Saturday, October 31, 2009

Interesting perspective on climate models

Over the last 100 years global temperatures have definitely been on the rise. So have greenhouse gas emissions. Theories have been developed linking the two. With greenhouse gas emissions on a steady upward trajectory as a larger part of the world joins the industrial age, soundfront lots on the coast might one day be oceanfront.

But climate models come in all kinds of different flavors and WSJ gave an interesting peak into their inner workings yesterday. The warming trend has flattened over the last 10 years, but the consensus among most climate scientists is that this is a mere blip before warming resumes. The models disagree on the role of such factors as changing ocean currents and cloud cover.

Why am I blogging about a discipline where I admittedly have zero technical expertise? One reason -- the parallel to economic models. Most macro models of the US economy use data that goes back 50-60 years; models for other countries go back much less because of data limitations. Models estimated over sustained periods of rising housing prices have difficulty predicting drops in those prices. Faulty models of housing were fed into models for financial markets and you know the rest of that story. It would be helpful to have a more open discussion about the uncertainty about climate forecasts in the coming months.

What does the GDP report really mean?

News that GDP grew by 3.5% in the third quarter is definitely welcome after four straight declines. A careful look at the major components in NYT and WSJ shows that stimulus has played a role. Consumption increased with a big help from cash for clunkers; investment grew because of an uptick in housing ($8k tax credits at work) and restoration of inventories. Net exports fell, whereas federal spending was up (no surprise there). More details are available in the Bureau of Economic Analysis press release.

There is still plenty of room for concern. Cash for clunkers boosted sales in the short term, but many economists (myself included) believe that the program merely accelerated purchases that car buyers were going to make anyway -- which is not good news for the next few quarters. The employment news continues to be bleak, as noted in a recent post. But +3.5% beats a negative number!

Wednesday, October 28, 2009

NYU b-school Dean Cooley on financial regulation

Must read column in Forbes on the future of financial regulation by Thomas Cooley, distinguished finance professor and dean of the Stern School of Business at NYU. Cooley first examines the question of whether commercial and investment banks should be re-separated a la Glass-Steagall. Although this would help on some dimensions, Cooley argues that it does not solve the central problem:

The real issue is that some institutions expose the entire financial system to risk by decisions taken within a single firm or business unit. That is what systemic risk is--it pollutes the financial commons. Making financial institutions smaller or simpler doesn't really address systemic risk. It may make it easier to identify, but it doesn't fix the problem.
For the past year, Cooley has been advocating the approach proposed by Ben Bernanke:

... they are discussing the "polluter pays" principle that I have been writing about for over a year as the way to think about systemic risk. On this view, the way to discourage the accumulation of systemic risk is to measure it, price it and make firms pay for creating it.

Tuesday, October 27, 2009

Two reports on how labor markets are changing

From an employee perspective, not for the better. Although there is evidence that output grew in the third quarter, firms are in no hurry to start hiring again. There are a number of factors behind this: some firms will raise hours per person to economize on training costs and employee benefits; others will emphasize increased efficiency; many have concerns about the duration and strength of the upturn; and no small number are worried about the potential outcomes in Congress with respect to health insurance regulation (can we stop using the word reform here?) and cap-and-trade. A recent WSJ article reports on how various firms are responding; the good news locally is that Cree is adding 275 positions. The article also has some interesting ideas about service innovation at the Sheraton Maui.

Obama's chief economics advisor Larry Summers developed a theory of long term unemployment called hysteresis back in the days when he was a Harvard economics professor. In a nutshell, this theory says that the longer a person stays out of work, the lower the odds become that he/she will ever work again as skills become outdated and the work ethic deteriorates. Summers used this theory to explain the persistently high unemployment rates observed in most European countries in the 1990s. Could the US be looking at the same situation in the 2010s?

