Category Archives: Economics

The Value of IR to the Citizen

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Steve Saideman recently blogged about how he conceived of his teaching mission, when teaching undergraduates: adding to an informed citizenry. This is is a noble endeavor.

It is precisely the need to be a better informed citizen that sent me on a now an 8 year journey towards a change of career, all inspired by Charles Hill’s excerpt from Grand Strategies: Literature, Statecraft, and World Order in the Review Section of the Wall Street Journal.

After reading that article, I realized I was too ignorant to be an effective citizen of the republic in matters of war and peace and trade. And after learning he taught in the Brady-Johnson Program in Grand Strategy at Yale, a non-degree program for training diplomats and would-be heads of state, a quick Google search yielded the syllabus for the program and I began to read.

The intellectual joy in studying the grand themes of the literature in IR had me thinking about a career change, which meant collecting a credential. Thus, I landed at Troy University for a masters degree and now University of Leicester for a PhD. My research interest, peacekeeping and civil war, came out of two courses at Troy. One on international organizations, a requirement, and one on Sub Saharan Africa.

I whole-heartedly agree with the value of undergraduate education in international relations, I wish I had been forced to take IR as part of breadth requirements as an undergraduate. UCSB at the time required a US government course in Political Science, but nothing dealing with relations among states.

Digression: If I had one criticism of the Brady-Johnson Program, it is that the syllabus I read from was too heavy on the diplomatic history approach and too light on theories. What I found most useful at Troy were the introductory course and the required ‘theory and ideology’ course, which prepared us for the exit exam. Those two courses gave me a large toolbox with which to conceptualize a given issue. (International political economy was less useful, mainly because I already had a background in micro and macro economics, accounting, finance, trade, supply chain management, and banking from an MBA. Although, I did appreciate the way the professor stressed the contradictions built into canonical developmental economics and the consequences for individual liberty in the standard policy prescriptions–i.e., Easterly’s critique.)

Diplomatic history is useful for context, but in the hands of policy maker–exactly whom they are training–it can lead to dangerous facile analogies. This is not to say that a policy maker needs Theory with a capital T, which is mostly useless academic abstraction, but an understanding of the claims of realism, liberalism, constructivism–although that ‘magic idea wand’ (Snyder 2002) can be rather dangerous in the hands of policy maker–will provide ways of conceptualizing issues.

Digression 2: The Brady-Johnson Program syllabus did include a book that became one of the most influential on my own thought: Walter Russell Mead’s Special Providence, which included a really helpful typology for understanding American foreign policy.

Culture and Wealth

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I’ve received a promotion and been busy with the Coast Guard Auxiliary and graduate school in addition to work, so I apologize for my tardiness on getting a post up.  That said, I’d like to treat you to a quantitative analysis I recently conducted on the relationship between a country’s wealth and its culture.

The purpose of the analysis was to attempt a identify what characteristics of a culture contribute to a nation’s wealth.  I first looked at Hofstede’s dimensions and the data set on his website, however, I deemed it not usable since it lacked completeness.  Many countries did not have data across all five dimensions.  I then chose the GLOBE Project data set which is similar to Hofstede’s dimensions.  I downloaded the 2004 GLOBE Phase 2 data set for Society Cultural Scales.

I combined the GLOBE Project data (the Practice dimensions only, not the Values dimensions) with Polity IV Polity Index for the 57 countries in the data set.  I chose Polity because it was a good single value proxy for the variable I am really after, which whether the country has a government that functions on Weber’s rational-legal authority type.  A key control for whether the state is wealthy because it has good government, or whether the state is wealthy because it has a culture that makes it wealthy.  Thus I built my set of 10 independent variables (Polity plus nine dimensions from the GLOBE Project).

For the response variable I created a dichotomous variable from the World Bank’s estimates for states’ income.  The states classified as “high income” were coded 1 and the states with lower incomes were coded 0.

