Saturday, December 31, 2011

Ultimate Cakeoff, Econometrics, and Causality Questions

For reality television and competitive cooking enthusiasts the show Ultimate Cakeoff, produced by TLC, is a real tour de force. The premise: top cake artists and decorators are brought together to compete in creating a cake for some high-profile event. The judges evaluate their efforts based on technical difficulty, adherence to the theme, and aesthetic value, then choose a winning team to receive the $10,000 prize.

Each team has nine hours to produce their ultimate cake. In order to keep the competition interesting and generate some much-needed drama, each episode is broken up by one or two smaller challenges designed to test the team leader's technical skill and speed at a particular cake-related task (such as piping, decorating, carving, etc.) The winner of each mini-challenge can choose one of the other two teams to sit out for thirty minutes.

Nine hours is already a short timeframe to create an award-winning cake - many wedding cakes can take up to a week to construct - so it would seem like losing 30 minutes to an hour would be a serious disadvantage. But, after watching two seasons of Ultimate Cakeoff (a dirty job, but someone had to do it) I noticed something strange: teams forced to sit out didn't seem to lose with any greater frequency. In fact, they often went on to win the competition!

This counter-intuitive trend sparked my curiosity, so I decided to put the question to a statistics program. After collecting data on every episode to find the characteristics of each team, who was forced to sit out, and who won each competition, I was able to find some results. The first regression found that being forced to sit out due to a challenge would increase the chance of winning by about 24%, a statistically significant result. After controlling for the individual attributes of of each participant the statistical significance vanished, and being forced to sit out had no measurable impact on the chance of winning at all (Click here to view the regressions performed, in STATA output format).

What might explain these findings? It would seem that less working time would result in a lower-quality cake, that was less likely to take the prize. Discovering the opposite result is somewhat surprising.

Of course, cake artists forced to sit out were not chosen randomly. The most common reason when choosing who to give a penalty was some variation of "(s)he looks way ahead! Take a break and slow down!" Apparently, cake artists are pretty good at judging each others' progress, and the team that is ahead partway through the competition is often the most talented. Trying to stall them with a penalty may even the field slightly, but not enough to overcome superior cake skills and design.

Admittedly, this is a pretty trivial application for a powerful statistics program. But, there may be some broader lessons for social scientists generally. When human choice is involved few events are truly random, which would be the ideal in an experimental setting. Economists can find some clever ways to mimic a true experiment, but perfect success in that regard still remains elusive. Examining how the data are collected and what selection effects are present is crucial to interpreting statistical results... Otherwise one might be inclined to believe that a shorter work-time makes a better wedding cake!

Saturday, December 24, 2011

Fuzzy Economics and Legal Fees

The New York Times has published several articles in the last two months targeting the American Bar Association. In October, Clifford Winston questioned the need for bar exams and professional licensing. Last week, David Segal wrote "For Law Schools, a Price to Play the A.B.A.’s Way" which blames the ABA's control over law school accreditation for overly high legal fees.In that article, he writes
...The lack of affordable law school options, scholars say, helps explain why so many Americans don’t hire lawyers.

“People like to say there are too many lawyers,” says Prof. Andrew Morriss of the University of Alabama School of Law. “There are too many lawyers who charge $300 an hour. There aren’t too many lawyers who will handle a divorce at a reasonable rate, or handle a bankruptcy at a reasonable rate. But there is no way to be that lawyer and service $150,000 worth of debt.”

This helps explain a paradox: the United States churns out roughly 45,000 lawyers a year, but survey after survey finds enormous unmet need for legal services, particularly in low- and middle-income communities...
This reasoning doesn't make sense to me. It may be true that lawyers are driven to make more money in order to pay off student loans. But, high fees are not the only way to make lots of cash; there is also the low-cost, high-volume strategy (think Walmart). If so much unmet demand for legal services exists, it could be more profitable to charge a lower hourly rate and just work faster or put a little less effort into each case. This wouldn't be practical if the supply of lawyers is artificially restricted, but given the 45,000 new lawyers every year as well as reportedly high numbers of unemployed or idle lawyers, a shortage seems to be unlikely.

Even if the ABA does drive up the cost of law school tuition, that alone can't explain why legal fees are so high. I'd hypothesize that clients pay lawyers a premium wage in order to ensure a high level of effort. As it is hard to monitor an attorney's effort directly, better wages are used as an incentive to keep on the job instead of slacking. In the economics literature, this is referred to as an efficiency wage; the concept has been used to explain why wages remain rigid during periods of high unemployment. That seems to apply quite easily to the legal industry.

I'm sympathetic to the argument for lowering entry barriers to practicing law, but there are other factors at work too which cause lawyer wages to be high. Otherwise, competition in the legal industry would have already driven down prices and serviced the unmet needs in low- and middle-income communities.

Monday, November 28, 2011

One subsidy I can get behind: Public Defenders

Interpreted at the most literal (or cynical) level, public defenders can seen as a subsidy for criminals because society pays for their legal fees. Of course, not everyone who is arrested is guilty of a crime, but if police are doing their job correctly, most people who are arrested will be guilty of something.

