Category Archives: Business

Economists: Incredibly Stupid for Smart People

The New Yorker recently (I am perpetually 4-6 weeks behind in my New Yorker, so I consider the March 1 issue to be recent) profiled Paul Krugman, the Nobel Prize winning economist and NY Times columnist. A section of this article made me realize that economists, despite being generally very smart and well-educated, are just incredibly stupid. And I say this as someone who was an econ major in college and very seriously considered going on for a Ph.D.

Krugman was exploring why there were geographic specialties in business: carpets produced in Georgia, cars in Detroit, technology in Silicon Valley, etc. This was an outgrowth of his work on international trade, for which he won the Nobel. He saw that once a company started in a place, an entire ecosystem built up in that place. Trained workers, relevant support businesses (eg. lawyers), and transportation infrastructure – all this tended to create an economy of scale which drew similar businesses to the area.

To this you undoubtedly say, as I did, “duh.” That theory just describes common sense. Which Krugman admits: he explained this idea to a non-economist friend “who replied in some dismay, ‘Isn’t that pretty obvious?’ And of course it is.” But Krugman was the first to mathematically model this common sense phenomenon. Before that, “because it had not been well modeled, the idea had been disregarded by economists.”

So just to be clear: even if a phenomenon is so obvious that my 16-year old nephew could figure it out, mainstream economists, all with Ph.D.s from Ivy League schools, choose to ignore it because a model for it doesn’t exist. No wonder the country just went through a financial crisis. We all knew there was a housing bubble. It was obvious to me and everyone I talked to that Starbucks baristas and migrant farm workers and cocktail waitresses can’t afford $750,000 homes. But the economists at Treasury and the Fed who were supposed to be watching this? Their models didn’t incorporate these sorts of housing hijinks, and so they ignored the gathering storm.

Economists: smart enough to understand Bayesian math, but too stupid to realize that meth heads can’t afford houses.

Taxes and Small Business

With tax day taking place last week, I’ve been thinking about the impact of taxes on the economy, and in particular about the conservative talking point that lowering taxes on small businesses will unleash growth and create jobs.

This is related to, but different than, another classic conservative point: that lower income tax rates will create more tax revenue. Regular readers know well my disdain for this theory (the Laffer Curve), which has never been supported by any research. Read my posts here and here to see more of my laughing at Laffer.

In the case of small business taxes, I decided to build a little model and see what impact reduced taxes would have. You can see the results below:

Reduced taxes on small business

In this case, we have the same small business generating $1,000,000 in annual revenues and $250,000 in annual pre-tax income. Right now, at a 40% tax rate, this business delivers $150,000 to its owner. If taxes were cut in half, to 20%, the business owner would make $200,000 instead. Now, our business owner might be forward thinking, looking to invest in his business, and use the extra $50k to hire a new worker. But more likely, he is going to use that extra $50k to put an addition on his house, or buy a new car, or pay his kid’s college tuition. In short, tons of small business owners are not going to use their tax break to hire people and expand, but rather to buy stuff.

Goldman Fraud and John Paulson

Finally, more than a year after the financial crisis began, the first legal action took place with the SEC charging Goldman with fraud. I don’t have much to say about the actual fraud charge, except that in prior cases like this, the first charge is rarely the last. Once discovery begins and subpoenas start being issued, all the dirty documents and emails start to come out, and the dominoes begin to fall.

I do want to talk about John Paulson’s role in this affair. Paulson was not charged with fraud, and rightly not: he didn’t misrepresent anything. From a legal standpoint, Paulson didn’t do anything wrong. But what he did – paying Goldman to create a security purely so he could bet against it – just feels wrong. As Daniel Gross of Slate put it, this is like paying a construction company to build a shoddy high-rise so that you can buy insurance that pays off if the high-rise collapses, which you know it will, because you built it out of crappy materials. I was discussing this with my friend Bark for Daddy yesterday, and I fully admit that I can’t logically make a case for why Paulson was wrong. But there is just something unseemly about it.

Although not only do Paulson’s actions feel wrong, but if you take a step back and look at the big picture, a case can be made that they really were wrong. Paulson, as much as anyone on earth, knew that we were in a housing bubble; that’s why he was betting so hard against mortgage securities. So when he paid Goldman to create a $1 billion security made up of mortgages, he was adding to the bubble, and he knew it. He knew investors were going to lose an additional $1 billion, just so he could make more money.

And make money he did: Paulson took home $3.7 billion in pay in 2007. And speaking of feeling wrong, the fact that hedge fund managers – individuals – are regularly making $1 billion per year is also unseemly. Yes, they are doing so by producing big returns for their investors, and working within the system, but then maybe something is wrong with the system. Scoring $1 billion paydays by simply trading stocks, compared to entrepreneurs who get rich by building companies, again, just feels wrong.

