this is what annoys me about Buffett's "favorite stock market indicator"). For one thing, public firms are almost never young--that NYT comment about "private tech companies growing faster than companies on the stock market" has probably always been true and is probably true in other industries. Since young firms are the ones growing quickly, leaving them out of your portfolio seems nontrivial (with all the caveats about how the bulk of them actually have zero growth potential). Levine points out a complaint some people have about this:

One worry is of course that the big investment professionals might lose money on these investments, since the professionals are perhaps not experts at private company investment, and since the investments are made at pretty fancy valuations. My view is that you can lose money on public investments too, and there are lots of reason not to worry too much about your pension being invested in Uber.

We already know that professionals aren't great at picking public stocks--or, at least, their abilities aren't paying off for their investors. So I don't have a reason to think they're any worse at picking private ones. But I admit that this is way outside of my wheelhouse; I just think it's interesting that these vehicles for investing in private firms are being made available to regular people. That's sort of how I've always thought of Berkshire Hathaway, by the way.

The other reason I find this story interesting is that J.W. Mason has done this interesting empirical work (I discussed it here) documenting a declining propensity to reinvest earnings among public firms. Mason's empirical facts are interesting and persuasive; what I found less persuasive was the conclusion that he was drawing from them: that this trend hurts workers. I don't think we know that yet because that depends very much on where the money is actually going. I'm a macro person, and macro people are pretty obsessed with aggregation identities and general equilibrium stuff, and I don't see Mason's story happening in general equilibrium. He asked me on Twitter what he could do to make his story convincing, and I think the answer is that he could try to trace where that money is going. If it's going under rich peoples' mattresses, or if it's being set on fire or thrown in the ocean, then his story might have legs. Though I think the mattresses thing isn't out of the question, I'm still pretty skeptical of that theory. This story about earnings being invested in private firms seems like one piece to the puzzle.

Thursday, April 2, 2015

Establishments ≠ Firms (guest post)

By Ian Hathaway


I recently read a paper that took an innovative approach to at least partially answer a question that is boggling the minds of many economists and other observers: why has the firm formation rate declined precipitously the last three decades? I think it’s one of the most important topics in the economics profession today, and warrants a great deal of continued research in the coming years.

Aside from liking what was new about this paper, something else stood out to me—something I’ve seen before. The paper itself isn’t important here, so I’m not going to reference it explicitly—I’m not one to needlessly criticize someone else’s hard work, particularly when doing so isn’t central to the argument I’m trying to make.

The paper analyzes the relationship between, let’s say variable X, and the “startup rate,” defined as the rate of new establishment formations, not firm formations. This was done, presumably, because data on the former are much easier to obtain. But firms and establishments are not the same, and evidence suggests it has increasingly become important to distinguish between the two.

In research published last year by Mark Schweitzer, Scott Shane, and myself, we showed that the source of new business establishments is increasingly coming from existing firms, or what we call “new outlets”:

Figure 1: Distribution of New Establishments by Type (1978-2012)
Source: Census Bureau, BDS; author's calculations
Click for larger image

Furthermore, because new outlets are generally larger than are new firms in terms of employment, economic activity at new business establishments (as measured by employment) occurs in no small part in new outlets:

Figure 2: Distribution of Employment at New Establishments (1978-2012)
Source: Census Bureau, BDS; author's calculations
Click for larger image

This is something that is not occurring in isolation. The data show that this trend has happened in each broad industrial sector (9 SICs sectors) and across each state (data are not available at the metropolitan area level) during the last three and a half decades:

Figure 3: Share of New Establishments that are new Firms by Sector (1978-2012)
Source: Census Bureau, BDS; Author's calculations
Click for larger image

Figure 4: Ratio of New Firm Share of New Establishments in 2012 over 1978 by State
Source: Census Bureau, BDS; author's calculations
Click for larger image

Among the sectors, the shift from new firms to new outlets as the source of new business establishments was greatest in finance, insurance, and real estate, the very broad transportation and utilities (which includes communications) sector, and in construction. Agriculture, retail trade, and mining saw the smallest changes over the 34-year period—but changed nonetheless.

For the states, the chart shows the 2012 new firm share of new establishments over that same share in 1978. Since the data are sorted by largest ratio at the top, states experiencing the smallest shifts from new firms to new outlets as the source of new business establishments are at the top, while those witnessing the most change are at the bottom.