To quote a former police officer: "I don't want to put anyone that's innocent in jail. But, I try not to bring anyone into the interview room that's innocent."

Free legal counsel reduces the cost of being arrested, increasing the net "payoff" to a life of crime. In an anarcho-capitalist system (which some of my classmates at GMU think would be just swell) there'd be no public defenders, the accused would pay the cost of legal representation, and in theory this would provide an additional deterrent to criminal activity.

That's all very well and good, as far as it goes. Ideally, the criminal justice system should take criminals off the streets, and also deter potential criminals with the threat of punishment.

But, there's also a very serious negative externality to the justice system when it puts innocent people in jail. This takes several forms: harm to the person imprisoned and their family and friends, but also society as a whole. People in jail become burdens on the taxpayer and produce nothing (except maybe license plates). The justice system loses credibility when it convicts the innocent. Finally, for each person wrongfully imprisoned there is a criminal walking the streets with impunity, out committing more crimes.

Economists are often skeptical of externality justifications for government subsidies. But, I'd submit that the harm of imprisoning innocent people is so great, that money spent on public defenders is well worth it. Even if career criminals benefit slightly as well, that's a tradeoff worth making (80% of people in jail confess anyway, according to the police officer quoted above, so the harm of that cross-subsidy is pretty minimal in my view).

A last tidbit for thought: being convicted in a criminal trial requires evidence "beyond a reasonable doubt" which amounts to 98% or 99% certainty from a jury. There are a little over 2 million people incarcerated in the U.S. currently. If 99% certainty means being wrong 1% of the time, that's 20,000 people sitting in jail for crimes they didn't commit, at the minimum. Combined with the over-confidence effect (people are lousy at estimating confidence intervals around what they are certain of) it's likely to be much more. A tragic situation, and one which might be made even worse without access to public defenders.

Thursday, November 17, 2011

Statistical Fallacy #176: Ignoring Selection Effects

I stumbled on a post at a credit-related blog. It starts off with the bombastic first line
"The average consumer is saddled with $29,985 in student loan debt..."
 Wow! That's a lot of debt! It's true that the U.S. population has a giant amount of student loan debt -- even more so than the amount of credit card debt. Last year, I wrote about the subject. But, the figure above is pretty high. That statistic is drawn from "262,887 user scores." Sounds pretty robust. But, some simple math reveals there's more to the story.

  • Total student loan debt in the U.S. is about $1 trillion (~$1,000,000,000,000).
  • The U.S. population is 308,745,538. Of that, 24% are under 18, leaving 234,646,609 adult consumers.

Do some division, and you'll find that the average adult consumer has $4261.73 in credit card debt. That's about $25,000 less than the Credit Karma estimate!

What went wrong? My guess: selection effects. Members of a site specializing in credit advice are not a random sample of the population. People who join are probably concerned about their credit... and people who are concerned about their credit probably have a lot of debt.

Nothing personal against the writers for that site, as it would be an easy mistake to make (and they were very nice, even in response to my snarky comment pointing this out). But still, they should have been more careful. A quick test, by multiplying their estimate of average debt by the number of consumers, finds that the U.S. has a total of $7,035,878,570,865 in student loans outstanding, about seven times the real figure. If it were true, that would be about 11% of the entire world GDP owed by American students!

The lesson: look out for non-random sampling due to self-selection, or your numbers will be nonsense.

Sunday, November 6, 2011

Fun Facts about Microsoft Co.

Why would anyone bother reading shareholder reports? They're dry, long-winded, and functionally outdated by the time of arrival, so there's no way to profit from the information. Reasons for reading would have to include boredom, duress, or idle curiosity. It was the latter which led me to the Microsoft Annual Report for 2011. A few interesting facts pulled from that document:
  • Microsoft is divided into five segments. The Windows & Windows Live Division gets 75% of its revenue from selling Windows to computer manufacturers, to be pre-installed for end users. The remaining 25% comes from sale of miscellaneous hardware products and online advertising on Windows Live. 
  • In the Windows Division, most growth over the last year was business sales (+11%) while consumer purchases went down (-1%). A substantial part of the drop in consumer PC sales was from netbooks (-32%).
  • Employee severance expenses were $59 million in 2010 and $330 million in 2009. Why the huge change? Microsoft: "In January 2009, we announced and implemented a resource management program to reduce discretionary operating expenses, employee headcount, and capital expenditures."
  • Research and Development costs took up 15% of Microsoft's revenue, or $9.0 billion, in 2011. That investment is well-protected -- by 26,000 U.S. and international patents, and another 36,000 pending.
  • Kinect for Xbox 360 is the fastest-selling consumer electronics device; confirmed by Guinness World Records
  • If you'd bought $100 of Microsoft stock in June 2006, six years later it would be worth $122.71 (compare to $115.61 for the S&P Index, or $157.48 for the Nasdaq Computer Index). 

