Two examples of good informal economic analysis

 I've spent the last couple of posts scoffing at the big ideas of a couple of big names in the econ blogosphere. But this isn't because I think all informal or off-the-cuff economic analysis is bad...far from it! And since I happened to encounter (what I consider to be) two really excellent examples of econ bloggery this week, I thought I'd share them, in order to show how I think it ought to be done.

The first econ blog win comes from Karl Smith at Modeled Behavior. He points out, far more elegantly than I managed, why much of rising inequality could easily just be a temporary result of globalization:

At the same time [we] are seeing massive growth in the pool of laborers. More laborers from rural China move to the city everyday and economic liberalism marches across South and South East Asia. This radically increases the pool of labor...

This means that the global economy is growing...but the size of the labor pool is growing faster and faster. Thus, labor’s slice of the economic pie is barely keeping pace with the size of the labor pool, itself. The result is a stagnant slice per laborer.

Indeed, I think the slice is probably declining in the Western World, so that a person with no knowledge or skills whatsoever, earns less today that he would have 20 years ago.

The greatest potential source of relief for low skilled Americans will be exhaustion of the global rural labor force. This will mean primarily a fully industrialized Asia. This will exert itself in one of two ways.

If Asian countries retain their very high savings rate then it will occur as enormous foreign direct investment (FDI) in the United States. Chinese and Indian corporations will set up shop in the United States and bid up the demand for raw US labor. One might be tempted to think that this FDI will only support “skilled jobs” but marginalist thinking suggests not.

As the price of skilled workers rises some tasks will be substituted by unskilled workers. Making predictions about what this will look like is hard, especially since it involves the future. However, an one easy vision is to imagine a world where grocery stores turn into a massive “fresh counters” where all the prep work necessary for your meal is done to order from fresh ingredients. You go home with little premeasured containers that you can combine into the recipe you want as easily as Food Network chefs do.

This is a pampered life for high skilled workers, but its also a world in which unskilled workers can regularly find work capable of supporting their families and an ever increasing standard of living.

Another alternative is for savings in Asian to decline, which would shift the balance of trade and cause at least a temporary surge in manufacturing done in the US. The transition period would be different in this scenario, but the end game likely the same. There would be a bidding up of the returns to capital in the US and rather than FDI, domestic investment would bring about the future.

I'd also like to spotlight Peter Dorman's comment on the prediction of bubbles. He points out, quite rightly, that the much-ballyhooed Efficient Markets Hypothesis only makes the timing of bubbles impossible to predict, not their actual existence:

One answer we keep hearing to that entirely reasonable question, “Why didn’t economists predict the crash?”, is that economic theory, in the form of the Efficient Markets Hypothesis, proves that reliable prediction is impossible...[N]o one outpredicts the market on a regular basis, so there is no reliable way to know whose predictions today will prove correct in the future. This, we are told, is the lesson we need to learn from the EMH.

The logical fallacy here is so obvious that I would not bother with this post if it were not for the persistence of the EMH defense. So here goes...

The [EMH says] that, while market prices may not always be a great guide to real economic forces, their movements are not systematically predictable. At every moment, prices reflect all the forecasts of all the market participants who, between them, have access to all potential information and ways of utilizing it. A price moves only when new information arises. But to be truly new, this information has to be unpredictable—otherwise it is simply an inference from information that already exists. Because the information is unpredictable, so is its effect on prices. The randomness of price movements in turn implies that no one can outperform the market in betting on where they will go.

I have no problem with this. The fallacy arises when this argument is invoked to deny the possibility that economists can identify bubbles in real time. If you’re so smart you can spot a bubble, why aren’t you rich? If people could spot bubbles with any predictability, then the EMH would be wrong—but we know it’s right.

Let’s put aside the possibility that [the] EMH can be wrong from time to time. We don’t need to go there; the error is more basic than this.

Let’s put ourselves back in 2005...Based on my perceptions, I anticipate a collapse in this market. What can I do?

If I am an investor, I can short housing in some fashion. My problem is that I have no idea how long the bubble will go on, and if I take this position too soon I could lose a bundle...What the EMH tells us is that, as an investor, not even your prescient analysis of the fundamentals of the housing market would enable you to outperform [the market].

The logical error lies in confusing the purposes of an investor with those of a policy analyst. Suppose I work for the Fed, and my goal is not to amass a personal stash but to formulate economic policies that will promote prosperity for the country as a whole. In that case, it doesn’t much matter whether the bubble bursts in 2006, 2007 or 2010. In fact, the longer the bubble goes on, the more damage will result from its deflation...

To profit from one’s knowledge of a market condition one needs to be able to outperform the mass of investors in predicting market turns, which the EMH says you can’t do. Good policy may have almost nothing to do with the timing of market turns, however.

I only wish that posts like these would get as much attention as the more flashy but less well-grounded stuff.