Thursday, March 28, 2013


From This Time Is Different: Eight Centuries of Financial Folly, Carmen M. Reinhart and Kenneth S. Rogoff, Princeton, 2009, 
If there is one common theme to the vast range of crises we consider in this book, it is that excessive debt accumulation, whether it be by the government, banks, corporations, or consumers, often poses greater systemic risks than it seems during a boom. xxv

Although private debt certainly plays a key role in many crises, government debt is far more often the underlying problem across the wide range of financial crises we examine. xxxiii

Severe financial crises rarely occur in isolation. Rather than being the trigger of recession, they are more often an amplification mechanism: a reversal of fortunes in output growth leads to a string of defaults on bank loans, forcing a pullback on other bank lending, which leads to further output falls and repayment problems, and so on. 145

[I]nflation has long been the weapon of choice in sovereign defaults of domestic debt and, where possible, on international debt. 175

Monday, March 18, 2013

Froma Harrop on incentives

Froma Harrop, a columnist who often writes about economics, opines:
"The most insidious effect of the Social Security and Medicare regimes is that they actually shift economic incentives away from having children," Jonathan V. Last, a writer for the conservative Weekly Standard, says in his book, "What to Expect When No One's Expecting: America's Coming Demographic Disaster ."
Here's a counter-argument: These programs reassure parents bearing the considerable expense of raising children that they won't be destitute if they can't save enough for their old age.
Ms Harrop has a strange notion of how incentives work: If you have children, you get state-funded retirement payments. If you do not have children, you get state-funded retirement payments. Therefore state-funded retirement payments encourage you to have children.

Economists have studied savings and fertility for many years and, as far as I know, none have seriously proposed what Harrop is suggesting. On the contrary, they expect social security programs to reduce the incentive to have children because they are alternative ways of providing income when people get old and are no longer productive.

There are three ways to prepare for old age. The only one available in primitive societies is to have children who will support you when you get old. In these societies being childless is a curse. In some of them, only male children support their parents, and in these societies there is a strong preference for male offspring.

When societies get financial markets and the rule of law, a new way, savings, becomes important. However, many people have self control problems when it comes to budgeting, so various sorts of pension funds, which force patience, develop. When this alternative way to prepare for old age becomes an option, having children becomes less important and we can expect fertility rates to fall.

A final way to provide for the old is for the government to tax the young and give the money to the old. This is what social security programs of welfare states do, though they may disguise what is going on by pretending it is a retirement plan similar to those offered outside of government. Because social security programs offer a third way to provide for old age, we can expect their existence will cause people to rely less on the other two ways, having children and private savings.

All three ways transfer income from the young to the old. With children the transfer is within the family. With private saving it is a voluntary exchange; assets that the old acquire are sold to the young. With government tax and transfer, it is a coerced transaction.

The emergence of articles like this from Harrop may indicate that the decline of fertility is finally attracting notice beyond a narrow slice of academic specialists. Demography is destiny, but math is hard.

See also Jonathan Last's reaction.

Thursday, March 14, 2013

Why interstellar space travel will never happen


Most people recognize that time travel presents logical problems--if you can travel back in time, you would change the present from which you came and your existence would be erased, so there would in fact be no one to travel back in time to change it. The purpose of this note is to argue that, although it does not face the logical problems of time travel, another popular theme in science fiction, interstellar travel in which humanity colonizes distant planets, faces such serious obstacles that this travel is unlikely to ever happen.

1. Physics

The first barrier to the spread of humanity beyond the solar system is physical--the distance to the stars is vast beyond the comprehension of most people. Light travels at about 180,000 miles per second. The nearest star to our sun is four light years away. If we could get a space craft to travel at 1000 miles per second, which is vastly faster than anything we can achieve with our current technology and could get us to the moon in four minutes, reaching the nearest star would take over 700 years.

The response to this objection is usually an appeal to technology and progress. A thousand years ago people could not image any way that people would be able to travel anywhere in the world in less than a day. Many of the technologies that we take for granted today were unimaginable to people living a couple centuries ago. What is to prevent an equally big jump in technology in the next two hundred years? What our great-great-great grandchildren will take for granted may be things that we cannot imagine today. Projecting the growth of knowledge and technology that we have seen in the past several hundred years into the future suggests that at some time even an achievement as daunting as interstellar space travel may not only be possible, but routine.

In the late eighteenth and early nineteenth centuries steam power was applied to manufacturing and transportation, beginning an era of rapid economic and technological change known as the Industrial Revolution. It is easy to understand why many people would assume that rapid technological change is the norm after two centuries of it. However, a longer view of history suggest caution. There have been periods in the past of economic growth and prosperity followed by stagnation and decline. The fall of the Greco-Roman civilization is the most obvious example. Much of the knowledge that was accumulated during the centuries that this civilization developed was lost in fires that destroyed manuscript collections, in economic collapse, and in depopulation of its territory during centuries of warlord rule. There is no guarantee that in the future much of the accumulated knowledge of the past two centuries might also be lost.

