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May 28, 2009

Economist's View - 5 new articles

"Fermi Problems"

My oral exam was a bit different from this:

Fermi problems, by Steve Hsu: Princeton University Press sent me a copy of Guesstimation: Solving the World's Problems on the Back of a Cocktail Napkin, by professors Lawrence Weinstein and John A. Adam. The book is a compendium of Fermi problems -- that is, problems which are simply stated and whose answers can be estimated at the order of magnitude level through simple logic from a few factual inputs.

The classic Fermi problem is: How many piano tuners are there in Chicago?

When I took my oral exam as a first year graduate student at Berkeley, theoretician Geoff Chew (a former student of Fermi's) asked me:

1. How many blades of grass are on your front lawn?

2. What is the ratio of paved to unpaved surface area in Iowa? (He had earlier asked where I grew up.)

Luckily I got them both right. The experimentalist in the examining pair, Paul Richards, held up a cylindrical metal device of some sort and asked me what it was -- to this day, I still don't know :-) I suppose I was destined to be a theorist!

Physicists are constantly solving Fermi problems in the course of their work, because it's the first step in sizing up any potential project, theoretical or experimental. ...Watching someone work out a Fermi problem in real time reveals a lot about their brainpower. Wall Street firms, consultancies like McKinsey, Microsoft and even small startups have been known to ask these kinds of questions of job applicants. This book discusses similar problems in a business context.

The difficulty of most Fermi problems is limited, unless the problem requires some specialized knowledge. But I like them slightly better than puzzles or brain teasers which rely on esoteric tricks that the solver either gets or doesn't get. A former collaborator of mine came up with the following (slightly broadening the genre) one evening while I was visiting U Chicago:

1. If the sun stopped radiating energy, what temperature would the surface of the Earth cool to?

2. In the above scenario, could humans survive using current technology if given enough time to prepare?

Weinstein and Adam's book is a nice collection. ...

Here are some you can try, e.g.:

  1. In the 1989 Loma Prieta earthquake in California, approximately 2 million books fell off the shelves at the Stanford University library. If you were the library administrator and wanted to hire enough part-time student labor to put the books back on the shelves in order in 2 weeks, how many students would you have to hire? (You may assume that the books just fell off the shelves and got a bit mixed up but books in different aisles did NOT get shuffled together.)

  2. Estimate the total number of sheets of 8.5 x 11 inch paper used by all the students in one semester.

  3. How many notes are played on a given radio station in a given year?

  4. How many drops of water are there in all of the Great Lakes?

  5. If you drop a pumpkin from the top of a ten story building what is the farthest a single pumpkin seed can land from the point of impact?

  6. How many flat tires are there in the US at any 1 time?

Suppose I want to ask a Fermi problem the next time I give an oral exam, what are some good questions related to economics?

[Oops - I thought I was saving a draft - I didn't mean to publish this yet as it wasn't quite ready - oh well, I lost part of a post last night on health care costs, so this is par for the course lately.]

"Housing Starts, Remittances and Macroeconomic Developments"

Federico Mandelman of the Atlanta Fed:

Housing starts, remittances and macroeconomic developments, by Federico Mandelman: Recent evidence collected by the Dallas Fed's Pia Orrenius suggests that apprehensions of undocumented workers attempting to cross the U.S.–Mexican border are a good predictor of the overall American job market. Simply put, if one wanted to predict job market conditions in July of a given year, one should examine immigrant apprehensions in January. Orrenius finds that more immigrants attempt to cross the border from Mexico (and more of them are caught doing so) when immigrants believe the U.S. economy would offer more jobs in the near future.

One area of the economy that relied heavily on immigrant labor was housing. The following chart plots monthly U.S. housing starts (lagged five months) and remittances to Mexico. ... I use remittances as a proxy for migrant Mexican labor.

Figure: Housing Starts and Remittances to Mexico 052809

Note: Remittances in U.S. dollars. Housing starts indicate new, privately owned housing units. Source: Bank of Mexico (remittances), Haver Analytics (housing starts)

The correlation between the two data series is strikingly high. ... Of course, the results are not unexpected as the construction industry heavily employs immigrant labor. ...

Migrant workers enter the country in response to upturns in domestic labor demand, and that upturn results in higher remittances both because of the increased number of immigrants but also because the existing stock of immigrant workers is earning more. Conversely, a downturn in labor demand should be reflected in lower remittance flows because of out-migration as workers return home and because of lower earnings among the remaining stock of migrants. But what happens when some of those workers have entered the country illegally?

