Wednesday, January 28, 2009

factors of production

Are slaves labor or capital?

I was just reading the introduction to Hayek's "The Pure Theory of Capital" — a book I fully expect not to finish — and he ultimately decides to use the term "capital" to mean "the total stock of the non-permanent factors of production". Presumably this includes some of "natural resources", insofar as those are depletable; I typically think of "capital" as something in which one can invest. (What "human capital" and "physical capital" have in common; each represents the devotion of some economic resources in the past to enhance production in the future. Natural resources I suppose represent a decision not to have depleted them faster in the past than we have. Perhaps Hayek's distinction makes sense.)

Of course, I can gear my slaves toward reproduction rather than production of something else, thereby enhancing my future stock of slaves. This isn't so different from human capital in general, though. In many ways, labor simply looks like a particular kind of capital. I wonder how fundamental the "factors of production" are, and how much they rely on ontology to be useful.

Monday, January 26, 2009

The Wealth and Debt of Nations

Consider an international economic system in which there is relatively little trade, and then it opens up to trade in goods and to mobility in one and only one factor of production. Assume the different nations have different total factor productivities, due to technology or institutions, but that such differences are factor-neutral. What one would see is that the mobile factor would tend to move toward productive nations, increasing (even further) the marginal product of the other factors in those countries, while reducing the comparative attractiveness of the now abundant factor in those countries. If domestic "supply" of factors is at all elastic, the domestic supply of the mobile factor should decrease as its supply from foreigners surges.

I just read a snippet suggesting that it is inappropriate or confusing that the wealthiest nation on earth should have become (based on net foreign investment) a huge debtor nation. That doesn't strike me as a paradox; it just tells me that capital is more mobile than labor.

Sunday, January 4, 2009

GDP as a welfare proxy

GDP growth is popularly spoken of as though it were the ne plus ultra of economic policy; if growth is high, policy is succeeding, and if it's low, it's failing. Exogenous effects aside, GDP is not a perfect proxy for what economists call "welfare", namely how well off everyone is. One illustration of the discrepancy was recently given by Mankiw; longer ago the misuse of GDP was decried by Bobby Kennedy*. The best defense of the use of GDP in these ways has been that, while it doesn't conceptually capture everything it should, it's likely to correlate with welfare, and that eras of high GDP growth tend to be better for welfare growth than other eras. (I've made this argument myself.)

As Robert Lucas noted, though, correlations can be true under certain policy regimes but not others; in particular, policy tailored to a historical correlation, by creating an incentive by policy-makers to optimize a single (imperfect) measure of welfare rather than (unmeasurable) welfare itself, is likely to reduce that measure's correlation with welfare. Just as a chandelier factory in the USSR, told it would be paid by weight for its product, produced the heaviest chandeliers in the world, the focus on a particular measure will optimize that measure, both in ways that optimize what it should be measuring, and in ways that do not. As Mankiw pointed out, it's possible to design stimulus that increases GDP but not welfare. If GDP is being optimized, those forms of stimulus will look like a good idea.

In every popular, simple, short-term policy model of the economy — I'm thinking in particular of a sticky-wages model for the effects of unexpected inflation, but I've also thought in the last couple days that this is likely true of a simple microeconomic analysis of Keynesian demand-pumping — a boost in GDP comes at the expense of welfare. Unexpected inflation reduces real wages, so that workers work more than they would prefer at that wage; a deficit reduces savings, boosting consumption at the expense of capital accumulation. Other sticky prices or other mechanisms that these models leave out might change things, and certainly a good argument for boosting GDP is the psychological effect it has — the recession-as-a-coordination-problem model — and I'm pretty sure that in both cases I give above, the GDP boost is first-order while the welfare loss is second-order, so that a small error of analysis is likely to change the qualitative outcome. Still, it seems worth remembering that there is a distinction, and worth occasionally asking whether something targeted at GDP as a proxy for welfare is actually welfare-enhancing or not. I'm not sure Keynesian stimulus usually or always is.

* I would quibble with some of what Kennedy says, e.g. that GDP counts "destruction of our redwoods and the loss of our natural wonder". A better welfare measure would subtract environmental losses; GDP does not include additions for them, but does include additions for products that entail those losses. In any case, his broad thesis is correct.

Friday, January 2, 2009

time-ordering and information-ordering

There is a famous puzzle, which some googling suggests is known as Newcomb's paradox, involving an expert on human nature (or something) who presents each player of a game with two envelopes, one of which the player knows to contain $1000. The player is permitted to receive either just the other envelope, or both envelopes; if this expert believes both envelopes will be taken, the second envelope is empty, while if the expert believes that only that second envelope will be taken, then it contains $1,000,000. After observing several other players, for each of whom the expert's prediction was correct, do you choose to accept both envelopes, or do you decline the $1,000 to take just the second?