The present explosion of technological knowledge may be due to a confluence of events that can not be repeated. The discovery by Europeans that there were two continents not on their maps and the resulting unification of the world into a single trading network was a one time event that spurred innovation. The development of limited government with free markets was a break with the normal run of history that features powerful governments that promote stasis. Free markets are inherently dynamic.

We do not know what the limits of knowledge and technology are, so there is no way for us to prove or disprove the possibility of interstellar space travel. However, it should be recognized that belief in limitless possibilities for technology is not based on science. It is a matter of faith.

2. Biology

Suppose that humanity eventually does overcome the physical barrier of vast distance and finds a way to travel to the stars. It would then encounter a second barrier, the biological barrier. Humans evolved on earth and are dependent in a great many ways, some of which we do not understand, on the ecosystems and conditions on earth. If we could reach another solar system, we would find either planets that currently support some form of life or planets that need to be transformed to support earth life.

Planets that are most similar to the earth in size and orbit may be those most likely to already have life. If a planet currently supports life, that life most likely would be incompatible with our life needs because it evolved separately and may have a different molecular basis. Again, we evolved on earth along with other organisms and are dependent on those other organisms. We would have to alter the environment of a living world--disrupting the existing life--to make it compatible with our needs and that might take many centuries. There is no guarantee that the earth life that we bring with us could either co-exist or triumph over the established life. Any return voyage back to earth would run the risk of bringing alien life back to earth with potentially devastating consequences.

Trying to terraform a planet without life is completely beyond the technologies we have today. It took many millions of years for earth to develop the atmosphere and climate on which we depend. Believing that this process could be accelerated (on a planet that was inhospitable to the development of life) so it would take years or centuries is based on faith in technology; perhaps mastering the manipulation of DNA can lead to super organisms with capabilities far greater than anything evolution has produced. Even with such breakthroughs, mastering terraforming would require the trial and error needed to develop any engineering concept. Each planet that needs terraforming would have its own special conditions so that monitoring the process would require on-site decision making with little or no guidance from earth, which leads to a problem discussed in the next section. Finally, the cautions noted about technological progress in the previous section apply here.

The above discussion assumes that life is likely to develop whenever there is an abundance of liquid water. The biological barrier would be far lower if life has only developed on earth and planets in other systems that are similar to earth in orbit and size are barren.

3. Economics

A final barrier is the economic barrier and there are two parts to this. First, it is unlikely that colonizing the galaxy will make sense in terms of costs and benefits. There will be no prospect of intergalactic trade from colonizing distant planets for hundred or thousands of years after the colonization. This problem is why we are not currently colonizing the moon or Mars. The last man on the moon left in 1972. That effort to send men to the moon was a publicity stunt in which the U.S. wanted to show its technological superiority over the Soviet Union. It is unclear when or if we will return because these missions have economic benefits far less than their costs. As robotics improve, making the case for sending people gets harder. Traveling to a planet in another solar system will be vastly more difficult and expensive. What will be the rationale for investing in the effort? Further, if the effort requires hundreds of years to accomplish, it may be politically impossible. History suggests that governments or other human organizations are unlikely to last long enough to accomplish the task.

The second problem is one that Adam Smith would have recognized. The reason that we contemplate colonizing the galaxy is because we have seen living standards and technological progress explode in the past three hundred years. Both of those explosions are tied to specialization and division of labor. We are connected to millions and perhaps billions of other people around the world in the goods we use in everyday life. If we were cut off from the larger market, our standard of living would quickly deteriorate. A thought experiment along these lines was posed recently by the question of whether a single marine unit could defeat the Roman Empire if it could be transported back in time. Certainly it would have an overwhelming advantage in any initial encounter. However, once it used its supplies of fuel and ammunition, it would be unable to replenish them and the advantage of modern technology would be neutralized. The marine unit would quickly realize that modern technology depends on a vast network of support, a network that they would no longer have.

Stone-age hunter-gatherers spread around world, missing only a few islands. Their technology was simple enough to be contained in small groups and to be handed down from generation to generation. When they met new conditions--novel plants and animals--they needed to adapt and that adaptation undoubtedly was done at the cost of may lives. In contrast, European expansion after Columbus was aided by technology complex enough to require links back to the home countries. If Europeans had not had the re-supply lines back to Europe but instead had tried to settle with only what they brought in their ships, it is unlikely that any would have succeeded. Their groups were not large enough to complete the supply chain needed to reproduce their tools.

Colonization of another solar system would be highly technological and thus would require either a supply chain back to earth or an enormously big ship to bring enough people and supplies to sustain the effort. A physical supply line linking earth to a colony in another solar system seems impossible because of time. Resupply in the case of European colonization could take a year or two in the 16th and 17th centuries, but that is within the lifetime of individuals and governments. Those resupply lines do not tell us about how a resupply line that is longer than the lifetime of many generations and governments could be managed. The bigger the ship, the more costly and difficult the interstellar mission. At present we can not set up a colony on the moon, a task that is trivial compared to setting up a colony in another solar system.

