End November Links

Hurricane hits 'just-in-time' economy & When the hoarding equilibrium sets in - couple of interesting posts on hurricane Sandy
The case for electronic money: The end of inflation and the end of recessions - negative interest rates! Quote: "And as a society, we shouldn’t want money to be a good store of wealth over the long haul: we need people to put their wealth to work, either directly or indirectly building companies to help the economy to grow, not burying piles of paper in the sand." Brilliant.
Fasullo and Trenberth Find Evidence in Clouds for High Climate Sensitivity & Solar storm as desert plan to power Europe falters - the worst news I've read recently...
Murphy's Law - Noah Smith takes on Tom Murphy's exponential economist meets finite physicist post (I did this months ago)

End October Links

Welcome back, McArdle, Will American innovation slow if we go "cuddly"? & Acemoglu and Robinson versus the blogs - interesting debate on how global innovation rate could change if America became more social democratic [e.g. does pharmaceutical innovation, which Sweden benefits from, depend on high payments from America's private healthcare sector?], rounded off with Noah Smith's devasting summary of the scientific method in economics. Instinctively I'm with Mark Thoma & Noah Smith on this.
Is unlimited growth a thing of the past? - more comment on the Robert Gordon slow growth paper, this time from Martin Wolf 
Hard money and gerontocracy - Noah Smith describes an interesting paper relating monetary policy to demographics
Why we have to win -  I wanted to keep this blog economics focused, and never intended to link to pro-independence polemics (whether I agree or not). So my continued linking to WoS pieces must be viewed in this light: another excellent piece, strong on the economic history of Britain since 1979, which chimes with my views that ending the Right-To-Buy is the SNP's finest achievement (I wish they'd also endorse a land value tax and explicitly support a higher revenue base for Scottish public services though - legislation this week to reduce empty properties discount on business rates is a move in the right direction though).
So far so good: the global carbon sink in 2011 - this is the best news I've seen for a while...
Small is beautiful - Link to Robert Barro's classic article that started the optimal country size literature.
What explains poor growth in UK? The IMF thinks it's fiscal policy - and the multiplier is big!
Things that aren't bubbles - clear and concise
Framing worker democracy - this contains a very disturbing statistic for our long term well-being: "Capitalists have largely ceased to be providers of capital.For most of the last ten years, non-financial firms, in aggregate, have retained more in profits than they have spent on capital equipment. And except for the recapitalization of banks, net share issuance has been small or negative in recent years."
What do people mean by helicopter money? - I still think Wren-Lewis is missing the distributive differences between helicopter money and QE+Fiscal Policy, but this is a good clear post.
Does the "Entrepreneurship Subculture" prevent big ideas? -  interesting: another mechanism for increasing returns from interaction & agglomeration not to suck us into a black hole of prosperity; and another contributor to `Great Stagnation' type theories.

End September Links

Arguments for ending microfoundations - this post has lots of interesting links to possible future developments in macroeconomic theory
Come on Bernanke, fire up the helicopter engines 
Post growth politics - more on the Robert Gordon slow growth paper, Chris Dillow speculating on political impacts.
The gold standard and economic growth - James Hamilton replies to Tyler Cowan
Predistribution - good, bad & unoriginal - Chris Dillow has an excellent (whether original or not) critique of Ed Milliband's latest witterings
A good point and bad point from Sumner - I think this post deals very effectively with a lot of the criticisms other (good) economists have of Paul Krugman. Basically Krugman's right - you might not always like or exactly agree with the way he's expressing it - but get over it.
The regional escalator - there're not many good Scottish independence posts (pro or anti) that go into economics, but there's a whole economic model described in this one.
Why-I am a macroeconomist: increasing returns and unemployment - Martin Weitzman is my hero
Inflation expectations: a feature not a bug - Krugman sorts out some more terrible economics reporting!
Paul Krugman asks a question: On the "Austrian" hatred of fractional reserve banking, paper money, etc. Weblogging - Essay length rant from Brad DeLong
Covert virtue - the signal that doesn't bark? - This has made me change my mind!

Universally populist nonsense

Quick post on the nonsense that both the UK LibDems and Scottish Labour have come out with in the past few days: why assume revenues are fixed and therefore that benefits paid to wealthier sections of society are benefits that cannot be paid to lower income sections of society?

The tax and benefits system has to be looked at as a whole and therefore, of course universal benefits are affordable - just raise taxes. A 1% tax rise on Alan Sugar's income would not only pay for his bus pass but also for many many other poorer pensioners' bus passes.

Further, looking at the efficiency and political economy of universal vs means-tested benefits:
# universal benefits are cheaper to administer
# universal benefits are associated with the unifying externality that wealthier sections of society are more likely to 'buy-in' to the welfare state. If 'your' taxes are not just to be given away to 'other' people, then perhaps you become more predisposed to paying your taxes and recognising the benefits of aligning the organisation of public services with whole population benefits rather than treating them as consumer services that an individual purchases.

Some good relevant comment:
# Chris Dillow
# Jonathan Portes
# Stuart Campbell

Never waste a crisis

With Arctic sea ice extent and volume reaching new lows (see here & here for volume, here for area & here for impact on British weather), it's surely a good time to publicise my latest working paper: A balance of questions: what can we ask of climate change economics.

End August Links

Rational overconfidence -  I like the 10 heads strategy for predicting a biased coin: your prediction will be biased, but given only a single prediction can be made, this is the optimal strategy.
Filters and full employment (not wonkish really) & HP filters and potential output (good description of HP filters - unconvinced by attempt to rubbish Krugman for essentially just sloppy language, and unconvinced as well by the rest of the post)
Heterodox and mainstream macroeconomics, The heterodox versus the superhuman representative agent, sector financial balances as a diagnostic check & Can heterodox economists constructively engage the mainstream?
Something big happened in early 70's; Producitivty growth: the long term; Is economic growth going down the drain; & American growth could be higher than the pessimists think - I'm very interested in this - has to form the basis for some future project or two...
Unemployment: a brief history