Great Attack on Tea Party

Some dude writing for Salon has a very funny article on why he likes tax day, and it features this outstanding quote:

The Tea Partiers represent the aggrandizement of paranoia, rage and self-pity into a political agenda. It is a “movement,” created by for-profit demagogues whose sole mission is to build audience share at the expense of honest debate about our common crises of state.

I think that pretty much sums up the movement in two sentences. For another great article about Tea Party activists who are taking aid from the federal government even whilst they denounce all government aid, click here.

Mother Nature vs. Capitalism

I was recently reading a transcript of a speech that theologian Sallie McFague gave on religion and ecology. In the speech McFague works her usual metaphor magic, discussing how language drives thought, and thought drives actions. Specifically, she called for a reimaging of the Christian worldview, from one in which the world is seen as a thing, a machine in which humans live, to one in which the world and the humans therein are seen as shared parts of a holistic body of God. This view – “that the world is from the beginning loved by God and is a reflection of the divine” – would forefront the inherent value of the environment and the religious importance of its conservation.

Interestingly, McFague claims that this reimaging is not new, but instead a return to a traditional worldview, held by Christians and non-Christians alike. The concept of earth as machine, she claims, “is an anomaly in human history, for until the scientific revolution of the seventeenth century, the earth was assumed to be alive, even as we are.” McFague is not calling for a return to pre-scientific thinking, in which we must appease tree spirits and illnesses are caused by foul humours (although the current use of medicinal leeches is totally cool), but rather a recognition that all of creation is equally part of God.

For McFague, the culprit is less the scientific revolution than the drive toward individualist consumption that the market economy has engendered. Consumption of goods is linked to consumption of the earth’s resources.

“From the time of Aristotle to the eighteenth century, economics was considered a subdivision of ethics; the good life was understood to be based on such values s the common good, justice, and limits. Having substituted the insatiable greed of market capitalism in place of these values, we are now without the means to make the qualitative shift in thinking that is required.”

While I would not be inclined to say “insatiable greed,” there is no question that a market economy is inherently consumptive and that it drives people to focus on the individual rather than the common good. McFague would have us work within the current system, but temper its impact on our behavior by changing how we think and speak about the world.

To McFague’s argument from metaphor I would only add that it’s not nice to fool mother nature.

Less Health Care Will Lower Costs

Interesting piece from the NY Times about how if we plan to cut health care costs (which EVERYONE agrees we have to do) it is going to mean changing the general view that more care is always better. The facts indicate that more care is often not better, and is certainly more expensive.

If you want to see a prior post about health care rationing, it’s right here.

Best Commentary Yet Regarding the iPad

From GigaOm, which notes that the iPad is cool, but does not yet have the killer app that makes it a game-changer.

NY Times Copies Me. Again.

This time on the theme that much of Wall Street innovation does not actually benefit society. I’ve written about that here, here and here. And in today’s Times Magazine, they note that the current Wall Street trading mentality more closely resembles a casino than the capital allocation function that Wall Street was founded to perform. I commented on the Times’ prior copying of me here.

Where Does Wall Street Add Value?

I had lunch today with a guy I share office space with. He is a partner at a small investment bank and has spent his entire career at various investment banks, helping companies raise capital. He is part of Wall Street, and Wall Street pays for his house and his kids’ private schools. And yet even this insider, when our conversation turned to proprietary trading and hedge fund, he remarked “What do those guys really add to society? They don’t build anything. They don’t allocate capital. They just make money from gaming the market.”

It’s true. When we discussed Renaissance Technologies’ 45% annual return since 1988, I noted that there are 90 PhDs, mostly in physics and computer science, working there. Think of the great things those guys might invent if they were trying to grow something other than their bank accounts.

Is Ireland Tougher Than America?

The Wall Street Journal wrote an article yesterday about the austerity measures Ireland has imposed to deal with its burgeoning deficit in the wake of its massive housing bust. Ireland’s current deficit is 12% of GDP, just behind Greece’s 12.7%, and not that far from our 10.6%. So what did Ireland do to address its budget deficit? Cut teacher and police salaries 15%. Reduced civil servant pay. Increased taxes across the board. People are having to skimp and make do as a consequence, but Ireland was also able to issue debt with a yield 150 basis points below Greece’s recent issuance. Ireland did what needed to be done.

Contrast that with the US, which also has yawning deficits, at the federal, state and local levels. Can you imagine what would happen here if a politician suggested cutting police pay by 15%? The police unions would raise a shitstorm of fear about rising crime rates. Politicians would elbow each other out of the way to say who was “toughest on crime.” Hell, the police would probably end up with a raise. I’m not saying that cutting police pay is a panacea; what I’m saying is that spending is going to have to go down, and taxes are going to have to go up. And instead of posturing about being tough on crime, we need to do what is really tough: admit that the party is over and it’s time to cut back. If Ireland can do it, so can we.