A premise of the book Guns, Germs, and Steel: The Fates of Human Societies by Jared Diamond is that economic development in Europe and Asia was faster than development in other parts of the world because it had the largest population in communication with one another. Diamond notes that history has seen cases in which small isolated groups, such as those who settled Tasmania, lost technology and drifted backwards. If the initial colonist to another solar system were a small group, they would have a limited ability to make the discoveries and invent the technology that would be necessary to adjust the conditions on the new planet. Those adjustments would be necessary because of the biological problems mentioned above.

Again, a belief in technology can solve these problems. If as a byproduct of technologies developed for other purposes, humans stumble on a way to travel interstellar distances cheaply and quickly, not only are the barriers of physics removed, but also the economic barriers. (Travel to the moon was possible only because of technologies previously developed for war. If the technologies of rockets had not already existed, it is doubtful anyone would have developed them solely to get to the moon.) Although the biological barriers would still exist, mining on barren and lifeless planets could give a reason for exploration, trade, and limited settlement.


The Drake equation, which is popular among those searching for extraterrestrial life, is supposed to give an estimate of how many alien civilizations exist in the universe or galaxy. The problem with this equation is that we have a sample size of one solar system that we know a fair amount about, and with a sample size of one we cannot use statistics to estimate the parameters of the equation. That has not stopped people from using the equation, but since the parameters that they use are purely guesses, the results of the equation are also purely guesses. Similarly, those who believe that interstellar colonization is inevitable are using assumptions that are purely guesses. It is not logically impossible that at some time in the very far future humans may overcome the serious obstacles discussed above and travel to distant stars. However, people should also recognize that it is possible that the colonization of space can never happen because it is beyond the capabilities of humans.

Monday, March 11, 2013

Incentives and tricks

"But what Sunstein and Thaler say is that it's just easier to trick people than it is to change their incentives.... [M]y toolkit used to contain only incentives, but now tricks are in there, too."
Steven D Levitt, from an interview in Simon W, Bowmaker, The Art and Practice of Economics Research: Lessons from Leading Minds (Edward Elgar, 2012 ISBN: 978 1849808460) p. 237
Behavioral economics and the psychologists who inspired it may have introduced ways of tricking people into intellectual discourse but it is doubtful that they are discovering anything that has not been practiced by hucksters for generations. Their analysis of weaknesses in the ways people choose can be used in two ways.

First, it can help people manipulate others--to trick or nudge them. This can benefit those who are tricked if, as Levitt, Thaler, and Sunstein assume, the tricker is a benevolent paternalist preventing mistakes by an error-prone citizen or underling. Those who assume that even people in government are usually self-interested fear that the benefitting party will not be the one tricked, but rather the one who tricks. They worry that power combined with this knowledge creates temptation for abuse.

The second way to use the analysis of behavioral economics is not through manipulation but rather as a defense against manipulation.  If one understands the errors to which human decision-making is prone and how those errors can be exploited by others, one can attempt to correct for those errors and is less likely to be exploited.

Thaler and Sunstein do not use the word "trick." Instead they talk about "nudges," ways of framing choices so that people are more likely to make what Thaler and Sunstein consider good choices. Levitt has re-framed their message by using the word "trick," and their approach seems less desirable when it is seen as tricking people rather an as nudging them. Can the government of free and equal people be based on deception?

(Behavioral economics can be used to attack the notion of market efficiency. If people cannot be trusted to make rational choices, why should we want a system to responds to people's wants as markets tend to do? However, behavioral economics can just as easily be used to attack the underpinnings of democracy. If people can be easily tricked, why should we expect their political choices to result in good government? With or without behavioral economics, it is hard to make a convincing case that political processes have a greater tendency to self-correct than market processes.)

Friday, March 8, 2013

Entrepreneurs or thieves?

David Henderson has a good article on the so-called robber barons, a derogative term that became popular only in the 1930s. He notes that those who complained about Rockefeller and Carnegie were not their consumers but their competitors.

The technological breakthroughs of the second half of the 19th century created economies of scale in petroleum, railroads, and steel production. Someone was going to take advantage of these economies, and it turned out that Rockerfeller and Carnegie were the people at the right place with the right skills. But if they had not been there, someone else would have done something similar. Bill Gates in the 20th century is similar case, though it was network economies that he exploited rather than economies of scale. It was inevitable that the business world would standardize on some operating system, and if Microsoft had not offered one, someone else would have developed or offered one. (IBM totally bungled the introduction of their PC--they did not realize it at the time, but they destroyed themselves when they did not control both chips and operating system.) Microsoft has kept its dominance by being smart enough to copy Apple--many others would quickly have lost dominance by being less astute than Microsoft has been.