Another recent WSJ article reports on how the recession might have permanent effects on the relationships between employers and workers. We all know about firms (including state government) that have cut health benefits, reduced contributions to retirement plans, and eliminated other benefits such as employee education. Some companies and governments have reduced pay. In economic terms, employers appear to be taking steps to make labor more of a variable cost than a quasi-fixed cost. Hiring caution, benefit cuts, more contingent pay and lower salaries -- as one Unisys engineer was quoted "You've got to take care of yourself."

My take: the answer depends on the overall state of the labor market. If there is a robust recovery, then labor shortages will develop and employers will have to adjust. Remember -- employers instituted health, retirement and education benefits for two reasons: to attract and retain talent and to provide some tax-free compensation. But if the labor market gets a bad case of hysteresis, to paraphrase Bette Davis in All About Eve: "Fasten your seat belts, it's going to be a bumpy ride."

Sunday, October 25, 2009

"Superfreakonomics" on global warming

The sequel to the best-selling "Freakonomics" by Chicago economist Steve Levitt and journalist Stephen Dubner is about to hit the shelves. Their last chapter deals with global warming, and apparently a major storm has broken out in the blogosphere over their conclusion that more attention needs to be paid to geo-engineering as a solution. Levitt and Dubner's blog on the NYT website summarizes their conclusions. For a critique, check out Paul Krugman's blog on the same website.

Who pays the bill for "too big to fail" banks that fail?

Lots of discussion going on in various circles. Paul Volcker (former Fed chairman) and Mervyn King (governor of the Bank of England) have been pushing for regulations that essentially would restore the Glass-Steagall regulations separating commercial and investment banking. The former would be regulated and insured; the latter would be "let the buyer beware." In practice, FT columnist Martin Wolf points out that it would be very hard to separate the safe from the risky business lines in today's financial institutions. Thought: weren't mortgages thought to be safe, nonvolatile investments not too long ago?

Ben Bernanke proposed last week that we should have privately funded insurance to bail out banks whose failure would endanger the entire financial system. The model would be the Federal Deposit Insurance Corporation, which levies fees on banks to protect consumer deposits up to $250,000. Of course bank customers would end up paying these fees, but Congress might be happier with that compared to the alternative -- another bailout.

Local reaction to rules on banker pay

Some interesting quotes last Friday in the News & Observer from local CEOs about the proposed regulations from the Federal Reserve Board on banker pay. Jim Beck, CEO of TrustAtlantic Bank (and a member of the College of Management's Board of Advisors) makes an analogy to military or classroom justice: "Don't punish the class. Punish the guilty parties." Mike Carlton, CEO of Crescent State Bank said some oversight on pay could be warranted for banks with financial difficulties, but considered the new rules excessive for most financial institutions. My take: this is certainly a big step for the Fed to be taking; shouldn't they be spending their time on leverage ratios and reserve requirements?

Thursday, October 22, 2009

Killing the golden goose

Great WSJ op-ed by MIT president Susan Hockfield on how our immigration policies are going to limit growth and innovation in the future. The majority of our new PhDs in the sciences and engineering are born overseas and increasingly they are returning to their home countries rather than staying in the US. A further problem: the US is losing its advantage in education to other countries (other countries are ramping up higher education, whereas US enrollments are stagnant). Hockfield supports policies that would encourage more Americans to get science and engineering PhDs while at the same time allowing more foreign graduates from our schools to stay here after they graduate.

True story: in the Czech Republic two years ago my wife and I had a cab driver who said he was being allowed to immigrate to the US because he had family in Chicago. Do we really have all of the scientists we need, but happen to be short on cab drivers?

Health care in Singapore

Interesting article in Tuesday's WSJ about health care in Singapore, which spends 4% of GDP on health care (vs 15%+ in US) and gets comparable outcomes. A couple of interesting differences: (1) more weight is given to consumer choice via required medical savings account and different levels of hospital rooms (same care in all levels, but if you want to save money you can give up some privacy) and (2) a greater role for competition between doctors and hospitals for patients (although not much detail in the article on how this works). Procedures cost about one-third of their level in the US. I am sure there is more complexity that this article omits but this is a good example of using global comparisons to gain insights into our own system.