In a study published in 1997, Belinda Reyes found that about two-thirds of the undocumented immigrants returned to Mexico within three years upon arrival. In a recent paper I wrote with Andrei Zlate, we explore the implications of changes to enforcement policies for the U.S./Mexican border on undocumented labor and remittances. We find that increased border enforcement during the last decade has broken the typical pattern of flows of undocumented workers. Basically, while increased enforcement makes it harder/more expensive to enter the country, it also reduces the incentive for those already in the country to leave. Why? Because of the high cost/risk associated with reentering the United States in the future.

In a recent paper, Carolina Rodriguez-Zamora adds support to our claims. She finds that as the U.S. Department of Homeland Security increases the amount of resources spent policing the border undocumented immigrants tend to stay longer.

Increased enforcement protects the existing stock of undocumented immigrants from additional competition, and this development can put upward pressure on wages when U.S. labor demand is high. When labor demand is low, rather than returning home, these individuals could remain in local labor markets, placing additional downward pressure on wages.

"Crazy Compensation and the Crisis"

Alan Blinder urges "corporate boards of directors and, in particular, of their compensation committees" to create compensation plans for financial firms that discourage excessive risk taking:

Crazy Compensation and the Crisis, by Alan Blinder, Commentary, WSJ: Despite the vast outpouring of commentary and outrage over the financial crisis, one of its most fundamental causes has received surprisingly little attention. I refer to the perverse incentives built into the compensation plans of many financial firms, incentives that encourage excessive risk-taking with OPM -- Other People's Money.

What, you say, hasn't huge attention been paid to executive compensation...? Yes. But the ruckus has been over the generous levels of compensation,... not over the dysfunctional incentives...

Take a typical trader at a bank, investment bank, hedge fund or whatever. ... Unfortunately, their compensation schemes ... offer.. them the following sort of go-for-broke incentives when they place financial bets: Heads, you become richer than Croesus; tails, you get no bonus, receive instead about four times the national average salary, and may (or may not) have to look for a new job. ...

[L]et's consider the incentives facing the CEO and other top executives... For them, it's often: Heads, you become richer than Croesus ever imagined; tails, you receive a golden parachute that still leaves you richer than Croesus. So they want to flip those big coins, too.

From the point of view of the companies' shareholders -- the people who provide the OPM -- this is madness. ... Traders and managers both want to flip more coins -- and at higher stakes -- than shareholders would if they had any control, which they don't.

The source of the problem is really quite simple: Give smart people go-for-broke incentives and they will go for broke. Duh.

Amazingly, despite the devastating losses, these perverse pay incentives remain the rule on Wall Street today, though exceptions are growing. ... These wacky compensation schemes have puzzled me for nearly 20 years. ... But the issue could be considered an intellectual puzzle until the bottom fell out. ... after an orgy of irresponsible risk taking... [T]he consequences for the real economy have been devastating. ...

What to do? It is tempting to conclude that the U.S. (and other) governments should regulate compensation practices.... But the ... executives, lawyers and accountants who design compensation systems are imaginative, skilled and definitely not disinterested. Congress and government bureaucrats won't beat them at this game.

Rather, fixing compensation should be the responsibility of corporate boards of directors and, in particular, of their compensation committees. These boards, ... are supposed to represent the interests of stockholders, not those of managers. ... The unhappy (but common) combination of coziness and drowsiness in corporate boardrooms must end. ... For example, top executives could be paid mainly in restricted stock that vests at a later date, and traders could have their winnings deposited into an account from which subsequent losses would be deducted.

Comprehensive reform of the financial system will probably take years. The problems are many and complex, and the government's to-do list is not only long but also a political minefield. Yet fixing compensation incentives does not require any government action. It can be done by financial companies, tomorrow. Too bad they didn't do it yesterday.

But how is the board of directors chosen? See also:

The SEC's Proxy Access Proposal, by Lucian Bebchuk: The Securities and Exchange Commission voted last week to ask the public to comment on a proposal to let shareholders place director candidates on the corporate ballot. The adoption of such a rule would be a useful step toward the necessary reform of corporate elections. ...

"The Cost Conundrum"

Why are health care costs in McAllen, Texas twice as much as costs in El Paso County even though they have similar demographics?:

The Cost Conundrum, by Atul Gawande, The New Yorker: ...McAllen, Texas ... is one of the most expensive health-care markets in the country. ... El Paso County, eight hundred miles up the border, has essentially the same demographics. ... Yet in 2006 Medicare expenditures (our best approximation of over-all spending patterns) in El Paso were ... half as much as in McAllen. ...

links for 2009-05-28

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