I then ran a logit regression in R.  results of which are below:


> summary(globe_glm_1)

Call:
glm(formula = Income ~ Polity + UASP + FOSP + PDSP + C1SPIC +
HOSP + POSP + C2SPIGC + GESP + ASP, family = binomial(),
data = dat)

Deviance Residuals:
Min 1Q Median 3Q Max
-2.47623 -0.40988 -0.03516 0.30218 1.83126

Coefficients:
Estimate Std. Error z value Pr(>|z|)
(Intercept) 32.5330 18.3861 1.769 0.0768 .
Polity 0.1036 0.1125 0.920 0.3574
UASP 1.1436 1.5992 0.715 0.4745
FOSP 0.2514 1.8538 0.136 0.8921
PDSP -0.4908 1.5613 -0.314 0.7532
C1SPIC 4.1808 2.2206 1.883 0.0597 .
HOSP -3.3569 1.4078 -2.385 0.0171 *
POSP -3.2482 2.7042 -1.201 0.2297
C2SPIGC -3.3308 1.3347 -2.496 0.0126 *
GESP -1.6019 1.5218 -1.053 0.2925
ASP -1.0237 1.7447 -0.587 0.5574
---
Signif. codes: 0 ‘***’ 0.001 ‘**’ 0.01 ‘*’ 0.05 ‘.’ 0.1 ‘ ’ 1

(Dispersion parameter for binomial family taken to be 1)

Null deviance: 80.336 on 57 degrees of freedom
Residual deviance: 35.193 on 47 degrees of freedom
AIC: 57.193

Number of Fisher Scoring iterations: 7

>

The model reduces the deviance more than the NULL model. An analysis of variance of the model terms also shows the important coefficients.

> summary(globe_anova_1)
Df Deviance Resid. Df Resid. Dev
Min. :1 Min. : 0.1141 Min. :47.0 Min. :35.19
1st Qu.:1 1st Qu.: 0.5720 1st Qu.:49.5 1st Qu.:41.63
Median :1 Median : 2.7185 Median :52.0 Median :64.87
Mean :1 Mean : 4.5143 Mean :52.0 Mean :56.83
3rd Qu.:1 3rd Qu.: 7.5384 3rd Qu.:54.5 3rd Qu.:67.39
Max. :1 Max. :15.0461 Max. :57.0 Max. :80.34
NA's :1 NA's :1
Pr(>Chi)
Min. :0.0001049
1st Qu.:0.0122373
Median :0.1073930
Mean :0.2366209
3rd Qu.:0.4799755
Max. :0.7354827
NA's :1
>

The results indicate that the Humane Orientation Societal Practices and the Collectivism II Societal Practices (In-Group Collectivism) with both significant at the 0.05 level and negatively related to the odds of being wealthy society. What this indicates is that societies that are individualistic and competitive are more likely to be wealthy.

Furthermore, the Collectivism I Societal Practices (Institutional Collectivism) is significant at the 0.1 level and positively associated with the odds of being a wealthy society. What this means is that solidarity with employers is also associated with wealth–i.e., cultures like Germany, Japan and South Korea.

Interestingly, the Polity Index did not contribute more to the model. An investigation of outliers revealed that both Kuwait and Qatar, Gulf oil kingdoms, have negative polity scores–i.e., are authoritarian. All others are Polity 10’s, which is the highest score on the strength of democratic institutions and lack of authoritarian tendencies. Thus, there is an identity in this data set between wealth and liberal governance. Oil kingdoms appear to be a class all their own.

Federalist 10 and the UBI

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Universal Basic Income (UBI) has gained traction as an idea among the reformicon/technocratic Right in the United States. For example, Charles Murray recently wrote a lengthy piece on the cover of the Review section of the Wall Street Journal on the subject. The concept of the UBI as a replacement for the welfare state on the Right has been mainly on the libertarian wing, where the UBI promotes poverty reduction without restricting liberty as much as the typical welfare state alternatives of conditional grants. The reason for the Right’s new found love of UBI is the risk that automation poses to the social fabric of society. When 47% of today’s jobs are subject to automation over the next 20 years, issues of morality and equity are presented front and center.

With half the nation not only unemployed, but unemployable, what does it do to an American polity that has the poster child for Weber’s Protestant Ethic? What Murray does no appreciate in his article is the risk to the constitutional order that a UBI poses. The dangers of faction, something Madison warned about and sold the Constitution as a solution for in Federalist 10, will be acute.

Madison described two dangers of faction: (1) tyranny of the minority (mainly a propertied ruling class) and (2) tyranny of a majority (mob rule). The new constitution was meant to tame faction through the mechanisms of divided and limited government, an independent judiciary, and representative and deliberative democracy.