Michal Kalecki on the Great Moderation - another brilliant post from Interfluidity which links to the stability versus robustness trade-off of complex adaptive systems
Why are (almost all) economists unaware of Milton Friedman's thermostat?
Unit roots and pro-cyclical fiscal policy
Trade-offs between inequality, productivity, and employment  - this post is one of the most interesting ideas I've read about inequality and its effect on economic activity: utterly brilliant.
No theory X in shining armour - fascinating economic philosophy, I can think of objections though...
Innocent Bystanders? Monetary policy in the U.S. and inequality - this reinforces my priors: the so called 'Austrians' economic model just seems like nonsense to me. Also QE & Inequality: Don't blame the bank
Inflation target at 1.5% since 2008 - this is something that is not at all appreciated: the BoE is running tight monetary policy relative to it's policy objective (expected (not actual!) inflation = 2%)
House prices consumption and aggregation - a very clarifying post on relationship between house prices and aggregate consumption levels.
2014 v 2016: An open letter to Angus Robertson and all yes campaigners - Kevin Williamson hammers away at the conflation of SNP policy and policies that may be enacted in an independent Scotland. Can't be said often enough.
Austerity's not working - I don't know how many times it needs said, but this is a fairly eloquent repetition of the basic argument.
Why do we need to pay billions of pounds for big projects? - an excellent question! John Kay proposes that technological advances have reduced rather than raised productivity. Not sure, but very interesting...
The new gold rush - excellent point that in exploiting a non-renewable resource to maximise value, we should decrease production if current yields are lower than expected growth in prices. Related to my paper that presents a mechanism for growth in prices to be negatively related to future scarcity.
Neo fights (slightly wonkish and vague) - I love this put down of "Austrians" (and I think it applies also to other so-called "heterodox economists" - even though I'm inclined to agree with the policy prescriptions of some of these other heterodox economists whilst not at all with the Austrians): "They claim to reject neoclassical economics, but their alternative is not an alternative model but a lot of verbiage; they talk at the economy, and imagine that by so doing they achieve a higher level of sophistication and realism than economists who try to express their ideas in terms of little models. And they’re kidding themselves; all they’ve done is hide their implicit models and prejudices behind a dust cloud."
Arctic sea ice volume - scary stuff. Fitting a quadratic trend to Annual Minimum Sea Ice Volume from 1979-2011 and projecting forward, we get zero volume by 2017...

Songs in econ blogs

Economics blogs often feature the blogger's choice of music. For example Paul Krugman's aye posting Arcade Fire, Brian Ashcroft likes Julie Fowlis, and Tyler Cowan recomended King Creosote & Jon Hopkins. I'm not entirely sure why they do this: the fact that I enjoy their musings on economic policy or theory, surely doesn't provide any signal that we share musical tastes?

Therefore, in keeping with this practice, but instead of my picks being a musical recommendation, I'm posting songs with economic relevance:

• The central message of the new economic geography literature is that density is good. I think this can be nicely summarised by "Mmm skyscraper, I love you"

• Economic growth is usually modelled as being due to `technological progress'. And there surely cannot be a better description of the technological progress we have enjoyed over the past 2000 years than the lines: "If Jesus came to Earth today, They’d crucify him straight away, Upon a cross of `MDF', And they’d use `No Need For Nails' "

• More seriously... Is there a harsher description of Factor Price Equalisation than "They complained in the East, They're payin' too high, They say that your ore ain't worth diggin', That it's much cheaper down, In the South American towns, Where the miners work almost for nothin'."?

This is unlikely to be a regular feature...

Things I've Signed

A Manifesto For Economic Sense

Yes Scotland Declaration

End June Links

Abolish the equity premium now! - I like this sort of whimsy...
Krugman and Stiglitz: Our most widely ignored public intellectuals
Soros on the new German empire & Remarks at the festival of economics, Trento Italy
Fair enough: A Supply Side Liberal joins the Pigou Club, Carbon taxes won't work, here's what will & Henry George and the carbon tax
The disinflation will continue until morale improves
Peak oil and price incentives - an outstandingly good post from James Hamilton.
Stagnation and recession - sums things up brilliantly.
What's wrong with economics?
Stabilizing prices is immoral

Look beyond summits for euro salvation - Martin Wolf's analysis is fantastic: "the crucial elements would seem to be: clear plans for resolution of banks largely at the expense of creditors, instead of relying on recapitalisation by fiscally stressed states – an approach that would automatically share more of the pain between creditors and debtors; a strong commitment to symmetrical economic adjustment across the eurozone, instead of today’s debtor-focused adjustment; recognition by the ECB of its obligation to sustain demand; and enough conditional financing to give governments committed to reform the ability to manage their economies without entering calamity."
Fighting over claims  - the Stiglitz quote is outstanding.

 

The International Energy Workshop 2012

I attended the International Energy Workshop 2012 conference in Cape Town last week, presenting my paper on the possibility of an economy whose price levels respond to energy scarcity in such a way as to disincentivise the use of marginal energy resources and alternatives (and conditions for this to be true).

This conference consisted of a mixture of effectively three disciplines:

• The smallest set of attendees (it seemed to me) were engineering academics. Despite their small number, this group were well represented amongst the keynote speakers. Prof Filip Johnsson from Chalmers University in Sweden spoke on progress (not much!) of Carbon Capture & Storage deployment, and made the point that even if CCS is not ultimately needed for energy infrastructure, with current technology something like CCS will be needed for industrial CO2 emissions from e.g. iron, steel and cement industries, since these are process emissions rather than emissions associated with the energy that these sectors use. Prof Alexander Glaser of Princeton spoke on propects for nuclear (there will be no large scale early expansion, especially after Fukushima), with some focus on small modular reactors which could cut costs and mitigate proliferation and safety concerns. He did not think there were any short term imperatives to develop fast breeder technologies, and he did not mention thorium or fusion.  

• A major group both amongst the keynote speakers and the speakers at the parallel sessions were the energy modelling community. This work, as far as I understand it, takes energy demand and policy constraints exogenously, and uses large computational models (e.g. OSeMOSYS) of the energy sector to generate the optimum energy supply. These models are used in scenario analysis for reports for e.g. Rio+20 (Prof Mark Howells), IRENA (Dr Asami Miketa), IEA-ETSAP (Dr Uwe Remme), among others. A typical example of this type of work was Energy, economic and environmental implications of unconventional gas - Gabrial Anandarajah of UCL Energy Institute, which asked how the availability of cheap unconventional gas affects energy scenarios under various policies.