Should we limit bank size?

Columbia Business School professor Charles Calomiris says there would be some issues if we were to do so in Tuesday's WSJ. Calomiris points out that financial firms need to be larger than ever to (1) serve the needs of large global clients, (2) take advantage of economies of scale and scope, and (3) make global financial markets more integrated and efficient. He concludes:

We can solve the too-big-to-fail problem without destroying global finance.

Tom Friedman on today's labor market

As we head further into the worst labor market in at least 30 years, some patterns are beginning to emerge. Something I keep hearing over and over again is that a college degree of any type is no longer enough. Whether it is undergraduate electrical engineers, MBAs, or law students, employers have never had so much discretion in hiring decisions. They can write the job description of an ideal job candidate and get exactly what they want without too much trouble.

In his latest NYT column Tom Friedman notes what the MBA program hears constantly from employers --

Those who are waiting for this recession to end so someone can again hand them work could have a long wait. Those with the imagination to make themselves untouchables — to invent smarter ways to do old jobs, energy-saving ways to provide new services, new ways to attract old customers or new ways to combine existing technologies — will thrive. Therefore, we not only need a higher percentage of our kids graduating from high school and college — more education — but we need more of them with the right education. ...

Just being an average accountant, lawyer, contractor or assembly-line worker is not the ticket it used to be. As Daniel Pink, the author of “A Whole New Mind,” puts it: In a world in which more and more average work can be done by a computer, robot or talented foreigner faster, cheaper “and just as well,” vanilla doesn’t cut it anymore. It’s all about what chocolate sauce, whipped cream and cherry you can put on top. So our schools have a doubly hard task now — not just improving reading, writing and arithmetic but entrepreneurship, innovation and creativity.

Tuesday, October 20, 2009

Two MBA items of note

Business Week has recently posted two articles of interest. One deals with the success (or lack thereof) that various schools have had in recruiting full-time students this fall. The top ten schools experienced surges in applications and had higher than expected yields over the summer, resulting in crowded classrooms. The experience at second tier schools was mixed and not nearly so robust. At Jenkins we were able to almost double the size of our entering full-time class, which I attribute to the program's affordability and technology focus.

The other article deals with every MBA's best friend -- the GMAT. In today's labor market, employers have become more choosy and a rising share are using GMAT scores to decide which schools from which to recruit and to decide which applicants to interview. So now MBA applicants face extra pressure to ace the test. Maybe some of these companies should just use the GMAT to make hiring decisions and save students the trouble of two years of lost earnings and tuition?

Tuesday, October 13, 2009

Using cash incentives to encourage fertility

Japan has a birth rate of 1.37 children per woman and near zero immigration. The demographic math is simple -- Japan is going to have a rising percentage of its population aged 65 and older. With declining numbers of citizens in their prime working years, who will pay for the social security and medical care of a rapidly aging population? Also who will service the massive debt that Japan has accumulated?

WSJ reports Japan's new government has decided to provide economic incentives to parents: cash payments of $6000 at birth plus another $3300 a year through age 15 plus state-supported day care and tuition waivers. Japan is not the first country to go this route and, to date, the evidence of its effectiveness is mixed. Wonder why?

Results have been mixed, dividing researchers who study government enticements. They generally agree on one point: Money goes only so far. Other major factors governments need to consider, apart from a greater role for fathers at home, include the acceptance of working mothers and a supportive corporate culture.

Without other major changes such as shared responsibility for child rearing, "All the money in the world may not make a long-term difference," says David Coleman, a professor of demography at Oxford University.

The Nobel Prize in economics goes to ...