What, if anything, does this say about the corporation and its future? Microsoft's product focus is split between entertainment/gaming and business services, while the company's prior breadwinner - bundling software with new PCs - is taking a back seat. As stated in a note from their CEO, Steven Ballmer: "increasingly, we will view ourselves as a devices and services company." It sounds closer to Mattel than the Evil Empire. Regardless, Microsoft's diverse selection of both patents and products provides a foothold to compete against intimidating rivals like Google, Apple, and

Wednesday, October 26, 2011

How to judge campus safety?

A few days ago I was emailed a pdf document: the 2011 Annual Security Report for George Mason University. As mandated by the Jeanne Clery Disclosure of Campus Security Policy and Campus Crime Statistics Act (yeah I hadn't heard of it before either) it provides a breakdown of all criminal activity which occurred on campus, by year, and with special columns for "Hate Crimes." The picture I attached has the numbers for Fairfax. This is the most interesting part of the document to me because it contains some raw figures on different offenses committed in the campus I attend. Statistics for the other George Mason campuses (Arlington, Prince William, Loudoun, etc.) are also available but are a lot less edifying, because the columns have just a bunch of zeroes. Coincidentally, Fairfax also happens to be the only campus with attached undergraduate housing -- make of it what you will.

The most exciting table I've seen since breakfast.
This report is obviously intended to increase public awareness about crime rates on campus, allowing potential students and their parents to make an informed decision when comparing different universities. What I wonder is, how does someone look at this report and get any sense of the probability that they themselves will be victimized? This blog post is a rough attempt at answering that question.

Some useful figures to get started with:

So, to get a quick back-of-the-envelope calculation on risk of a certain crime you could take the number reported above (averaging across the three years to be fancy), multiply by three for property crimes or two for violent crimes, and then divide by 30,000. That would give the raw chance for any one individual becoming a victim of that crime. For example, burglary: 20.67 burglaries were reported per year, and if that's only 35% of the total we expect the true number to be about 62. Divide that by 30,000 and you find a 0.2% chance of being burglarized at GMU in a given year.

If a student was wondering about the chance of being caught for drinking on campus, they could perform a similar exercise. An average of 647 students get referrals or arrests for alcohol per year. From a resident student population of 7,000 we might assume 75% are underage (if everyone starts college at age 18, and stays 4 years) and nationally, 82% of underage college students report drinking in the last year. Taking one extreme, if we assume that all students caught drinking are underage, the chance of being caught for drinking is about 15% as an upper bound. If instead we assume that students above the legal age may also be arrested or referred for drinking, and that everyone drinks (an extreme belief indeed) then the chance of being caught drinking in a year is 9%.

If caught, about 40% are arrested if caught on campus, with the rest getting referrals. Of course, common sense would indicate that acting drunk and stupid in public can sway those probabilities in a dramatic fashion. It's also worth noting that students caught for drinking in the student residences were much more likely to get referrals, rather than being arrested.

In other respects, these figures are less helpful. Looking at "Nonforcible Sex Offenses" there are none reported in any of the last three years. While I would like to say this proves that GMU students are paragons of virtue and would never take sexual advantage of each other, it is more likely that these offenses just go unreported. How many such crimes occur at any college is a hotly debated question, which is important to address but very hard to answer conclusively.

Overall, I'd say that GMU's Annual Security Report paints a fairly pleasant picture of crime risks on campus, and justifiably so -- anecdotally, the George Mason area and Fairfax in general are probably the safest places I've lived yet. Compared to my undergraduate institution, Gonzaga University, which had a rash of stick-up robberies by two teenage thugs with shotguns during one year, GMU-Fairfax seems pretty rosy. It's no reason for complacency, but safety-conscious parents or students should take some comfort in knowing that their lives and property are pretty well-protected when attending George Mason.

Thursday, October 6, 2011

Shirking, Malingering, and other Unpopular Terms regarding the American labor force

So, the title might be overly sensational.

For an outside observer, finding measures of low conscientiousness on the job (shirking) or active deception to evade work (malingering) is a bit of a challenge, because workers have an incentive to conceal that sort of activity.

This rough study addresses worker injury on the job and attempts to determine whether outside incentives motivate changes in sick time and injury rates. Using some unsophisticated econometric techniques, surprising results are found. Surprising if you think unemployment levels and interest rates will not influence worker absences, anyway.

The paper:

Incentives for Health and Safety: Do Economic Conditions Influence Worker Absences?

Click the link to access the paper, in PDF form, off Google Documents.

Bonus material:

Malingering and/or exaggerating a real injury to avoid work is not a new phenomenon. Here are some illustrative anecdotes, documented roughly a century ago, which didn't quite make it into the paper.

Case I. W., aged 54, a labourer, met with an accident in February, 1907. He was crushed between a wagon and wall. He returned to light work eighteen months later, but after three months stopped, as he said work was causing him vague indefinite pains in the abdomen, especially on stooping, and that work made him sweat. On examination there was marked abdominal obesity due to his recent easy life, and the waist band of his trousers was too tight, so that the three upper buttons could not fasten. No other abnormality existed. This man could not be persuaded to work till the court stopped his compensation. He has worked well since and reduced his weight.