• Others, including me, are economists who work on energy or climate change issues. Amongst the keynote speakers, Prof Tom Rutherford of Wisconsin talked about one of his favourite energy economics papers: Hogan & Manne (1977) 'Energy-Economy Interactions: The fable of the elephant and the rabbit'. This paper makes the point that energy demand may be inelastic and so the contribution of energy to aggregate production cannot be determined from its current factor share: as availability falls to zero, the share of income to this factor of production may tend to 100%. Highlights for me from this group (other than my own paper of course!) amongst the parallel sessions were:

• A Consumer-Producer Model for Induced Technological Progress - Bob van der Zwann: This presentation was a good summary of theories of the learning curve, and how it can be decomposed. This has obvious applications to renewable energy given the large cost reductions that have been seen in solar: how much of these large cost reductions are due to learning-by-doing and how much are due to economies of scale and other factors?

• Funding low-carbon investments in the absence of a carbon tax - Julie Rozenberg: The idea is that if climate mitigation investments are a cost to this generation and a benefit to future generations (I don't think I accept this premise - it's possible that we, or our parents, are the richest generation - but taking it as given...) then an appropriate way to fund these investments is issuing certificates (creating money) and tightening monetary policy such that overall consumption for the current generation is unaffected. The certificates function as an investment subsidy for green technology whilst higher interest rates penalise other investments. The productive capacity of the future generation is adversely affected at the expense of the low carbon infrastructure. Therefore the future generation benefits from the climate change mitigation at the expense of its own consumption. This is quite a neat idea and a side effect would be that in present circumstances, with monetary policy at the ZLB, we get climate mitigation for free using otherwise unemployed resources.

• A multi-phase model of optimal transition to global climate stabilization - Adriaan van Zon: This is an endogenous growth and optimal investment model that derives optimal stabilisation paths given a climate threshold. I especially liked this because its approach is consistent with the approach I advocate in my paper 'A balance of questions: what can we ask of climate change economics'.

• Overlapping generation extension of DICE-2007 model - Andrey Polbin: The dispute between Nordhaus and Stern centred on the use of parameters that produced real interest rates consistent with those we observe (Nordhaus) or using ethically determined parameters (Stern). Using an OLG model allows agents to make consumption-savings decisions using their high private time preferences, but policymakers can set climate policy by maximising a weighted sum of the utilities of all generations where the weights use a very low, ethically determined, rate of time preference. We end up with a result that can match the observed interest rates and but is intermediate between Stern and Nordhaus in the level of optimal climate mitigation.

• When starting with the most expensive option makes sense - Adrien Vogt-Schilb: Reading off the optimal carbon price from a Marginal Abatement Cost Curve can be sub-optimal in that it may not take into account the time to deploy the various technologies. The current real-world example of this issue is the widespread advocacy for using gas as a low carbon "bridging technology" that will allow intermediate targets to be met, but which could lock us into carbon emitting infrastructure and prevent long term targets from being reached. The social planner's solution may be to invest in difficult and expensive mitigation technologies first, whilst saving some cheap and quick projects for later. However, any price signal that causes the decentralised economy to implement the difficult and expensive mitigation technologies from the outset, will mean that the quick and cheap technologies are also deployed immediately (therefore, it's not clear what the decentralised policy is that could implement the social planner's solution).

• Demand for gasoline is more inelastic than commonly thought - Tomas Havranek: This was a meta analysis of gasoline price elasticities which controls for publication bias. It produces a short run elasticity of 0.1 and a long run elasticity of 0.3. This compares with a previous study which did not control for publication bias which found 0.3 and 0.8 respectively. These results seem consistent with those reported by James Hamilton (blog & paper).

• Imperfect cartelization in OPEC - Samuel Okullo: This presentation described an ingenous model of OPEC where the relationship between the OPEC members could vary between a perfect cartel (where they act as a single supplier) and Cournot oligopolistic competitors. Given their available resources, and the external competition that they face, the optimal strategy of OPEC members is intermediate between a perfect cartel and a competive oligopoly. The model predicts that, in this optimum, Saudi Arabia sticks to its OPEC quota whereas other members overproduce - as is seen in the data.

Finally, here's a picture:

End May Links

Austerity has brought Europe to the brink again, particularly the line: "Normally, an individual helps his creditors by borrowing less; but a person who stops borrowing to finance commuting to his job does his creditors no favor."
Macro: Intuition vs Theory. The number of Noah Smith posts that I'm linking to is getting embarassing. I've no idea why I like the politically liberal, physics to economics switcher...
The incredulity problem, brilliant argument for general rather than partial equilibrium analysis.
Ex-President Bling-Bling, especially the starkness of the policy choice: "But this means, yes, overall inflation in the euro area significantly higher than the less than 2 % target. It certainly means a lot higher than the 1.5% the market currently expects. Don’t like that? OK, so no euro. It’s that stark."
The problem of living with capital-ism, this plays to my prejudices. I need to compare and contrast with the Ed Glaeser book "Triumph of the city" that I'm reading at the moment.
The left & shareholder activism
Is it all Gordon Brown's fault, which follows on from On major macroeconomic policy mistakes
The return of schools of thought in macroeconomics
The zero lower bound and output gap uncertainty
Inflation targeting is not working
Dangerous voices and macroeconomic spin & Cameron is consigning the UK to stagnation
What makes countries rich or poor? Jared Diamond reviews Robinson & Acemoglu's Why Nations Fail
The liberal Keynesian dilemma "Very few people are arguing for a big shift from current to capital public spending" - not sure about this? I'd argue that we certainly don't want to be cutting current spending in a depression (but if it's more than average revenues over the business cycle then it does need to be cut eventually) but the countercyclical boost to government spending should be predominantly capital spending. To at least some extent therefore, I would definitely argue for a big shift, at least in relative terms, from current to capital public spending.
State dependence and fiscal multipliers
The end of the Euro: A survivors guide
The riddle of German self-interest
Economists who don't do it with models
Mervyn King and the fiscal multiplier - I heard the interview on Radio Scotland of Spencer Dale (by Gillian Marles I think): it was another BBC Scotland can't do economics moment - all "inflation's bad" and "government deficits are bad" as self evident truths, true at all times and in all circumstances, that don't need questioned.
Balance sheet monetary policy a primer

Testing the Infallibility of Paul Krugman's Pontifications

Noah Smith says: "I could count on my fingers the number of times Paul Krugman has obviously been wrong about something, and still have enough fingers left to type 60 words per minute."

