Why economics is hard
People say to me ‘How come economists can’t predict things like REAL scientists?’ Well, just tell someone that you’ve found a closed solution for life and see how seriously they take you 😛
The myth of “over-investment” in housing
I have just been to a lovely presentation for the NZIER forecasts. However, an issue was raised which brings me to some slight irritation. During the Q&A session it was suggested that New Zealand “productivity is struggling” because we invested too much in housing and not in productive assets.
Such a load of tripe. Here are the two reasons I would say why:
- Housing is “productive”. It produces this thing called “somewhere to live”. When someone consumes the house they are getting this service. This is just as much of a service as getting a hair cut – the only difference is that it doesn’t require a labour input to keep it going!
- We have been told we have a SHORTAGE of housing. How can we have invested too much in housing if we have too few houses – this is a contradiction. And before anyone says “we borrowed to buy houses off each other” lets try to remember that if we buy something off someone else in the country it doesn’t change national debt – it is just a transfer.
There are issues with the housing market. The tax status is a bit favourable and building costs have been held up by consent issues and industry bottlenecks. But this doesn’t mean we have over-invested in housing – so lets stop propagating this urban myth aye. Click here to see post relating day trading and learn quick ways of making more money.
Taxing height and utilitarianism
The blogsphere has been a flutter about “the optimal taxation of tall people” (here, here, here, here, here, and here).
The way I see it there are two debates going on here:
- Do we see it as fair to tax tall people/why not just tax income,
- Should we be using utilitarianism to figure this out.
Now Rauparaha covered off the first issue back in March last year here. Many people are saying “why target height when you can target income.
One answer is that you can’t change your height, but you can fiddle your income. A slightly better answer (although the other one is fine) is to note that there are two ways of getting income, luck and effort. Generally policy makers think it is good to redistribute luck but they also want to avoid penalising effort (that is why we talk about keeping effective marginal tax rates down). What height you get is the result of genetic luck at birth. Assuming that height conveys an advantage to earning income we can tax height directly, thereby redistributing and not influencing individuals incentives to work. This is the argument Rauparaha made. [Note: I am short but Rauparaha is tall 🙂 ].
Whether this is fair or not is a moral question to be sure. However, there is definitely an argument for taxing fixed variables related to income rather than taxing income itself.
Bounded rationality: A parable
Often people accuse economists of relying on an imperfect view of human nature – a view that is often disparagingly called “homo-economicus“. However, our view of the world does not rely on the individuals being able to perfectly calculate the satisfaction they get from things or perceive every opportunity.
Ultimately all we require is that individuals respond to incentives (derived from the relative costs and benefits of things) and as a result try to set themselves up such that the benefits of their actions exceed the costs (include opportunity costs). Such a situation can occur when individuals are bounded rational.
A good example of bounded rationality comes from the parable of the centipede and its 100 legs. In the parable there is a centipede walking along. Now it co-ordinates its 100 legs without thinking and without calculating – it does so just because it has become part of its nature. Effectively, it is following a rule of thumb which allows it to make the optimal decision.
When asked about how it moves its legs it gets confused and trips – at this level anyone watch the centipede would take this as a failure of rationality, it obviously can’t deal with the complex calculation required to come up with its optimal solution. However, is this really fair? Even though the centipede couldn’t consciously decide how to move its legs, over time it had evolved a rule of thumb that had allowed it to achieve the optimal solution.
Economists “believe” (this is our value judgment here) that individuals create rules of thumb that allow them to achieve the optimal outcome – without having to consciously calculate.
Understanding how these rules of thumb evolve and change in a highly complex and changeable world is a big deal (in the parable the rule of thumb does not shift favourably to the introduction of information!), and is something behavioural and neurological economists are currently studying. However, it is clear from this individuals can still make optimal decisions, even when they aren’t expert calculators with complete information.
New Zealand budget 2009
So, we’ve had the Budget.
The one time that we need a shift in government policy – and nothing happens.
Treasury believes that the size of our economy is fundamentally smaller, that there has been a permanent shock to our income. As a result, spending needs to fall or taxes need to rise – 11 years of operating deficits isn’t good enough. And I’m not sure that S&P will let us get away with it …
I don’t agree with David Farrar when he says:
There’s not much one can argue should be done differently.
As a commitment to cut spending or lift taxes from 2011 would have been the way to go. However, he does give a good summary of what was in the budget.
Update: Miguel noticed that S&P put us back on stable outlook. Story here. Good news and congratulations to the team, but to be honest I have no idea why. Unless …
New Zealand budget 2009: Is there a cost from a downgrade?
I have noticed only two extreme positions in the media about a downgrade:
- It will be terrible – it will cost the govt alone $600m pa
- It doesn’t mean much – the credit ratings are “dis-credited”
Let me tell you something – the truth is inbetween.
Treasury’s estimate of the cost of a credit downgrade are based on the downgrade to Ireland. As we are already facing a fairly high price for the globe underlying belief of our risk, and as it is unlikely we will be knocked down and put on negative watch AGAIN (like Ireland was), the cost will not be this heavy.
However, there is a cost! It would lead to higher interest rates, restrict access to international credit, and prevent some possible capital investment from overseas. It doesn’t matter that the credit rating agencies didn’t pick the subprime crisis – investors still stick to their recommendations for what is going on in the little backwater parts of the world (like NZ).
As a result, I wish Labour would shut up about this being a “budget to satisfy S&P rather than to help people”. If they don’t I wish National would respond by saying that they are trying to stop interest rates going up – which would hurt people, instead of saying that it is “their budget”.