Case II. W., aged 26, a collier, was said to have sprained his back lifting a tub of coal. When examined fourteen months later he localized pain in a certain spot in the gluteal region; the spot was apparently excessively tender, but when his attention was withdrawn he did not notice the pressure. He also varied the locality of the tender spot. No other symptoms were present. He had bluffed the insurance representative for months by the vivid description of an injured spine, whereas there was no injury to the spine or lumbar muscles.[1]

[1] Gullan, Gordon. (1912, August) Medical Training For The Detection Of Malingering. The British Medical Journal. p. 222

Monday, August 29, 2011

My 13-bean inflation hedge.

Never mind gold or TIPS. There are much more mundane ways to protect your purchasing power from inflation. Durable food commodities work just fine. I recently invested in 75 lbs. of 13-bean soup mix, purchased from The Great American Spice Company.

Beans: the grad student's investment vehicle.
Assuming that core commodity inflation continues at its current pace (almost guaranteed) and that these beans last the several years it will take me to consume them (less certain), I think it's a nearly foolproof investment. Other methods of hedging against inflation carry their own risks and are also much more expensive. Bulk food purchases are the chickenhearted investor's best friend, as Andrew Tobias has put it.

Now, any suggestions on bean soup recipes?

Followup (2/4/2012): I'm not quite as excited about the beans as I used to be. The problem with a bean mix is that some types of beans cook faster than others... and the gastrointestinal consequences of under-cooked beans are obvious to anyone who's suffered through them. If I were doing this over again, I would have gotten a bulk order of one type of beans and saved some money and hassle. Oh well - live and learn.

Wednesday, July 20, 2011

Tax wedding rings. No one will know the difference.

With our huge budget deficit, there are many ideas on how to raise more government revenue. Most of them involve raising taxes on the highest-earning households. I have a better idea: tax the ultimate in status purchases -- wedding rings.

Not romantic, but practical. The reasoning: wedding rings are purchased largely because they are expensive. No bride wants to feel cheap. Men are usually advised to spend some fixed amount of their income on the ring: somewhere between 5% and two months of salary being the most common advice. If men are looking to spend a certain amount of money, and care very little about the ring's actual attributes, a tax would not affect their purchasing at all!

How much revenue could a wedding ring tax raise? From a little Google-work, here are some starting figures:
If we split the difference on average engagement ring prices (arriving at mean of $2,650) make the heroic assumption that every bride gets both an engagement and wedding ring, and the less-heroic assumption that wedding ring demand is inelastic with regard to price, it becomes fairly easy to estimate revenue from a tax.

Suppose government taxed half the cost of rings. Price of the ring would remain about the same because it's a status purchase; jewelers would use slightly less high-quality gold, diamonds, etc. to make up lost profits from the tax.

For a quick back-of-the-envelope calculation:  
Revenue = ($1,325 + $2,500) * 2,400,000 = $9,180,000,000 or $9.18 billion dollars per year.

It won't balance the budget but neither will most of the proposals floating around, like turds in the political punchbowl, being pushed back and forth by the Obama Administration and Congress. If taxes are going to be raised, I for one think it would be better to choose targets that will impact consumers as little as possible. From this perspective, wedding rings are an easy target.

Saturday, May 21, 2011

"Fat Head": why fat is good and nutritionists are wrong.

My role model.
I try to blog on topics within my field - economics - which is usually easy, because economics encompasses almost everything. However, I recently watched a health documentary which inspired me to brave the big, scary world of health and nutrition. Written and directed by former health writer and comedian Tom Naughton, "Fat Head" is a must-watch for everyone, especially those who liked and/or took seriously Morgan Spurlock's "Supersize Me."

Available on Netflix and Hulu as well for sale off the creators website, "Fat Head" is a quick, fun and informative video. However, for those who want the factual gist of it without the cheesy (but amusing) commentary and animations, I present this partially-digested version of the food documentary, broken into three main chunks for easy consumption.

1. The numbers in "Supersize Me" don't add up. In the movie, Spurlock's nutritionist repeatedly says he's consuming over 5,000 calories per day. Problem is, according to Spurlock's own rules, he only had three square meals per day. Even if he Super-Sized at every opportunity (which he claims not to have done) that still only adds up to a rough 3,600 calories. Where'd the rest come from? He must have added several desserts. If someone stuffs themselves with over twice the calories required for a healthy adult... is it really surprising that they gained weight?

We could easily check the veracity of Spurlock's claims by looking at his food diary for the month -- but he won't release it. Naughton called his agents three times, other journalists have inquired, and I sent him a tweet to ask about it. No response.
Pictured: my journalistic responsibility, fulfilled.
So, Mr. Spurlock, if you truly ate 5,000 calories of McDonald's daily while sticking to your "diet," what are you so desperate to hide?