In short, the importance of new outlets to the formation of new establishments has grown steadily and significantly during the last few decades, and this shift has occurred in each of the broad industry sectors and US states. As a result, studies that substitute new establishments for new firms—including when exploiting industrial and geographic differences—are increasingly using less precise estimates over time.

Ian Hathaway is a Nonresident Senior Fellow at the Brookings Institution. You can follow him on Twitter @IanHathaway.

Saturday, March 21, 2015

How should we study the economy?

Schumpeter's approach:

We shall proceed as the physical sciences do in those cases in which it is impossible actually to isolate a phenomenon by producing it in a laboratory: from our historic and everyday knowledge of economic behavior we shall construct a "model" of the economic process over time, see whether it is likely to work in a wave-like way, and compare the result with observed fact. Henceforth, therefore, we shall disregard not only wars, revolutions, natural catastrophes, institutional changes, but also changes in commercial policy, in banking and currency legislation and habits of payment, variations of crops as far as due to weather conditions or diseases, changes in gold production as far as due to chance discoveries, and so on. These we shall call outside factors. It will be seen that in some cases it is not easy to distinguish them from features of business behavior.

He goes on:

All we can do about this here is to recommend to the reader to hold tight to the common sense of the distinction and to consider that every business man knows quite well that he is doing one kind of thing when ordering a new machine and another kind of thing when lobbying for an increase of the import duty on his product. It will also be seen that many of the things we list as outside factors are, when considered on a higher plane and for a wider purpose, the direct outcome of the working of the capitalist machine and hence no independent agencies. This is surely so but does not reduce the practical value of the distinction on our plane and for our purposes,

Thursday, March 19, 2015

Straw man "economists"

"If Economists were Right, You Would Have a Raise by Now" is the title of an article by Peter Gosselin and Jennifer Oldham. I gather from the address bar that a previous title may have been "Your wallet isn't getting fatter as economics 101 comes unhinged."

What mistaken Econ 101 idea that economists embrace is to blame for this epic failure?

One of the fundamental axioms of labor economics, called the wage Phillips curve, says that, all else equal, lower unemployment leads to higher wages.

A lot of economists would be surprised to know that economists believe in the Phillips Curve (and that it's all about wages, but that's not my complaint). More broadly, on the first Friday of every month I see a flood of tweets about how puzzling it is that employment is growing while wages aren't rising (or are rising too slowly). I want $1 for every internet/press claim about Thing A violating Econ 101 when Thing A is perfectly consistent with Econ 101.

The article was published by a top economics news outlet! The Phillips Curve is a good example of what happens when you don't take economic theory seriously. The Bloomberg article is a good example of what happens when you write about what economists think without actually knowing what economists think.


Another event this week reminded me of this odd obsession some people have with criticizing bogus caricatures of economics. Look at this tweet:

Click for larger image


"Relentless insistence on the idea that . . . the economy will self organize into a state which has satisfactory welfare properties. . . . It has become an assumption." Anyone remotely familiar with mainstream economics knows this is, by any reasonable standard, misleading if not totally false. To the contrary, discovering and describing market failure accounts for a significant portion of economic research. Noah Smith has some nice thoughts on this.

I pointed this out to the tweeter, who responded:

2 approaches:
1. Assume benchmark state is perfect markets and distort your models until they resemble reality.
2. Assume economy is complex and adaptive and watch its history, derive analogies to disequilibrium systems.

Notice the sleight of hand: We started with the claim that the economics profession totally ignores market failure. When I pointed out that the claim is false, we moved to a different complaint: the Rethinkers don't like the way we study market failure. Why not say so in the first place? Click here for another example.

The sleight of hand leaves me with questions about motives. The problem with the critics of macroeconomics is not that macro is perfect as is. It's not. The problem is that they so often start with inaccurate portrayals of what people in the field actually believe and do. Progress in the discipline isn't going to be made this way. Note that this problem exists even within mainstream econ, see e.g. here and here.

Just as politics isn't about policy, perhaps demanding reforms to economics isn't about reforming economics.

Monday, March 16, 2015

Isaac Brock on research and teaching in economics

Well, he might actually be talking about songwriting, but it seems to apply reasonably well:

The method is this: Small ideas? Don’t hone in on them too much. If they seem too specific, too dead on, if your point is too on the nose, you’re going to lose the opportunity to have a lot of people get your point. Change it. Find a way to make what you’re saying matter to people without saying too much at all. Allow everyone enough imagination and ownership of coming to something themselves. They could come to something better, which would be great. They could come to something worse, which is dangerous.
So don't use too many of the big words you learned in college. The interview is here.