Well Krugman has outlined a couple of definite scenarios for how the crisis in the Eurozone may pan out over the next 6 months or so. We'll see if he's right...

End April Links

New Classical, New Keynesian, and Real Business Cycle Models
Demand or productivity? Do I agree with this? I think there is a supply problem due to lack of growth in energy inputs; but I don't think I agree with "the policy remedies are less likely to involve fiscal expansion" - am I being inconsistent?
From gold standard to CPI standard
A puzzler on statistical risk and fundamental uncertainty
Because the stakes are so small
Exponential economist meets finite physicist
Going it alone is the way forward
Depression is a choice & Two quick responses
Mo money, mo problems - I argued for negative interest rates 6 years ago though (though not very well (I was just wee) and in relation to conserving renewable environmental assets rather than fighting recessions) 
DSGE vs weather forecasting & Roger Farmer Response & Only ever equilibrium . See also Equilibrium Analysis & On Equilibrium, Disequilibrium and Rationa Expectations.
Plutocrats & Printing Presses
Neither real, nor business, nor cycles

Great Britain as a case study: which sticky price?
3 Arguments for NGDP Targeting & Why NGDP Targeting 

Economists need taught about physical constraints - but physicists need to learn about prices

Another excellent post from Tom Murphy entitled "Exponential Economist Meets Finite Physicist" is causing some interest. In the post the point is made that exponentially increasing use of energy is impossible, and that economic growth without energy use growth is difficult to imagine. These issues need to be more widely considered within economics, especially in these times of depressed output amid high energy prices. They are not simply for 400 years hence but are worth considering now - see relatively recent New Scientist article "How Clean is Green Energy?".

However certain points are made in the post that I don't think are justified and which are the sort of thing that is frequently stated without sufficient analysis at (informative and interesting) places like The Oil Drum and Our Finite World.

First of all, it is asserted that "If the flow of energy is fixed, but we posit continued economic growth, then GDP continues to grow while energy remains at a fixed scale. This means that energy—a physically-constrained resource, mind—must become arbitrarily cheap as GDP continues to grow and leave energy in the dust." This cannot be simply asserted - within most models it's simply not true, and the models in which it is true are the most unrealistic models (we would need elastic substitution of energy and other factor inputs but it appears that other factors can only substitute for energy on a very inelastic basis).

The baseline, first-order model of economic growth is the Ramsey model with Cobb-Douglas production and logarithmic utility (which the representative agent maximises in order to make consumption/investment decisions). If we suppose a constant returns to scale Cobb-Douglas production function with labour (fixed), energy (fixed) and capital (endogenous) subject to some exponentially growing productivity (*), then we derive a balanced growth path in which output, consumption and capital stock all grow at the rate of productivity growth (despite fixed labour and energy implying effective diminishing returns). The prices of the factors of production on the balanced growth path in this model are: constant for capital (i.e. interest rate is a positive constant); exponentially growing (at the rate of productivity growth) for energy and labour. This is because under Cobb-Douglas production, factors earn a constant share of output i.e. payments to energy are constant as a share of output, but the quantity of energy used is constant whilst output is exponentially growing: therefore energy's price must be exponentially growing.

So the first order model for describing economic growth predicts that if we had an economy with fixed energy inputs but positive economic growth, then energy prices would be growing, not falling. The post then relies on a floor for energy prices as it's mechanism in generating subsequent phenomena: but economic growth with constant energy input implies growing prices that do not run into this floor constraint, so the rest of the argument does not necessarily follow.

The post then also repeats various assertions that have been made for a steady state economy: "it’s not your father’s growth. It’s not ... , interest on bank accounts, loans, fractional reserve money, investment." I'm not sure where the idea comes from that a positive rate of interest on bank accounts relies on economic growth, but it's a meme that I've seen expressed before. It doesn't seem logical to me: a simple case is a model of generations in which the young work, consume and save (i.e. make loans) whilst the old consume out of their savings. These savings/loans are just pieces of paper so in reality the young work and their earnings provide the consumption goods for themselves and the older generation. The interest rate on the savings is just a price(**) that agents take when splitting their consumption from their own earnings into consumption whilst young and consumption whilst old - a high interest rate is perfectly compatible with a steady state economy if agents have a high rate of time preference. Fractional reserve banking likewise has nothing to do with economic growth. 

The post is fantastic at outlining an issue that economists have not grappled with, but in considering the economic impacts of the issue, the article makes clear a need for economists to provide some of the analysis!

(*) I'm not saying that this is a good model of long term growth, in particular I agree with this criticism of Noah Smith: "

Step 1: Take the parts of the economy you can't explain (i.e. the residuals) and label them either "culture" or "technology".
Step 2: Make ultra-confident pronouncements about the future behavior of culture and/or technology.
What I don't like, first of all, is that Step 2 just never makes any sense. The thing you are calling "culture" or "technology" is precisely the part that you couldn't explain with your models. Hence, it is the least likely thing for you to be able to predict going forward.
Admit it, economists: You don't know what is going to happen with technology. You don't know what is going to happen with culture. If you did, you would have included those things as endogenous variables in the model instead of simply labeling the residual."

(**) Though in steady state equilibrium it will be a positive function of both the growth rate and the rate of time preference.

Complex Systems

I've just noticed that Prof Yaneer Bar-Yam of the New England Complex Systems Institute replied to my letter (full version here) on the New Scientist's Limits To Growth article. I'm quite chuffed about this - Prof Bar-Yam is a big guy in the world of applying complex systems theory to the social sciences: for example see his recent (joint) paper on social unrest and food prices, incorporating speculators and biofuel production, which makes a definite prediction that "Policy actions are needed to avoid a third speculative bubble that would cause prices to rise above recent peaks by the end of 2012."

Naively, and certainly before I started studying economics, I would have guessed that the above paper would have been classified as an economics paper. It's not though: complex systems is a separate discipline, and although of interest to many economists, it's a difficult topic for economists to get involved in. (On a seperate but potentially related topic, I recently came across this record of correspondence that Prof Ken Judd compiled on his difficulties in getting computational work published.)