The belief that this is all McDonald's fault rests on what Naughton refers to as "Lawyer Logic." That is, many factors may be causing obesity, but a lot of them - local restaurants, parents, school districts - don't have enough money to be worth suing. McDonald's does, so of course THEY'RE the ones to blame!

"Fat Head" also points out the element of paternalism in these claims. As Eric Oliver (professor of political science at U. of Chicago) points out, anti-obesity conferences are attended mostly by skinny white people. It's perhaps no coincidence that anti-fat crusades have been directed at low-income groups and people of color, using many of the same epithets relating to "laziness" or "lack of self-control" which used to be part of the segregationist repertoire. By targeting obesity, skinny white people get the same sense of self-superiority that racism provided, without the politically incorrect connotations. In fact, they get to be on the news proclaimed as "food activists" or "health scientists" and are lauded for their efforts to control other peoples' lives.

2. Obesity is not actually that big of a public health problem, and for two reasons: the extent of obesity has been inflated, and so have the health risks of being overweight.

It's common to hear that "1/4 of American adults are overweight" but the way government statistics calculate obesity, I'm surprised it's not more. A man who is 5'11" and 190 lbs. is considered overweight. According to the government, if you don't look like Napoleon Dynamite or a Kenyan marathon runner, you could stand to drop some pounds.

Perhaps more importantly, even though more Americans are "overweight" we're still living longer than ever before. At one point, the CDC estimated that obesity was killing 400,000 people every year. To accomplish this statistical feat, the government researchers would count any cause of death in an overweight person as being caused by weight problems; get run over by a car while eating a cheeseburger, and CDC would say it was the burger's fault! Negative attention quickly caused them to reduce their estimate to a less staggering 25,000 per year -- an eighth of their former estimate. Give or take 375,000 and I guess they weren't too far off.

As you may have already inferred, the obesity "epidemic" is a lot more more figurative than literal. A lot of America's heaviness can be explained by demographic trends just as well as eating habits. In the 1970s the average age was 27; now the average age is 36. As Naughton argues, is it really surprising that a population on average about ten years older would also be 8-10 pounds heavier?

Weight gain could even be interpreted as a sign of our success; more people have time to enjoy leisure rather than doing exhausting work to make a living. If only more countries could suffer from this "problem"!

3. Low-fat diets are bad for your health, and aren't even any good for losing weight. The belief that high amounts of (saturated) fat causes high cholesterol, and that high cholesterol causes heart disease has been scientifically discredited. The connection between fatty diets and heart disease - the lipid hypothesis - was "discovered" by Ancel Keys in his famous seven country study. Why only seven? Data on 22 countries was available, but Keys just threw out the data that didn't fit his desired trend line, and went ahead to publishing. If you're an economist, that's a good way to get kicked out of grad school, but apparently it can get a health researcher's face on the cover of Time Magazine.

The real relationship between heart disease and cholesterol is much more complicated. "Fat Head" does a very thorough and accessible coverage of the science behind those issues which I won't attempt to repeat here in full. I will say that the literature disproving the lipid hypothesis is stunning in its depth, significance, credibility of researchers, and apparent ability to be completely ignored when formulating government policy.

Key's findings stuck around, in spite of mountains of conflicting medical studies, because it happened to agree with the beliefs of important government bureaucrats at the time. The official position became that a low fat, high carbohydrate (in the form of pasta, grains, and bread) was the way to stay healthy. People were advised to stay away from animal fats, which were a core food source during the course of human evolution. Only recently have processed vegetable oils and starches become widely available. By strange coincidence, this also happens to be when diabetes and heart disease start to become major killers. The government's advice: eat more processed oils and starches, not animal fats!

Al Sears, M.D.
"There's only one group of animals that lives well on grains, and that's birds."
- Al Sears, M.D., 
Director of the Wellness Research Foundation (interviewed on "Fat Head").

Processed carbs or starches are converted into sugar in the intestines. The glycemic index on "heart healthy" foods like Raisin Bran have around the same output in the body as table sugar. The body produces insulin to manage the high blood sugar levels. Over time, this causes diabetes and makes fat cells within the body retain more mass.

This is why low-fat diets set people up to fail, and the McDonald's diet is actually not so bad. Eating large amounts of fat and protein but relatively little carbs, Tom Naughton dropped over twelve pounds in 28 days... And that's eating double Quarter Pounders! He demonstrates that if you make smart choices, it's possible to lose weight eating fast food for every meal. By corollary, the average person will probably not give themselves a heart attack or become morbidly obese by eating fast food a couple times per week.

High blood sugar levels is a more serious public health issue than obesity. What makes high blood sugar especially insidious is that it does not always cause obesity and as a result, often remains untreated. Thin people can have high blood sugar but fail to take the situation seriously because supposedly heart disease and diabetes only happens to fat people. 

Rather than being overly concerned about what we eat, "Fat Head" argues we should be much more concerned about the (in)activity of Americans, both children and adults. It's not mentioned in the movie, but research shows that more time sitting down significantly reduces life-spans. That's right; I'm putting my life on the line to give you this blog! Instead of suffering through a restrictive diet, you're likely to be healthier from seeking moderate exercise and sensible eating habits.