Tuesday, March 3, 2015

Straightening deck chairs during the "retirement crisis"

Here's Eduardo Porter:

On average, a typical working family in the anteroom of retirement — headed by somebody 55 to 64 years old — has only about $104,000 in retirement savings, according to the Federal Reserve’s Survey of Consumer Finances. . . . 
The standard prescription is that Americans should put more money aside in investments. The recommendation, however, glosses over a critical driver of unpreparedness: Wall Street is bleeding savers dry. 
“Everybody’s big focus is that we have to save more,” said John C. Bogle, founder and former chief executive of Vanguard, the investment management colossus. “A greater part of the problem is the failure of investors to earn their fair share of market returns.”

So people are approaching retirement with $104,000, and "a greater part of the problem is the failure of investors to earn their fair share of market returns." What are we talking about? Bogle and Porter suggest that the real problem is about active vs. passive management.

I'm not kidding. That's what the article is about (despite its title).

This is what I'm talking about when I say that the early retirement people have shown that the emperor has no clothes. Do Porter and Bogle really want us to believe that the main reason people are trying to retire on $100 grand is that they haven't made sufficient use of passive funds?

Really? Really?!

I'm as big a fan of passive management as anybody, but this is totally absurd. This sort of logic is straightening the deck chairs on the Titanic. What would the average nest egg be if everyone had chosen the right fee structure and asset allocation? Whatever it is, it's not going to get anyone very far in retirement, particularly if they're accustomed to spending money at the kind of rates that lead to having such a small stash at that age. Porter and Bogle even reveal the real problem with their own example:

Assuming an annual market return of 7 percent, he says, a 30-year-old worker who made $30,000 a year and received a 3 percent annual raise could retire at age 70 with $927,000 in the pot by saving 10 percent of her wages every year in a passive index fund. (Such a nest egg, at the standard withdrawal rate of 4 percent, would generate an inflation-adjusted $37,000 a year more or less indefinitely.) If she put it in a typical actively managed fund, she would end up with only $561,000.

But even $561,000 would be a massive improvement on the status quo, and we're talking about someone who started at $30,000/year. Where's the example where active management reduces a $927,000 nest egg to $104,000?

By all means, don't throw your money away on active management, and don't waste your time trying to pick stocks. That stuff matters at the margin. But that particular margin is insignificant compared to the problem of low savings rates. And the early retirement people have shown that almost everyone could easily hit a higher savings rate. The journalists who tell people that the problem is the banks, or the government, or stagnating incomes, or anything other than savings rates are doing people a huge disservice (see MMM on this topic).

I understand the urge to do something about Wall Street misleading savers. I understand the role that journalists can play in showing people that they're getting duped; I even understand why some people want the President of the United States to do something about this. But if Porter's readers are relying on changes in banking or policy to save their retirement, they are totally screwed.


UPDATE: First, check out the comment by "ed" in my comments section. Second, Noah Smith responds:

Ryan is wrong to say that this makes Bogle and Porter's argument invalid. Actually, Bogle and Porter have a good argument.

Noah then proceeds to explain how switching from active to passive management is basically a free lunch, allowing people to have higher total lifetime consumption without having to save an extra dime. I agree! But Noah isn't reading me--or Porter--very carefully.

I'm not saying that switching from active to passive management isn't worthwhile. Do it! I'm a huge fan of Bogle, and all of my retirement savings is in Vanguard passive funds. I'm also not saying that people should want to have larger nest eggs. Rather, I'm responding to Bogle and Porter's actual argument. Porter's piece isn't just telling people to switch from active to passive. Porter and Bogle are selling passive management as the solution to huge shortfalls in retirement saving. Let's see what they actually say:

That’s not nearly enough [meaning, the average nest egg of $104,000 isn't "enough"]. And the situation will only grow worse. . . . 
The Center for Retirement Research at Boston College estimates that more than half of all American households will not have enough retirement income to maintain the living standards they were accustomed to before retirement [this seems to be Porter's definition of "enough"]. . . . 
The standard prescription is that Americans should put more money aside in investments. The recommendation, however, glosses over a critical driver of unpreparedness: Wall Street is bleeding savers dry.