The basic problem as I see it is that the economics profession has collectively made a methodological decision to study how decisions are 'optimally' made. This is a perfectly valid choice for microeconomics, and it does a good job of constraining and disciplining our models i.e. we cannot just assume any old behavioural rule or heuristic.

It is much more difficult to conclude that this choice is valid for macroeconomics (see recent debate on microfounded models in macro), partly because of aggregation issues, but also because this choice actively gets in the way of studying what many people would regard as economics: the allocation of scarce resources, regarding human society as part of an ecosystem that is subject to the same rules of thermodynamics as any other ecology. Has it really been demonstrated that the growth of human society within the fixed boundaries of the Earth is any more rational and forward looking than the growth of bacteria in a petri dish?

End March Links

A sketch of a model of higher education
Scotland should be proud to stand alongside Ireland and Iceland
The worst type of parochial, faux 'internationalism'
Microfoundations in macroeconomics
Do illiquidity and sticky prices go together
how high gas prices triggered the housing crisis
Why quantitative easing is the only game in town
Is solar a bigger deal than people realize?
The future is another country
Tell us about the rabbits George
Regional pay the first step to fiscal federalism
How can debt affect potential gdp
Nonergodic model of business cycle
Partial equilibrium intuitions about choice - in particular the line "It is not incoherent to argue that a country might benefit from retaining talented people, and it is not even incoherent to argue that individuals who would choose to emigrate might in fact be better off themselves if they as well as all their compatriots could be persuaded to stay and contribute to development at home."
Zoning laws and property rights
Soak the rich
A rational reason for high oil prices - in particular the line "The question is not whether there is a rational reason for high oil prices, but rather whether there is a rational reason the world is not producing 100 million b/d today."

Agglomeration in action

Good news for Edinburgh and the renewables industry in Scotland with the announcement of a wind turbine manufacturing plant in Leith. This comes shortly after other relevant announcements: offshore servicing in Nigg in Easter Ross, green finance with the Green Investment Bank in Edinburgh; and follows on from news of other renewables manufacturing plants in Dundee and Methil, and renewables R&D facilities in Glasgow and Edinburgh.

As well as being fantastic news for jobs in Scotland, it is an example of economic theory in action - the theory in question being the new economic geography developed by Paul Krugman which predicts and explains clusters of related activity.

The worst policy prescription

Former MPC member Andrew Sentance, has an article in the FT today in which he recommends a 'leaning against the wind' policy of raising interest rates to curb that inflation whose underlying cause is an excess of demand for energy over the available supply. This is the worst advice imaginable and seems to be driven by (a) considering this as purely a problem of excess demand; (b) the assumption that interest rate policy has no impact upon long run supply (so that central banks can concentrate solely upon managing inflation expectations).

However, the world's oil supply has stagnated with essentially zero growth in supply since 2005. Alternatives are difficult and so we can expect an extended period with little energy supply growth. It's facile to state, as Sentance does, that the inflation is "responsible for the slowdown in global growth". This gets causality backwards: to first order, growth in output is only possible with growth in energy inputs. With constant energy inputs, we cannot expect growth in output, so strengthening demand has to lead to higher prices rather than expanded output. The supply restrictions have caused the growth shortfall and the rise in prices, rather than the rise in prices causing the growth shortfall.

If energy supply stagnation leads to higher prices, how should we respond? I would recommend whatever policy response leads to fossil fuel substitutes being incentivised as quickly as possible. Sentance's prescription is higher rates - does this work? Higher rates depress demand, lowering energy prices and hence lowering incentives to invest in fossil fuel alternatives. Higher rates provide a higher yield on alternative investments to new energy infrastructure projects, raising the hurdle rate that these projects must achieve, lowering the incentive to invest in fossil fuel alternatives.

Sentance has it backwards: raising rates may well be the appropriate response to inflation caused by domestically generated wage-price spirals, but it is completely the opposite response to that required to the problem of global energy supply stagnation. The fact that we are running into supply constraints needs to be strongly signalled through the price mechanism so that there are incentives to invest in mitigating technologies. Interest rate rises are a demand depressing response to energy supply constraints. Since energy supply constraints will get worse over time if we do not develop alternatives, a policy which causes a contraction in demand rather than stimulating an alternative supply is a prescription for long term decline.

Phase Changes in the Oil Market

There was a recent flurry of interest (see e.g. Skeptical Science and Dosbat) in response to a Nature article "Climate policy: Oil's tipping point has passed" (behind a paywall), the gist of which is that the oil market has undergone a 'phase change' from a market in which supply grew in response to price increases, to a market in which supply is essentially constant but "prices swing wildly" in response to demand changes. See diagram below. 

The 'phase transition' terminology is by analogy with physics (in particular, but not limited to, the physics of solids, liquids and gases) and is a phenomenon that can be seen in other complex systems (e.g. the transistion from free flowing to congested traffic). As complex systems, clearly economic systems could be subject to the same phenomena. Multiple steady state models are perhaps the best examples of economic models that could fit this analogy, and I have done some work on such a multiple steady state model of the oil market exactly to explore this issue.

I initially came to the problem after reading Prophets of doom: the secrets of Soothsaying in the New Scientist in February 2011 which outlined the technique of detecting transitions between different steady states by observing 'Critical Slowing Down'. I then did some work in December 2011 on this (see paper (it's not reached the quality required be described as a working paper yet) and slides). I did not find any evidence of critical slowing down, or by implication, of a phase change as supplies plateaued. My explanation of this (negative) result is that a phase change would be due to some change in supplier behaviour, rather than being associated with a geological inability to increase supply. The shift in supplier behaviour in such a phase change would lead to a jump in the steady state e.g. from low price high quantity, A, to high price low quantity, B, in the diagram below:

We do not see this phase change, and so (potentially) only geological explanations remain. A geological explanation is consistent with a monotonic, but at some point very (infinitely) steep, supply curve, and no phase change.

I wanted to highlight the work I had done on this for two reasons: (a) there was the flurry of interest created by the Nature article that came after I had done my work; (b) I then read Noahpinion's Sketch of a model of higher education where he says "Anyone can, of course, feel free to take this model and run with it if you like it (and if you do, feel free to include me as a co-author, or not, as you like)."