Madison’s primary concern were with violent factions composed of land owners and the unpropertied, creditors and debtors, and geographic diversity (large versus small states and North vs. South). UBI carries tremendous risks for abuse through the democratic process. First, while the numbers proposed by Murray (an annual basic income of $30,000 with elimination of UBI at $40,000 of private income) will likely erode the likelihood of entering the workforce for those who could be employable, who is to say that the “dolists” who live off the UBI will not become the new unpropertied faction that will seek to exert their political influence to increase that dole to a more generous amount over time. Electoral politics is built around campaign promises and log rolling. It is unlikely the current institutions could restrain electoral majorities in the quest for “soaking the rich.”

Any UBI introduction will likely have to be via Constitutional amendment with anti-democratic protections installed to make it work. Otherwise, faction could tear the republic apart. It may also have to change the way the government funds itself. The repeal of an income tax and a substitution of a tax on capital may need to be implemented—i.e., tax the owners of the robots rather than the workers. The challenge there, is that it is essentially a tax on productivity gains, which will limit the increase in prosperity over time. Technology has not made republicanism obsolete, but it does pose challenges for the 21st century.

Beware the Fracklog

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If Saudi Arabia intentionally crashed the price of oil in order to strangle the infant U.S. fracking industry, it didn’t work. In the world of Nietzsche: that which does not kill us makes us stronger. It spurred innovation and culled marginal players from the industry rather than killing the industry.

It isn’t entirely clear that the U.S. fracking industry was the prime target, Russia, Saudi Arabia’s adversary in Syria, and Iran, Saudi Arabia’s adversary in control of the Persian Gulf, may have also been targets as well.

As detailed in this article by Ambrose Evans-Pritchard, what Saudi Arabia did succeed in doing is destabilizing undercapitalized petro states around the globe like Nigeria and Venezuela. The destruction of offshore production projects may have an effect in the future since they require years to come on line, and supplies may be tight a decade from now, but for now petro states need to beware the fracklog. To quote AE-P:

Worse yet for Opec, consultants Rystad Energy say that 90pc of the 3,900 drilled but uncompleted wells – so-called ‘DUCs’ – are profitable at $50. This implies an overhang of easy supply waiting to hit the market.

If it is true that the majority of the world’s petro states need an oil price above $100/barrel, then political instability is only going to get worse. Imagine the Saudi regime failing or Iran’s perpetual revolution slipping into civil war.

Trump and the politics of nostalgia

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Donald Trump spoke in western Pennsylvania on the evils of free trade. It is time to dispel the myths in his speech.

The destruction of the U.S. steel industry, and smokestack industry generally is not the result of NAFTA and China’s entry into the WTO.

That those two events and a reduction by 1% off the historical growth rate of annual inflation adjusted GDP is not an indication of causation. For example, also it comes after the stock market crash in April 2000 and American manufacturing had been in decline since 1970.

Trump declares that at the founding of the United States, there wasn’t an income tax, only tariffs on imported goods. Well, at the nation’s founding there wasn’t a welfare state either. Trump wants people to think that foreigners should pay taxes, not Americans. The problem is that Americans pay those taxes in the form of higher prices.

The problem with today’s economy is a severe case of secular stagnation, an idea from the 1930s that has been resurrected by Larry Summers to explain the low growth, high unemployment, low investment, low interest rate environment we find ourselves in. The idea is that savings are high and investment is low, because demand is low (i.e., it is going into savings). Fundamentally it is a failure of demand. It is a function of demography and changes in the amount of capital investment needed to create value. The computer changed the equation. In an industrial world, to build a billion dollar company took tremendous investment in plant and tools. Today, it takes a few computers to build a billion dollar company. Summers cites the example:

Another way to think about it, or a more sort of practical way to think about it, is to think about canonical leading companies, and their cash position. It used to be that the canonical, leading, fast-growing companies in the country needed to go to the bond market in order to expand, and couldn’t make dividends because they had so many investment opportunities. Think about Apple, as dynamic as any company in the economy. What activists are demanding it do is pay dividends and repurchase stock. Think about Google. Similarly awash in cash. That kind of, you can already think about.