The context suggests that "prescription" here refers to the remedy for massive shortfalls in retirement savings. Noah is annoyed because it looks like I'm telling people that they should want to save more, when maybe they're actually happy with their current rate of savings. But I'm not doing that. Porter is starting with the assumption that nest eggs are far too small. I'm taking his premise as given and simply pointing out the obvious: if people want to "have enough retirement income to maintain the living standards they were accustomed to before retirement," switching from active to passive isn't going to do it for them. Porter isn't just saying that passive management is a good idea; he's portraying it as an alternative to saving more if people want to have his definition of "enough" retirement money.

It's a pretty simple point. I'm not moralizing about whether people should have a huge nest egg. I'm just saying that if they want a huge nest egg--which Porter and Bogle are clearly taking as given--then the only prescription that can get them there (compared with the current average) is more cowbell, I mean saving. If you're happy being poor in retirement, by all means don't change your savings habits--and keep your stuff in passive since it's basically a free lunch compared to active. But if you want a lot of retirement money, you need to save more. That's a much higher priority than getting the fee structure or asset allocation just right.

Noah's other argument is that telling people to save more is assuming we know better than they do what they want. If they don't want to save more, stop moralizing! It's ok to tell them to switch from active to passive because they may have been making that choice based on limited information or behavioral blinders. That's fine. Again, I'm taking preferences as given--Porter is the one assuming that people want larger nest eggs, and I'm just pointing out the unpleasant fact that if we think $104k is several hundred thousand dollars too little, reducing fees isn't going to suddenly give us enough.

Moreover, we can just as easily justify the save-more moralizing in terms of limited information: Maybe people are making their current savings decisions because they actually think they are on track for a big nest egg. Maybe part of the reason for this misconception is that people like Porter keep writing articles telling everyone that it's not their fault their nest egg is tiny--if only they'd used Vanguard they'd be sitting on a million bucks! Showing up for retirement with $100k in the bank then complaining that fees kept you from having your pre-retirement living standard in retirement is like losing a basketball game by 60 points then blaming the loss on the referee because he called one too many fouls on you. The ref should make accurate calls, but you just needed to make more shots.

I'm also responding to a broader sentiment suggesting that it's impossible for the middle class to have enough money for the retirement they want. It's all doom and gloom about how the middle class is totally screwed by forces beyond their control. But Bogle's own numbers in the Porter article reveal that even people on low income can accumulate a large amount of savings in time for retirement by putting away just 10 percent of their income. Maybe Noah is right and people are happy with tiny nest eggs. Or maybe Porter and Bogle are right that people want more. I don't care who is right: either way, the doom and gloom stories are misguided.

The bottom line is that it's hugely misleading for Porter and Bogle to start from the assumption that people want enough retirement savings to preserve their pre-retirement standard of living, then to suggest that the main thing standing between having $104k and having the appropriate amount for the goal is active management. That's what they're suggesting (Bogle: "A greater part of the problem is the failure of investors to earn their fair share of market returns"), and that's what annoyed me about the article. Bogle isn't doing his job as an investment guru, and Porter isn't doing his job as a journalist.

Wednesday, February 25, 2015

Articulating my confusion: Shareholders vs. the real economy

Here's an article by Lydia DePillis based on a study by J.W. Mason. Excerpt:

The years since the recession have given firms even more of an incentive to dispense cash rather than invest in growth: The Fed’s policy of keeping interest rates low has made credit cheap, and with weak consumer demand, high-yield investment opportunities have been scarce. So instead, companies have been borrowing in order to buy back stock, which boosts their share price and keeps investors happy — but doesn’t give anything back to the world of job listings and salary freezes, where most of us still exist.

DePillis (and/or Mason) blames the rise of a "shareholder-above-all philosophy" for the more-cash-to-shareholders trend. The article's headline (which was probably not written by DePillis) is blunt: "Why companies are rewarding shareholders instead of investing in the real economy."

We might call this partial equilibrium reasoning. Shareholders are not modeled explicitly. Firms can use their earnings in one of two ways: hire people, or make payouts to shareholders. Since shareholders are not modeled, the latter means throwing money outside of the economy. We might as well be setting it on fire. Regular folks like you and me will never see that money--all those corporate profits just disappear.

In general equilibrium, those shareholder payouts go somewhere. If the shareholders invest the money in companies (or loan the money to someone else who invests in companies), then this is just a roundabout way of doing what DePillis wants. The money might not be staying inside the firm that earned it, but it will find its way into some other firm. The fact that the reallocation happened suggests that the funds are more productive in the second firm than they would have been in the first firm, unless some sort of policy is distorting things.