This is kind of where I am with this project: I found no evidence to support any suggestion of a 'phase change' - which I thought was an outlandish idea that might just be true. A negative result though was, I thought, equivalent to stating "No evidence found for phenomenon that no-one thought would be there anyway", which I surmised would not be a very interesting paper. However, given the Nature paper, clearly this is an idea that people are proposing and so perhaps my rejection of it is of interest? And in case I don't get round to working on this before somebody else does, this blog post is, to some extent, stating my claim to the idea. I would modify Noah Smith's quotation to read "Anyone can, of course, feel free to take this model and run with it if you like it - and if you do, please consider including me as a co-author!"

Smaller Better?

Chris Dillow had a very good post yesterday: "We need smarter people". In it he makes the case that large organisations are almost never well run by a hierarchy led by powerful individuals, and "in the case of management, the solution is to break up conglomerates or seek the wisdom of crowds by using market-based management or worker democracy." This applies to countries too and is related to a possible argument in favour of Scottish independence.

It's not that Scotland is small enough for its politicians to manage whereas Britain is not. Rather it's that if the global economy and polity consists of a few large countries, then the inevitable mistakes really really matter. Each country is not only too big to fail, but also too big to even falter. If we have a multitude of small countries then when we make poor decisions, other countries will be making good decisions. Their buoyant economies can then provide external demand when our economy is floundering, and vice versa.

Climate Change Economics

Our February energy meeting was on the subject of climate change economics and specifically the Weitzman Nordhaus debate that was conducted in a series of papers in 2009: Weitzman, Nordhaus, Weitzman.

This debate is on the treatment of low probability, high impact events in cost benefit analysis (CBA). The standard approach to climate change economics as pioneered by Nordhaus is essentially deterministic. It evaluates the price of carbon that a social planner would have to set in order to implement the policy programme that maximises their objective function (usually lifetime CRRA utility), in a world where high temperatures damage production and production in the absence of abatement technology causes high temperatures. Weitzman's contribution was to show that if instead of calculating the carbon price by putting central assumptions into a deterministic model, we took the expected value of the carbon price given our uncertainty on the assumptions, then the price should be infinite.

This is a consequence of there being some non-zero probability of catastrophe and our infinite valuation of zero consumption (which is what catastrophe equates to in this framework). That there is a non-zero probability of catastrophe seems to be unarguable (*), so if we are to argue for anything other than the entirety of current output going towards climate change mitigation and prevention, then we must be arguing with some feature of the CBA framework. This also applies to other catastrophe risk like asteroid impacts. See also Millner and Ikefuji et al for recent work in this area.

A solution to the problem of infinite results is is to truncate the valuation of bad events i.e. so that we value another unit of consumption when we have a very low consumption level at a high but not infinitely high rate. However Weitzman shows that this truncation becomes the dominant factor in the CBA calculation (so for example the size of the median impact does not really effect the calculation, all weight is put on the impact at the extreme downside). This may be true (avoiding catastrophe perhaps should indeed be the policy target) but it is contrary to our usual understanding of the value of an investment program (e.g. the value that we might put on a company share will be closely related to the expected income stream rather than the tail of the income stream distribution).

An interesting side-issue to this debate is that Nordhaus's 1996 paper, 'The Value of Scientific Knowledge' which has a limited monte-carlo simulation of the deterministic CBA model, produces much higher estimates for the cost. My suspicion is that the value so produced was actually a function of the size of the grid over which it was estimated, and that as the grid got larger and more representative of the distribution of the parameters of the model, the the value would also have tended to infinity.

The criticisms that Weitzman effectively makes of the standard approach to climate change economics seem valid to me. However, my main problem with these models is that they produce 'optimal' projections of output, consumption, emissions and atmospheric CO2 that leads to CO2 concentration peaking at over 650ppm (see figure 5.7 of Nordhaus's 'A Question of Balance'). Despite the claimed inputs from IPCC projections etc to Nordhaus's models, I don't believe that many climate scientists would agree that this represented an optimum (see Hansen et al 2008) - rather it's a prescription for passing tipping points which are not in Nordhaus's models.

(*) Two recommendations for books credibly outlining future catastrophe:
# Hansen 'Storms of my Grandchildren' (2009)
Hansen is a climate scientist who has basically turned into an activist because he is so concerned. Has testified to Congress on numerous occassions. Works for NASA. Very credible guy who's at the top of his profession. A section from this book is copied below (**).
# Ward 'Under a Green Sky' (2008)
Ward is a paleontologist and astrobiologist who has studied mass extinctions and concluded that most of the extinction events in the geological record are 'greenhouse extinctions' associated with anoxic oceans. An amazon review (from the above link) outlines the thesis:
"That an asteroid caused the mass extinction at the end of the Cretaceous period is widely accepted and also widely disseminated to the public. Less well known to the public are the other mass extinctions. Ward contends that they all have a common cause: climate change caused by carbon dioxide increase. This can in turn release methane (a more powerful greenhouse gas than carbon dioxide) from methane hydrates creating a runaway effect. At the end of the Permian period 250 million years ago this was severe enough to kill over 90% of all species on Earth.
Now Ward is not the first to relate the devastation of the Permian-Triassic extinction to modern day human-induced climate change to show us what could happen (see for example When Life Nearly Died: The Greatest Mass Extinction of All Time), but just when you thought that the devastation could not possibly get any worse, Ward introduces a new element into the equation: photosynthetic sulphur bacteria.
The effects of the climate change causes the oceans to become increasingly anoxic. In these conditions the only life to thrive is sulphur-producing bacteria. The boundary between the oxygenated and anoxic water comes closer and closer to the surface, to the point where photosynthetic sulphur bacteria, which use the sulphur from below, thrive in the surface waters and give off large quantities of hydrogen sulphide. Apart from being very poisonous in itself to surface life, the hydrogen sulphide also destroys the ozone layer of the Earth. Ward paints a picture of the Earth at the end of the Permian: most life is dead; the oceans are purple from a thick layer of bacteria; the hydrogen sulphide has changed chemistry of the atmosphere such that cloud formation has altered drastically - clouds form in the upper atmosphere far above where clouds normally form, giving the sky a green colour."
Also consistent with this thesis is the recent New Scientist news story that almost all the fish in the sea have fresh water ancestors.