What I took away from "Fat Head" is the surprising degree to which nutrition and health has been politicized, and largely to the detriment of the American people. Health bureaucrats have been guided by what is popular and expedient, rather than following the advice of medical professionals and researchers. Everyone should watch Tom Naughton's "Fat Head"; even if you disagree with some of the conclusions, it is both contrarian and well-supported, making it a highly entertaining documentary as far as I'm concerned.

Friday, April 29, 2011

Royal Weddings Aren't News.

Heck, royalty in general isn't news. What does the English monarchy even do these days, except splatter their events and "personalities" across global news media at any opportunity?

Here's five things in the news today that I care about more than William and Kate's media circus.
  1. India, Mauritius agree on Joint Working Group on Double Taxation
  2. In Shift, Egypt Warms to Iran and Hamas, Israel’s Foes
  3. Attorneys General Battle NLRB Over Boeing Plant
  4. Space Jam: Thousands Flock to See Shuttle Fly, creating potential traffic problems on East Coast
  5. Benjamin Moore's "Odorless" Paint Stinks and is Sticky, Suit Charges
Yes, the failure of paint to dry as promised is probably of greater significance than the royal nuptials.... and yet here are the top four items today from Time Magazine.
  1. William and Kate: Scenes from a Dazzling Royal Wedding
  2. Kate's Grace Kelly Moment
  3. Kate Middleton's Sensational Wedding Dress
  4. Royal Wedding: The Day's Schedule
The U.S. debt ceiling will be reached in two weeks, the American military is engaged in three different countries, and all we can hear about is royal frippery. If I cared any less, I'd be in a coma. 

Friday, April 8, 2011

Inefficiency of health, education sectors is more than coincidence or the "Baumol effect."

From The Economist, March 17:
Larry Summers, Mr. Obama's main economic adviser till the end of 2010, argues that the goods governments buy, especially health care and education, have proved much more resistant to productivity enhancements than the rest of the economy. Since the 1970s real wages in America have risen tenfold if you measure them against the cost of televisions; set against the cost of health care, they have gone down.
Mr. Summers expects that trend to continue. An ageing population will need ever more health services provided by the state...
Unintentionally, Mr. Summers has presented some truly fabulous arguments against the increase in government spending he seems to advocate.

Is it truly just random chance or amazing foresight which has led the state to invest in sectors which just happen to be resistant to productivity enhancements? The Economist article points to the so-called Baumol effect, whereby some activities are immune to improvements in labor productivity. For example, it still takes the same number of musicians to perform a Beethoven symphony as it did in the 1800s.

To me, this seems like a completely inadequate explanation for the growing costs of education and health care. Unlike symphonies, there have been many technological improvements which should make the provision of those services much cheaper. Increased access to computers has revolutionized other industries and this would seem to be especially true in health or education, where the rapid and accurate transfer of information matters especially. But that hasn't happened.

There is a much simpler explanation: more government intervention causes higher costs. As health and education became increasingly regulated, the incentive to increase productivity became smaller. Teachers and doctors have to satisfy the demands of politicians and not just the parents or patients. There's no reason to rein in costs because taxpayers will foot the bill regardless.

I'd speculate that if the government had decided to regulate and oversee the production of symphony music, it would take twice as many people as it did to perform in the 19th century (and they'd miss twice as many notes). Instead, we have a medical industry that kills 98,000 people per year with preventable accidents, and an educational system that spends the most in the world but can't keep us in the top ten for global rankings of student proficiency in basic math and sciences.

Is this really a success story for government social spending? To me, it sounds like a reason to chop down the vines of red tape choking the market for education and health care. If costs continue to rise after the government's influence has ended, there may actually be an argument for the Baumol effect. Until then it's just empty apologetics.

Tuesday, April 5, 2011

Real causes of debt are simple; debtors' explanations more complicated.

In my constant quest to find the pot of gold at the end of the Internet, I discovered this gem.

CCCS Causes of Debt

Does this make sense to you? As far as I know, there's only one cause of debt: borrowing money. Whether that is "bad" debt depends on the circumstances surrounding efforts to pay it back.

In short, there are two big problems with the statistics above.

1) Data are from surveys of where people say their debt came from (revealed in tiny font at the bottom of the picture). Perhaps I'm too cynical, but I think more people are apt to blame their debt on external events, such as a pay cut, rather than admit they are spending beyond their means. It's more sympathetic and less hard on the ego to say that you were forced into debt rather than led down the path willingly.

2) After losing a job or taking a pay cut, if you continue to spend at the same rate as before, in my book that still counts as "going wild in the aisles." If expectations remain static as situations change, is it really accurate to blame the situation (less pay) for the outcome, rather than one's personal failure to adapt to the new circumstances? If it were the opposite case and income had just increased, I don't think many people would say "I blame this higher wage for my not having time to go shopping and spend as much as I want" (holding hours worked constant, of course). The real problem is not adjusting behavior to fit the new constraints that reality imposes.