Another alternative is that the shareholders spend the money. That boosts aggregate demand, right? Maybe DePillis and the other people who don't like what's happening here don't think more demand is good for regular workers.

But maybe the shareholders don't invest or spend the money. They put the cash under their mattress and it does nothing. That may be the case, but it would be very odd in light of the argument that all this flow of cash is happening because shareholders have become so powerful. Dictatorial shareholders demand that firms give them the cash, so that said shareholders can... do nothing with it.

So I don't understand the story, but the notion that money going to shareholders is money lost from the economy is fairly popular. I would like to see that modeled. In any case, the recommendation at the end is that politicians should have more power over credit allocation, which would not surprise Arnold Kling.


Monday, February 23, 2015

The early retirement movement

Many times on Twitter I have revealed that I am a huge fan of Mr. Money Mustache, profiled here and a million other places. For the unfamiliar, MMM is part of a movement ("early retirement extreme," or ERE) that basically says: most people in developed countries are rich by any reasonable standard; we can live a materially abundant, happy life on a tiny portion of what we are actually spending; as a result, it's possible to retire after only a few years of full-time work (depending on your wage, of course). Keynes was right, or at least he should have been: we can do the 15-hour work week but choose not to. A lot of people on the internet hate this movement because it runs counter to some popular political and economic talking points. My assessment of the debate is that MMM is winning handily, but that's not what this post is about.

I was reminded of this recently when Josh Brown tweeted about it ("Not sure how it's a badge of honor to substitute shampoo with baking soda so you can retire at 30. What are we trying to win here?"). I think Brown is missing the point. One need not make such substitutions to live a life that approximates what MMM has pulled off. Most of us are spending far more than necessary on cars, housing, restaurants, cable TV, the latest gadgets, clothes, and so on. We're riding the hedonic treadmill; MMM gets a lot of flack for suggesting that we might be just as happy--and far wealthier--if we step off of it. Learning to distinguish between wants and needs can be extremely valuable, even if you are happy with working until 60 or 70 or 80. But more generally, the MMM people aren't trying to "win" anything. Apparently Brown values the time he spends at work more than he would value more leisure, so clearly ERE isn't relevant for him. That's fine. MMM is just pointing out that some people have a different preference, and the growth of developed economies over the last century or so has allowed those people to get the leisure time they really want.


Price and quality dispersion

Following the ERE movement has made me think a lot about the relationship between price dispersion and quality dispersion. Here's Steve Jobs:

Most things in life, the dynamic range between average and the best is at most 2:1. If you go to New York City and you get an average taxi cab driver versus the best taxi cab driver, you’ll probably get to your destination with the best taxi cab maybe 30 percent faster. And an automobile; what’s the difference between an average and the best? Maybe 20 percent? The best CD player and an average CD player? I don't know, 20 percent? So 2:1 is a big, big dynamic range in most of life.*

This is a concept I think about a lot. I think Jobs is right; but the prices of various goods might suggest otherwise. Call it the Camry Concept. You can buy a car for $200,000, but in automobile functionality terms there is no way it is 10 times as good as a $20,000 Toyota. In my utility function, there is no car worth $200,000; once a car gets me from A to B safely, comfortably, and reasonably quickly, additional improvements to the machine won't be worth a lot of money to me, even though I would find them enjoyable. Watches are even more striking. You can buy a watch for $500,000. It will basically do the same things that a $100 watch does. The extra $499,900 is the price of prestige or some other benefit that is largely orthogonal to the ostensible function of the watch.

I don't judge preferences--all of this price dispersion is fine. I get utility from lots of things that others would find pointless. But one of the things ERE people do is focus relentlessly on functionality. This is not a lifestyle for the type of person who gets a lot of utility from high price/quality ratios. The concept can be generalized some. Does a $75 cable TV package provide fives times better entertainment than getting subscriptions to Netflix and Hulu Plus? Maybe, if you watch sports. Otherwise, probably not. The ERE people ditch the cable.


The "retirement crisis"

The ERE people have basically shown that a large portion of Americans should have no problem being ready for retirement. We can all think of obvious exceptions--things happen. But MMM has shown that a 30-year working life should be plenty of time to accumulate a lot of savings, even on below-median incomes. ERE is the solution to the retirement crisis, the student loan crisis, and probably a bunch of other crises--at least at the individual level. It's the Garett Jones approach to inequality:

So let's start training ourselves and our children to delay gratification, to forego that great sound system on the new car, to eat at home a little more often.