(**) "As global warming continues, storm effects will ratchet upward in three major ways. One of these ratchetings will be the development of more powerful and destructive midlatitude or frontal cyclones. Frontal storms will be more powerful, because they depend upon the temperature difference between the cold and warm air masses as well upon the amount of moisture in the atmosphere behind a warm front. This intensification of frontal cyclones will be an effect of melting ice sheets, once ice sheets begin to disintegrate rapidly enough to keep regional ocean surface temperature from rising as fast as continental temperatures and temperatures at lower latitudes. The most important point is that there will be places and occasions in which the warm air masses will be loaded with far more water vapour than would be the case in a cooler world. ...

This first ratcheting, though, will pale in comparison to the effects of the second ratcheting: when ice sheets' rapid disintegration causes a sea level rise measured in meters. ...

Ice sheets eventually begin to disintegrate at rates of several meters of sea level per century, even with the slow pace at which natural climate forcings change. But predicting when ice sheet mass loss will accelerate in the twenty-first century is a notoriously difficult ``nonlinear'' problem. We could "lock in" disastrous sea level rise very soon, that is, create conditions that guarantee its occurrence, but it is likely to be several decades before a rapid sea level rise begins. On the other hand, we have been surprised by how fast some other climate changes have occurred - such as disappearance of Arctic sea ice ... For the moment, the best estimate I can make of when large sea level change will begin is during the lifetime of my grandchildren - or perhaps your children. ...

With the combination of a higher sea level, even of only a meter or so, and increased storm strength, the consequences of future storms will be horrendous to contemplate. ... Social and economic devastation could be unprecedented. It is not necessary to put the entire island of Manhattan under water to make the city dysfunctional and, given prospects for continuing sea level rise, unsuitable for redevelopment. ...

The timing of the third ratcheting effect of global warming, the melting of methane hydrates, is as unpredictable as the others. Warning signs are beginning to appear already, with bubbling of methane from melting tundra and from the seafloor on continental shelves. So far the amounts of methane released in this way have been small. The methane hydrates of greatest concern are those in sediments on the ocean floor, because of their great volume. ...

The flooding of the ocean floor with warmer Pacific Ocean water may have been a key factor in the melting of methane hydrates during the PETM [Paleocene-Eocene Thermal Maximum - 54 million years ago, when temperatures suddenly (i.e. over millennial rather than geological timescales) rose by between 5 and 9 degC]. Could a change of ocean circulation happen again in the near future? Global models of today's climate sometimes have a problem with spurious formation of deep water in the Pacific Ocean, which suggests that it would not take much change in the densities of ocean surface waters to alter the location of deep water formation. The instigation for such a change could be freshwater additions to both the North Atlantic and Antarctic Oceans, after the rate of ice sheet disintegration in both hemispheres has reached high levels. ...

When deep water formation begins in the Pacific Ocean, the inertia of the climate system, specifically ocean circulation, will be far too great for humans to stop, even if social systems are still in order. Once large sea level rises begin to devastate coastal cities around the world, creating hundreds of millions of refugees, there may be a breakdown of global governance. But regardless of that, if ocean circulation changes, such that warmer Pacific Ocean water begins sinking to the ocean floor and melting methane hydrates, there will be no plausible way for humans to reverse that change of ocean circulation.

While we can't predict the details of short-term human history, changes will be momentous. China, despite its growing economic power, will have great difficulties as hundreds of millions of Chinese are displaced by rising seas. With the submersion of Florida and coastal cities, the United States may be equally stressed. Other nations will face greater or lesser impacts. Given global interdependencies, there may be a threat of collapse of economic and social systems.

Physical science is easier to foresee. While the timing of the three ratcheting effects is difficult to predict, their effects are not. With methane hydrate emissions added on top of those from conventional and unconventional fossil fuels, the future is clear. Diminishing feedbacks that help to keep the magnitude of natural long-term climate changes within bounds, such as the ability of the long-term carbon cycle to limit atmospheric carbon dioxide, will have no time to counter amplifying feedbacks. The huge planetary energy imbalance caused by the high levels of atmospheric carbon dioxide and methane will take care of any remaining ice in a hurry. The planet will quickly get on the Venus Express. ...

A devastated, sweltering Earth purged of life may read like far-fetched science fiction. Yet its central hypothesis is a tragic certainty - continued unfettered burning of all fossil fuels will cause the climate system to pass tipping points, such that we hand our children and grandchildren a dynamic situation that is out of their control.''

End February Links

Money as store of wealth
Defending Independent Invention
Competitiveness is about capital much more than labor
Incentives Doublethink

One of the finest economics posts of all time

For my own future reference, a link to Noah Smith's post.

The Economics of Independence

I don't know, but perhaps the expectation that there are "tremendously negative economic consequences for Scotland" with independence, is the mainstream view? [Quote from an international MSc Economics student]. Is this a reasonable view? Let's analyse this from both short run and long run perspectives.

In the short run surely the most relevant way to answer the question is to take Scotland's capital stock and productivity as given and look at its current fiscal and external position relative to the UK as a whole. The fiscal position according to the latest GERS report (see p26) is that Scotland was running a net fiscal balance deficit of 10.6% in 2009-10 relative to a UK net fiscal balance deficit of 11.1%. So whilst neither Scotland nor the UK have particularly healthy public sector finances, the current situation reflects a small fiscal transfer (approximately 0.5% of Scottish GDP) from Scotland to the rest of the UK (this includes a geographic share of North Sea oil revenues).

Scotland's external position, its trade deficit, is in a similar position: it's not great, but it's not quite as bad as the position of the UK as whole (again taking the North Sea into account). The other short run indicator we might look at is productivity, here again Scotland does relatively well as the third highest ranked region of the UK in GVA per capita terms (after Greater London (which to be fair is way out in front), and SE England). The short run position then is fairly clear. Whilst independence could be associated with some transaction costs (in the main these will be job creating transaction costs since they will be incurred due to the fact that some functions of government have to be created here), the fiscal, external and productivity positions suggest that the economic situation would be broadly unchanged.