My favorite example for thinking about these dynamics is think about two companies. Sony, the company is a strong company. It has factories, it’s got offices, its got tens of thousands of people working for it. It’s worth $18 billion. Now, think about Snapchat. All of it – the machines, the people, everything – could fit in this room quite comfortably. It will … It’s about to be valued by our nation’s capital markets at $19 billion. What’s that say, suggests that when you can start a company for nothing, and with nothing, that you will have the possibility of wealth creation without substantial investment, again, reinforcing an increase of savings over investment.

Tariffs will do nothing to change the dynamics of labor and capital in the developed world. This is not something that can be addressed with protectionist trade barriers. The barriers prevent the flow of deflation around the globe—i.e., the flow from Germany and Japan to the United States, but it does not address the aging of the population and the deflationary impact of technology.

Ham-handed policies like living wage laws, just speeds the replacement of workers with robots, which accelerates the process. It is as if most workers are like the artisans when industrialization happened. What happens now is anyone’s guess. Perhaps we may end up with most people on the dole. We may be at full employment now, even with a large fraction of working aged people not working.

Demonizing China and Mexico will not solve our problem. Both Trump and Clinton are profoundly nostalgic. Trump believes America could become a small mercantile power as it was 200 years ago and Clinton would return us to a mid-twentieth century industrial model. Neither are viable in the twenty first century.

US Nearly in Deflation

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The Saint Louis Federal Reserve Bank had a blog post on the regional variations in consumer price index for urban residents (CPI-U) numbers.  All regions except the Western United States already have falling prices from a year ago.  When you break out the components of the CPI-U energy and shelter are the main contributors to price increases in the West.  So if you take out the chronic lack of housing on the Coast, which drives up prices (not to mention the buyers from China arriving with cash to buy properties), and take out the increases in energy prices (regulatory driven since the prices for energy are falling in all other regions?), you’ve got falling prices nationally.  And the Fed wants to raise interest rates?!

Ignoring Volatile Markets

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Dan Solin over at the Huffington Post has a blog post entitled “The Secret to Investing in Volatile Times.”  The secret:

Instead of watching the breathless reporting from the floor of the New York Stock Exchange, do the opposite. Ignore the financial media. Pay no attention to what is happening in the market. Be blissfully ignorant. Spend the time you might normally devote to these anxiety-producing activities on pursuing your hobbies, spending time with your family and taking a vacation.

Once you understand that monitoring the markets is harmful to your long-term returns, a whole new world of opportunities will await you.

Because long term returns are higher under a buy and hold strategy, you will have greater peace of mind and higher returns, if you just ignore the market’s gyrations and try to time it.  Obviously your broker, who is in part motivated by commissions, isn’t too keen on this strategy, nor are newsletter writers and analysts with a good track record of market timing.  Bob Brinker and Marty Zweig come to mind.

Generally market timing is a fool’s game.  Burton Malkiel studied stock market efficiency, which says that the prices in the stock market reflect all known information at the time.  Generally the stock market returns can be modeled as random walk and guessing at the points when prices reverse is nearly impossible to do, i.e., technical indicators aren’t reliable, nor does doing fundamental analysis, because the information will be reflected in the prices by those with an opportunity to arbitrage.  So if you should just buy and hold, how should you invest?

Harry Markowitz, developed a method for constructing optimal portfolios, the method for which was enhanced to account for risk tolerance (the Sharpe ratio).  This is the basis for most of the new robo-advisers, where you answer a series of questions to gauge your risk tolerance and then the robot constructs an optimal portfolio that is supposed to return the greatest risk-adjusted rate according to your risk tolerance.

That is great, but what if I am saving for more than just retirement, such as a boat, the kids’ college tuition, etc.?

Well, the academics have a solution for that too.  We haven’t seen it make its way into the robo-adviser products yet, but certainly a human adviser can use the tools of both classic portfolio selection and lessons from behavioral finance and, rather than treating the person as a single pot of money to be invested in one portfolio, the concept of mental accounts can be used to construct optimal portfolios for aspirational investing (that boat or Porsche), college funds and retirement funds.

So back to Solin.  Solin is only partly correct.  You are best ignoring the market hype, but only if you have a well diversified portfolio that is optimized for your level of risk tolerance.  If you can’t sleep at night, you’re taking too much risk.