Elinor Ostrom of Indiana University and Oliver Williamson of UC-Berkeley. Ostrom's selection is unique for two reasons: she is the first woman to be recognized for the economics Nobel plus her academic affiliation is actually political science, not economics (true confession: I never had heard of her until the prize was announced yesterday). Ostrom is best known for her work on how resources such as pastureland and forests are shared by individuals in agrarian socieities; at least that's what the NYT and WSJ say. Williamson has long been rumored as a top-level contender for the award; he is known for his work examining behavior and incentives inside organizations as well as explaining the structure of organizations (e.g., should an electric utility with coal-burning generating plants own the coal mines that supply them?).

Wednesday, October 7, 2009

A tax credit for new hires

Today's NYT reports that a bipartisan consensus is building around a proposal to give employers a tax credit for new hires. The article reports that wages would be subsidized by 15% in the first year and 10% in the second year in a two year program. The basic economics is very straightforward, employers will hire more people than they would have in the absence of the subsidy and workers will end up with higher wages and salaries. In a severe recession, these might seem like deadweight loss triangles we could live with (at least at first glance), especially compared to the "cash for clunkers" program.

The most significant criticism of this policy is that it will pay many employers a bonus for something they would do anyway. To get a feel for the numbers, employment is about 140 million. For a new worker, this amounts to a 15% cut in the price of labor. Elasticity of demand for labor is about -0.5, so this is likely to result in a 7.5% increase in new hires. So if employers were to create one million new jobs in the next three months, the subsidy would create an additional 75,000 jobs. Of course the employers would collect the subsidy for all 1.075 million jobs, costing the Treasury roughly $8 billion (assuming an average labor cost of $50k), or a bit more than $100k per job.

For the same expenditure, the government could select 160,000 random unemployed persons and give them $50k each per year for two years. Of course we won't see that option discussed. As discouraging as this sounds, the taxpayer cost per job created/saved for the employer tax credit is actually very favorable, especially when compared to the Chinese tire tariff and cash for clunkers.

Tuesday, October 6, 2009

What to do with TBTF banks?

Stimulating piece in today's Financial Times by Harvard Business School professor Niall Ferguson (also has an appointment in the history department) about TBTF (too big to fail) banks. Professor Ferguson is quite disappointed with the proposals on the table (in both the US and Europe) to deal with these institutions. "Very strong government oversight" is needed, says Treasury Secretary Geithner -- but what does that mean and weren't we already supposed to have that before all of the bailouts? Ferguson's take:

This is moral hazard run mad – a system in which a few giant banks get to operate as hedge funds with a government guarantee that if they blow up, their losses will be socialised.

Ferguson's solution: make a credible commitment that in the future bondholders as well as stockholders will be wiped out the next time a big bank goes belly up. But can the Obama (or any) administration pull this off? How often does "this time we really, really mean it" work in other settings?

Monday, October 5, 2009

How economic policy gets made

Great story in this week's New Yorker that goes behind the scenes in the Obama administration and spills the beans on how key decisions about the stimulus package and the auto bailout were made. Fascinating reading for those interested in how serious academics like Christina Romer and Larry Summers interact with the politicos. The article also traces the intellectual odyssey of Summers over the last 20 years. MBA 505 students should note the use of multipliers in the discussion.

Friday, October 2, 2009

China closing in on Japan -- what does it mean?

Story in today's NYT reports that China will soon overtake Japan as the world's 2nd largest economy. This is happening for two reasons: (1) economic growth has resumed its rapid pace in China and (2) Japan's economy will flatline as rising standards of living are offset by depopulation (low birth rate and virtually zero immigration).

What does this really mean, however? Some caution is warranted -- after all, what did being the world's biggest auto company do for General Motors? It does mean that China will play an increasingly important role in global trade and finance. The US continues to be a significant borrower, so it would be wise to maintain good relationships so that the Chinese continue to buy dollar-denominated assets. A sharp rise in interest rates or a quick drop in the dollar would not help at this time.

On the other hand, everyone would do well to keep in mind that Chinese standards of living lag significantly behind those in Japan or even Taiwan. Click on the graph that accompanies the Times article to see how far China has to go in this dimension. American visitors see the modern marvels of the cities, which makes it easy to forget that China remains primarily agricultural.