I'm sure some people end up in bad debt through no fault of their own, or as a result of unavoidable expenses or unforeseen changes in income which may coincide with less opportunities for work. However, I don't think that number is large enough to make up 48% of all cases of bad debt. Further, by claiming that a pay cut is the largest cause of bad debt this chart implies that people are largely incapable of changing their consumption patterns to fit a more modest standard of living, which is not a very good lesson to live by.

If anything, the big difference between "perceived" and "real" causes of debt would be better labeled as "how I think other people got into debt" and "how I explain my own debt" respectively. Knowing only a little about psychology, it is unsurprising that respondents hold other people responsible for their choices (spending too much) but apply a much more ego-gratifying standard when considering themselves.

Maybe the 21st century version of old proverb "don't take any wooden nickels" will become "don't trust statistics off of online infographics." Less catchy perhaps, but much more common application!

Monday, February 7, 2011

How to Gain Twitter-Fame for Penny Stock Advice, with no Skill, Knowledge (or Profits) Required.

Along with upcoming rappers, Bieber fans, and ad-bots there’s a rash of penny stock advice to be found on Twitter. At first I dismissed it as one of many eccentricities of the platform, but after seeing a few dozen assorted “penny stock” accounts I started to wonder. What could explain these accounts peddling advice on securities that most investors wouldn’t line a litter-box with?

So-called "penny stocks" may range in cost from a few dollars to a fraction of a cent. For example, instead of buying one share of IBM at $164.68, it would be possible to instead purchase 4,450 shares of Double Eagle Gold Holdings (DEGH) at $.037 per share (amusingly, both stocks are currently near their respective peak historical values). DEGH had been running at an average price of about $.003 for most of the last year. If an investor had a crystal ball and could foresee this recent ten-fold run up in price, there would have been a lot of money to be made; therein lies the temptation of penny stocks.

Of course, anyone who actually had that crystal ball and put it to use in the market would be far too rich to bother with running a Twitter account. So why are there hundreds of penny stock tweeters out there? To explain, here is a theory of how ANYONE can appear blessed with penny stock clairvoyance.

The Five-Step Guide to Achieving Twitter-fame with Penny Stock Advice:

Step 1: Pick out 100 penny stocks at random, and buy $10 worth in each of them for a total cost of $1,000 plus brokerage fees (or, if you’re cheap, just consistently follow the prices of 100 penny stocks).

Step 2: Wait. As is normal for inexpensive and highly volatile stocks, the price of some will go up dramatically and others down equally dramatically.

Step 3: Ignore the stocks that go down. Out of the 100, by random chance you’re almost assured to see one go up every now and then. Get on Twitter and brag about how well your picks in the stocks that went up are going.

Step 4: Construct self-promotional statistics to describe how well an investor could have done if they had known exactly when these volatile stocks would move up and down, then tweet about anyone can generate “POTENTIAL 237% PROFITS!!!” based on your expert advice.

Step 5: Bask in fame and adulation. If you are lucky, people will buy a subscription to your newsletter. Or, if they follow your advice, it will drive up the price of penny stocks you own. Then sell off the penny stocks that went up due to your “wisdom” and leave your followers to eat the losses as the stock shifts back down. 

I can’t verify that every penny stock tweeter uses this self-serving strategy. However, it’s the only way I can think of making money off penny stocks, so I’d guess that a large ratio of those Twitter accounts have something like this in mind.

In the time it took me to write the above, DEGH – which I noticed as a result of a penny stock tweet – has dropped 35%. IBM, on the other hand, changed 0.30% in that hour. In a nutshell, this is why investing in penny stocks is probably not a good idea: you get all the risk of stock market speculation without much stake in any real value (or else why is the stock so cheap?). Markets tend to be efficient and integrate available information into stock prices, so when a stock costs a fraction of a cent, it’s probably because many people rate its investment value somewhere near a lottery ticket.

The DEGH rollercoaster, courtesy of Google Finance. Notice the peak, then sudden drop at the end.

To make matters even worse, even if you successfully buy low and sell high with penny stocks – a difficult proposition, given how quickly the values change – you’ll be eaten alive in brokerage fees. For the example above, even if one used a discount brokerage like Scottrade, the cost of each purchase would be a $7 flat fee – making a $1,000 investment cost a total of $1,700. It would take a crystal ball, extraordinary luck, or loads of self-serving information delivered to a mass audience in order to generate enough returns to cover that cost. When you see someone giving investment advice on Twitter, mentally ask which of those three categories you think they fall into.

Note: for entertainment purposes only. I’m not dispensing investment advice; the stocks named were solely for example purposes, not as endorsement. If you’re reading this and run a penny stock service I’m sure you’re the exception to the above, and love children, flowers, kittens and your advisees all equally and would never pull such a scam on them. I’m just writing about your competition. But I would awfully like to peak at your crystal ball sometime when you get a chance.