My answer is that I take only the second envelope. I don't know what's going on in precise detail, but it appears to me that, one way or another, my decision is available to the expert when the envelopes are sealed. I apparently take my action after the expert acts first, but, the way the game appears to me, the information I have available when I act is circumscribed — I don't know what's in the second envelope — but the expert's decision is made knowing what I will do. The game, in information order, is that I make my decision, and then the expert places the checks, even though that is not the time-ordering of events.

There are a lot of situation in which uncertainty is of importance in economics, and it is very rarely the case that it matters whether the uncertainty is due to a lack of knowledge about the present or a lack of knowledge about the future. If you and I are stuck together for six hours, and we know that a football game has taken place during that time but that neither of us knows how it has gone, it is just as reasonable for us to bet on it at the end of six hours as at the beginning; in the former case we are betting on an event that has, in a time sense, already happened, but for which we are just as uninformed as if it hadn't taken place yet. Similarly, if I am about to have a test done to determine whether I have a genetic predisposition to some disease, it seems reasonable to ask an insurance company to provide me insurance against an adverse result, provided I don't initially know any more than the insurance company does, even though the genes are already there and the information in some sense already exists.

Studying actions of policy-makers or financial markets is invariably complicated by causal relationships running both directions in time; the stock market may rise because the economy is likely to improve in six months, but the economy may improve because the stock market rose. In that case, the effects likely reintensify their own causes — a "positive feedback loop" — but there are negative (i.e. stabilizing) feedback loops as well. Monetary economists speak of a "price puzzle" when one does a naive analysis of the effect of monetary policy on the economy, where tighter monetary policy seems to be followed by an increase in inflation for a short period of time; this is what one would expect if monetary policy is being done competently — the monetary authority should tighten policy when an increase in inflation is coming. Because the earlier event is being taken on the basis of anticipation of the later event, the causal relationship runs backward in time (though, in these cases, it runs forward as well).

I think the real-world solutions to a lot of game theory conundrums — incidentally, I've done less reading on this than I should — involve effects of this nature. People will work out that a repeated Prisoners' dilemma can yield cooperation, at least for a while, so long as future results are discounted relative to current ones, or some such, but, while time-preferences can be screwy and extreme, it usually seems to require too big a discount to generate the results you see in experiments (or real life), and almost certainly isn't in accord with how the agents themselves would describe their rationales. They might talk in moral terms, but it seems likely to me that a certain amount of what is going on is that people know that other people are somewhat cooperative, and — especially in real life — they believe they can tell "what kind of person" some counterparty to some arrangement is. Insofar as one can be read ahead of time, one is at least partially precommitted before the game formally begins.


I first used the term "microspeculation" to refer to people topping off their gas tanks in advance of a coming hurricane; clearly some of the demand for gasoline was being driven not by a consideration of immediate need as weighed against the current price but by the expectation that future needs could be better met now than at the price at which any gasoline might be available a few days later. The phenomenon is much more pervasive, though, in less blatant terms; many people will buy something because its price is lower than what they consider typical for the item, and, to the extent that this is rational, it is often on the presumption that one would like to consume some of the item occasionally at the given price, and that the given price is low relative to an alternative price at which one might be able to buy it at the future. Perhaps more clearly, someone will forego a purchase at a higher price than was expected, not because that price exceeds its value to the purchaser, but in anticipation of being able to get a better deal later. If the current price were expected to prevail for a long period of time, the buyer would be better off purchasing it immediately, but is holding off in speculation that the price will come down. By and large, microspeculation is characterized by its size (small), its pervasiveness, and by the lack of intention to sell; one is substituting a purchase at one time for a purchase at another time, rather than performing an actual sale on the visible market.

For goods that can be stored in a straightforward manner microspeculation can be effected through "stocking up" on an item at what seems to be a temporarily low price; insofar as an item cannot be stored, the only way this comes into play is in a taste for diversification over time. Consumption of fresh fruit, for example, may be more sensitive to price changes in the short run than in the long run because one can gain more pleasure from eating apples during some portion of the year if one is comparatively deprived of them the rest of the year than if consumption is steady. Canned fruit, on the other hand, can be more readily stored, and short-run price elasticity can be driven higher (relative to long-run price elasticity) because one can "stock up" in anticipation of rising prices; while the response of fresh fruit sales to price changes is limited to one's willingness to consume it now, canned fruit can be purchased now to be consumed later.

To some extent this is a question of technical substitutability; it is easy to turn a can of canned fruit now into a can of canned fruit tomorrow (just wait 24 hours), while fresh fruit will start to deteriorate, and can not be so substituted. This is different from the question of consumption substitution, but from the standpoint of the visible market, it looks the same, and any attempt to measure substitution of consumption is likely to include this as well.

While some price-stickiness is surely "behavioral", in the sense that it probably can't be put on a strictly rational basis, I imagine that a fair amount of price-stickiness originates in microspeculation on the part of market participants' responding much more elastically to changes in conditions than they might if they believed that every change was permanent.