The other issue that impacts on the short run, but also on the long run, is monetary policy. The eurozone crisis has highlighted the risks of monetary union without fiscal integration - which given the stated policy of keeping Sterling initially, looks like an economic cost of independence. However, as Martin Wolf at the FT (and others) have pointed out, the best predictor of difficulties within the eurozone was balance of payments problems, where at a fixed price (exchange rate) the peripheral nations were net importers of goods and services funded by capital flows from the core. Scotland is not in this position: our economy is 'pre-adjusted' to this fixed exchange rate, and there are not massive balance of payments imbalances. Eventually, with policy divergence, this currency arrangement may no longer be appropriate. However, by then we will have a government with the power to change it and either join a reformed supranational currency area (Sterling or Euro) with transfer payments, or start a Scottish currency.

This brings us on to the long run. Energy resources and a favourable long term climate situation, as well as other advantages like a strong university sector and ownership of the Scotch label for putting on bottles of whisky(*) suggest that Scotland has the resources to prosper in the long term, at least as well as any other country of similar size. But what about the effects of being part of a country of 5 million relative to being part of a country of 60 million?

Economic theory, in the main, is pro free trade and the regime in which trade is free-est is within a single state/regulatory area. This theory underpins international moves towards globalisation, reductions in trade barriers and the creation of the EU and NAFTA etc. Two important contributions to these theories are increasing returns to scale, and a survival of the fittest mechanism that leads to only the more efficient firms surviving in larger economies. Both these mechanisms have a persuasive appeal and probably apply to some extent. However, if they were the dominant effects then we would expect to see a systematic effect of larger countries being wealthier than smaller countries. We do not see this relationship which suggests that there must be offsetting benefits that come with being small.

My favourite mechanism by which Scotland could benefit economically from independence is to do with agglomeration and increasing returns to scale. Currently I think that large UK companies are 'agglomerating' head office functions in London to realise economies of scale. This may produce some private efficiencies, but it has social costs at the level of the lifestyles that it imposes upon the workers in London (2 hour commutes for City workers, impossible living costs for public servants, and monopoly rents paid to landowners) and at the level of career opportunities that it leaves for people outwith London (move to London or never reach the top). I believe Scottish independence could lead to some companies 'agglomerating' their head office functions near policymakers in Scotland, so that we have a self-sustaining business ecology here too.

There are other arguments that follow from analogy with ecology, for example: multi-polar centres of power, or a diversity of localities with political and economic power, could lead to a diversity of opinions and strategies. In the same way as genetic and species diversity leads to robust ecosystems, a diversity of economic strategies, policies and companies is more likely to lead to a robust global economy.

Therefore, the main conclusion that I draw on the subject of the economics of independence for Scotland, is that the evidence is probably consistent with making an argument in either direction, but that the central expectation should probably be for little impact either way. Independence or union are both economically feasible, and our choice between these options is political rather than economic.

(*) Personally I think this is overvalued but if other countries are willing, in aggregate, to pay vast sums for a product that could be produced anywhere but just not labelled 'Scotch' then that's up to them!

Modelling Peak Oil

On Wednesday 18th January we had another of our Energy Journal Club meetings. Sean was talking about Hamilton (2011) - Oil Prices, Exhaustible Resources, and Economic Growth, Jelte talked to Murphy & Hall (2010) - Year in review—EROI or energy return on (energy) invested, Sebastian covered Greene et al (2005) - Have we run out of oil yet? Oil peaking analysis from an optimist’s perspective, Erkal spoke to Hamilton (2005) - Oil and the Macroeconomy, and I talked about Holland (2008) - Modeling Peak Oil.

To summarise the Holland paper:
# It started from the usual no-arbitrage Hotellings condition (prices must move in such a way so that the owners of exhaustible natural resources are indifferent between: extracting the resources, selling them and investing the financial proceeds;  and just sitting on the unextracted resources), but presented 4 models that were sufficient to generate a peak in production. You may have thought that since oil production started from zero in the mid nineteenth century and rose to the present day, and since oil is a finite resource, then any good model would show a peak in production. But most economic models of the oil market, including the basic Hotelling model, have peak production at time zero since this is when prices are lowest and demand is highest.
# The 4 models are models of cost reductions through technological change, demand growth, endogenous reserve additions, and site development. This last model in particular is novel to this paper, and is consistent with the story described in Hamilton (2011) - Oil Prices, Exhaustible Resources, and Economic Growth.
# I have two objections to this paper:
(a) It uses a partial equilibrium approach. This means that the interest rate, that the Hotelling mechanism says is the rate at which the oil price rises, is independent of the aggregate oil supply.
(b) It assumes that oil that is uneconomic to exploit now will be economic to exploit at a higher price. This ignores the possibility that the capital goods with which this future oil can be exploited do not change in price (or at least that their price doesn't rise faster than the oil price).

I'm being slightly unfair in my objections since the paper is following standard assumptions in the literature. However these objections essentially form the basis of my own work.

Limits To Growth

The New Scientist recently had an article on Limits To Growth, and this week's issue features a letter from me in response to this article. They've edited my letter somewhat, the original is reproduced below:

"The article states that economists' objections were that future innovation was not included in the model. This is to misrepresent economists' concerns to a certain extent: what is missing from LTG are prices and incentives.

LTG is essentially a 'fixed factor' model so that output is associated with certain inputs. Assuming a path for output and some endowment of input factors, we can always make the model overshoot and collapse, no matter how abundant we choose these input factors to be.

Economic models on the other hand require that these inputs be purchased by the sectors creating output. Under standard assumptions, scarcity drives up prices - a continuously rising price may spur innovation, but if it doesn't then it will instead restrict demand. Rising prices incentivise innovation, substitution or a smooth contraction in activity. Because of this, it is quite hard to construct an economic model that displays overshoot and collapse i.e. in most economic models we are automatically in the 'stabilising scenario'.

I think LTG is likely to prove closer to the truth than e.g. the endogenous growth models with exhaustible resources of Dasgupta & Heal, Stiglitz, and Solow. However, this is not because LTG is right and economists are wrong. It is because prices and and incentives have not responded to the finite nature of resources in a manner consistent with a model with rational and perfectly foresighted agents. These are wrong assumptions in much the same way that a model without prices and incentives contains the wrong assumptions.

Non-economists will get nowhere in convincing the economists, by producing models that lack economic mechanisms and incentives. Instead economists and non-economists alike have to work together to tease out the correct economic mechanisms and incentives."

Just Testing

Just testing whether I can put videos into this blog - but I'm sure there's an economics angle here: asymmetric information maybe...