Thursday, January 13, 2011

Self-Educate on Economics – Seven Books to Read.

Selected based on three criteria: content (the book does a thorough and exhaustive review of the material) relevance (the book speaks to issues which matter in terms of current world events) and readability (writing style is accessible and engaging). With that said, here are seven good books for an economic self-education.

1. Exchange & Production: Competition, Coordination & Control. (1983) by Armen Alchian & William R. Allen.

Any student of economics has to start with solid principles textbook. While many different books could suffice, this Alchian & Allen book is readable, comprehensive, and avoids unnecessary complexity while providing excellent coverage. In spite of being several decades old and out-of-print, copies of this book are still available from various online retailers.

2. The Wealth and Poverty of Nations: Why Some are So Rich and Some So Poor (1999) by David S. Landes.

Landes’ book covers a broad spectrum of history, and has the benefit of being an easy read. The general thesis: richer countries tend to be those that embraced trade, private property rights, and intellectual inquiry (these three, historically, tend to occur together). Europe gained a developmental advantage because, by accident or historical circumstance, the conditions for innovation which made the Industrial Revolution possible happened to thrive there. Lest this seem overly Anglo-centric, Landes also does an interesting coverage of other civilizations, and attempts to explain what factors prevented them from making the same leap that occurred in Europe. This book situates the global context of wealth and poverty that exists today.

3. The Wisdom of Crowds (2005) by James Surowiecki.

A recently-published book that has already become a classic in some circles, The Wisdom of Crowds explains why decentralized knowledge informed by self-interest can result in highly accurate predictions. Contradicting the common opinion that experts are better at predicting outcomes than ordinary people, Surowiecki finds that not only are supposed “experts” much less accurate than they claim, but that guesses taken by ordinary people when aggregated are far closer than any single estimate. As this is the principle which guides most markets, it offers a compelling insight into why those systems work so well.

4. The Housing Boom and Bust (2009) by Thomas Sowell.

Probably the most important and relevant book on recent financial history there is to read. Unlike many other treatments of the financial crisis which focus the blame on one particular party, Sowell constructs a multi-faceted picture, including all the relevant policies, government decisions, and lobbying groups whose efforts unintentionally led to the recent financial crisis. He also debunks the common perception that “markets run amuck” caused economic downturn, and instead traces the series of government intervention which built the housing bubble and then led to its collapse. For anyone is convinced that more regulation can save the economy, this book will give reason to rethink that position.

5. Failure and Progress: The Bright Side of the Dismal Science (1993) by Dwight R. Lee and Richard B. McKenzie.

An interestingly prescient (but little known) book, this short publication by the CATO Institute explains why it’s best if the government stays out of the way when a business begins to fail. It exposes the inherent contradiction in political positions which desire the wealth which capitalist systems can attain, but also want to prevent the painful dislocations created by business failure or bankruptcy that occurs under a free market. Lee and McKenzie convincingly explain why wealth for all is impossible without failure for some enterprises; unprofitable businesses represent a misuse of society’s resources, so it is better they fail so those inputs can be put to better use by other firms. When government becomes involved in preventing failure it ends up creating further deprivation, by favoring producers with connections over those who can provide goods using the fewest resources. Political victories for inefficient producers are a loss for society.

6. The Mind of the Market: How Biology and Psychology Shape our Economic Lives (2008) by Michael Shermer.

This book does an excellent job of summarizing recent research in behavior psychology, neuroeconomics and similar fields, and explaining how they relate to behavior in a free market economy. While many studies show that humans have an altruistic, egalitarian and cooperative element to their interactions, this does not deny the role or importance of markets in shaping social behavior in positive ways. While a slightly more challenging read than some of the other books, The Mind of the Market provides a comprehensive look at how psychology and evolution have played a role in shaping economic interactions.

7. The Only Investment Guide You'll Ever Need
(most recent edition in 2011) by Andrew Tobias.

The first edition of this book was written back in the 70s, and since then it’s sold millions of copies world-wide. The premise: if a deal sounds too good to be true, it probably is. Tobias happens to be both very smart about money and also a highly enjoyable read. I went through this book several times as pleasure-reading when I was too young to understand what money, investing, or economics even was and still found it very entertaining. To secure your future wealth and have a good time doing it, this is probably the best book you could purchase.

It might seem from these summaries that I’ve chosen a highly partisan, libertarian or even “conservative” set of books to represent economics. While I will not claim this is the definitive “best books” list, in my personal and limited experience, I found the ideas contained very useful in interpreting economic events. There are obviously some giants not represented (Friedman, Hayek, and so on) but most of the relevant ideas can be found above. The summaries are just my biased take, but I honestly believe that all of these books are written from an open (if not apolitical) perspective. Even if you disagree with the conclusions, the analysis contained is worth thinking about for anyone.

The point: If someone wanted a crash-course on economic thought with a minimum of fluff, jargon, or general verbosity then the above list would be the direction I’d point them. If you think I left off something important or just disagree with all the above then let me know in the comments.