This approach might not be of much help to policymakers, but it's a pretty good solution at the individual level. It might prevent some of this sort of thing.


What if everybody did it?

A popular rebuttal to the ERE arguments is something like this: That's fine for you, but if everyone did it, the economy would collapse since nobody is buying anything. One of the founders of the movement (he goes by Jacob) has a note in response:

It is important to realize that a consumer economy in which people go to work in order to buy stuff is not the only form of economy. It is just the current one. 
Money can also be spent on productive assets, art, preserving nature, space exploration, eliminating hunger, maybe even eliminating war. It’s just that we've collectively chosen to spend it on cell phone upgrades, furniture replacements, fashionable vehicles, shoe collections, throwaway electronics, and so on.

I don't have a problem with the ERE people responding to the consumption question in this way. There is no economic law saying that two thirds of output must be spent on consumption (though some of the secular stagnationists seem to agree with the ERE critics...). But they're ignoring other important channels. ERE isn't just about less consumption; it's about less labor. Labor is a production input! Less labor means capital is less productive in the short run; in the long run, this means less capital as well.

When we do economic analysis of big economic changes, we have to think carefully about feedback mechanisms. We can sometimes leave everything constant when we ask what happens if a few people change their lifestyle preferences. We don't have that luxury when we want everyone to change. A useful way to think this question through is to use a model in which the relevant prices and quantities are allowed to adjust.

Suppose I take a little economic model off the shelf (for those who care, this is from page 40 of the McCandless RBC book, see description here; set depreciation=0 and set theta=0.33). This isn't the right model for the job, but I think it will illustrate the point. We produce stuff with capital (machines, buildings, whatever) and labor. We get utility (happiness) from consumption and leisure time. Think of two ways we can model the shift to ERE: people become more patient, or people increase their preference for leisure. Each concept maps directly to a parameter of the model (beta and B, respectively. Higher beta means more patient; higher B means more leisure preference).

Let's look at model steady state (long-run) outcomes for various levels of impatience and leisure preference. In the figure below, the X axis shows time spent working. The Y axis measures GDP. I plot lines for several different levels of patience, with higher beta meaning more patient (click for a larger image).


First, let's suppose the shift to ERE is all about an increase in patience. Then things look pretty good: increasing beta means more output for a given amount of labor. But ERE isn't about patience. It is explicitly about leisure time. We want to move along a given curve in the graph, not shift between curves.

Focus first on the black line. Reducing labor time from about one quarter to one tenth reduces GDP by about 60 percent (note: in this setup, all GDP is consumption in the steady state). We can even be generous: suppose we reduce labor to 10 percent while also raising beta to 0.99. GDP still falls by about 14 percent. That might be fine: in this model, all outcomes are optimal given households' preferences, so a change in output caused by a change in leisure taste doesn't bother anyone. But reason beyond the model a bit. Here's Jacob:

Money can also be spent on productive assets, art, preserving nature, space exploration, eliminating hunger, maybe even eliminating war. 

The space exploration and hunger elimination, at least, will require output. The chart shows a pretty reliable tradeoff between labor time and output--after allowing the economy to adjust thoroughly. We can somewhat mitigate the output loss through increased patience. But to keep output high, we need a really big increase in patience and/or a smaller reduction in labor supply. This is just a simple model, and the specific numbers aren't that important. What's important is that the ERE world is a world where a key input to production--labor--is supplied in lower quantities. The ERE strategy is to own productive assets--but those assets are less productive without workers, and in the long run that means fewer productive assets.

ERE works great in partial equilibrium. Mr. Money Mustache is very enthusiastic about how technology and general wealth have made his lifestyle possible. But if everyone did it, who would build the gadgets? Who would build and operate the machines that build the gadgets? Who would work for the companies in which MMM owns stock? The key point is this: the ERE world isn't just about people saving more. It's about people working less, and that's what kills it.

ERE works if we're willing to accept lower aggregate output than the counterfactual. I don't get the impression that the ERE people accept that. The robots can make it possible. Until then, it's not in the feasible set.

But that doesn't matter! Because not everyone is trying to do it. You and I can still do it, or at least get as close to it as we want.

UPDATE: Here is a model description

*This is from The Lost Interview; an abridged version is in Steve Jobs, page 363.