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April 14, 2014

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Latest Posts from Economist's View


Paul Krugman: Three Expensive Milliseconds

Posted: 14 Apr 2014 01:36 AM PDT

 What is the "true cost of our bloated financial industry"?:

Three Expensive Milliseconds, by Paul Krugman, Commentary, NY Times: Four years ago ... Spread Networks finished boring its way through the Allegheny Mountains of Pennsylvania. Spread's tunnel was ... a fiber-optic cable that would shave three milliseconds — three-thousandths of a second — off communication time between the futures markets of Chicago and the stock markets of New York. ...
Who cares about three milliseconds? The answer is, high-frequency traders, who make money by buying or selling stock a tiny fraction of a second faster than other players. ...
Think about it..., spending hundreds of millions of dollars to save three milliseconds looks like a huge waste. And that's part of a much broader picture, in which society is devoting an ever-growing share of its resources to financial wheeling and dealing, while getting little or nothing in return.
How much waste are we talking about? A paper by Thomas Philippon of New York University puts it at several hundred billion dollars a year. ...
What are we getting in return for all that money? Not much, as far as anyone can tell. ...
But if our supersized financial sector isn't making us either safer or more productive, what is it doing? One answer is that it's playing small investors for suckers, causing them to waste huge sums in a vain effort to beat the market. Don't take my word for it — that's what the president of the American Finance Association declared in 2008. Another answer is that a lot of money is going to speculative activities that are privately profitable but socially unproductive. ...
 It's ... hard ... to see how the three-millisecond advantage conveyed by the Spread Networks tunnel makes modern America richer; yet that advantage was clearly worth it to the speculators.
In short, we're giving huge sums to the financial industry while receiving little or nothing — maybe less than nothing — in return. Mr. Philippon puts the waste at 2 percent of G.D.P. Yet even that figure, I'd argue, understates the true cost of our bloated financial industry. For there is a clear correlation between the rise of modern finance and America's return to Gilded Age levels of inequality.
So never mind the debate about exactly how much damage high-frequency trading does. It's the whole financial industry, not just that piece, that's undermining our economy and our society.

Links for 4-14-14

Posted: 14 Apr 2014 12:03 AM PDT

'The Social and Moral Philosophy of the Minimum Wage'

Posted: 13 Apr 2014 12:52 PM PDT

More Delong -- Brad makes this point about value neutrality every once in awhile, it's one I sometimes forget in these discussions, so it's a nice reminder:

The Social and Moral Philosophy of the Minimum Wage: Matthew Yglesias is surprised that most economists favor raising the minimum wage: ...
...at the University of Chicago's Booth School of Business found they supported a minimum-wage increase. They weren't sure, however, whether increases would create unemployment. Most said that, on balance, the benefits exceeded the costs...
But why should he be surprised? ...

One possibility is that Matthew has spent too much time listening to bad right-wing economists who are even worse philosophers--people who say things like: "We are economists, We talk only about efficiency, and so we talk about what maximizes real income per capita. If you want to introduce some other consideration and maximize something other than real income per capita, well then you are introducing interpersonal value comparisons into the problem and you should consult the philosopher or theologian. But we should agree at the start that it is maximizing real income per capita that is the efficient outcome."
The problem with this, of course, is that maximizing real income per capita does take a stand, and a very fictional your stand, on interpersonal value comparisons. To maximize real income per capita is to assert that each dollar at the margin--no matter how rich is the person that goes to--has the same effect on marginal utility, has the same effect on the greatest good of the greatest number. If we were, instead of maximizing real income per capita, to go about maximizing the geometric mean of real income we would be taking another stand: that utility was logarithmic in real income, so that each doubling of real income had the same effect on the greatest good of the greatest number no matter who that doubling went to or how rich they already were.
Both maximizing real income per capita and maximizing the geometric mean of real income are wrong, are not what we really want to do. ...
But if one wants a neutral place to start, it is surely less obnoxious to start from maximizing the geometric mean of real income than from maximizing real income per capita. And once one starts from there you need a very large disemployment effect--one that we simply see strong evidence against at the current level of the minimum wage--for an increase in the minimum wage to flunk any sensible benefit-cost calculation.

Notes and Finger Exercises on Thomas Piketty's "Capital in the Twenty-First Century"

Posted: 13 Apr 2014 10:51 AM PDT

Brad DeLong attempts to answer a question many people have been asking. Can the Summers claim of secular stagnation due to the real interest rate being too low be reconciled with Piketty's argument that the real interest rate is too high, high enough to generate rising inequality (larger than the growth rate of the economy)?:

Notes and Finger Exercises on Thomas Piketty's "Capital in the Twenty-First Century": When I look at Thomas Piketty's big book, I see one thing that he failed to do that I think he really should have done. A large part of the book is about the contrast between "r", the rate of return on wealth, and "g" the growth rate of the economy. However, there are four different r's. And in his book he failed to distinguish between them.

The four different r's are:

  1. The real interest rate at which metropolitan governments can borrow: call this r1.
  2. The real interest rate that is the actual average return on wealth in the society and economy: call this r2.
  3. The real interest rate that is the average risky net rate of accumulation--what capital receives, minus the risk of confiscation or destruction or taxation, plus appreciation in valuation multiples, minus what is spent in order to keep the world in the appropriate social position: call this r3.
  4. A measure of the extent to which capital and wealth serve as an effective claim on income independent of how much capital there is--a standardized measure of what the society and economy's return on wealth would be at some standardized ratio of wealth to annual income: say, 4: call this ρ.

These four r's are very different animals.

The first r, r1, is what Larry Summers is talking about when he talks about secular stagnation. When that r1 falls to a level equal to minus the rate of inflation, the economy is in big trouble. At that point, wealthholders would rather become coupon-clipping rentiers holding government bonds then invest in industry of any sort. Full employment can then be attained only via:

  1. A bubble that produces unrealistic and unsustainable expectations of the profits from investing in industry.
  2. The government borrowing money and buying stuff on a large scale.
  3. A higher rate of trend inflation that relaxes the zero lower bound constraint on safe government debt interest rates. .

Larry Summers is worried that this is the dilemma we face: that we are in a world in which r1 is too low...

Thomas Piketty, by contrast, says that he is worried about the world in which r2 is too high.

But it is not r2 but rather r3 that he should be talking about. And r3--the average rate of accumulation--is r2 to which there are a good number of sociopolitical factors plus and minus.

Are Piketty and Summers Reconcilable?

We have a world in which some eminent economists (Larry Summers) say r1 is too low, and other eminent economists (Thomas Piketty) say r2 is too high. Can this compute?

Yes.

The difference between r1 and r2 is the risk premium. In a well-functioning market economy with well-functioning financial markets, there are powerful reasons to believe that this risk premium should be small: less than 1%-point per year. The fact the risk premium appears to me to be 7%-points per year today is a powerful evidence of the profound dysfunctionality of our financial markets, and of their failure to do their proper catallactic job. But that is a separate and largely independent discussion: that is a dysfunction of our modern market economy which is different from either the dysfunction feared by Summers or the dysfunction feared by Piketty. For the moment, simply note that it is perfectly possible for all three of these major dysfunctions to occur together.

What Does This Neoclassical Economist Say? Build a Mathematical Model

When a conventional American post-World War II neoclassical economist--somebody, that is, like me--tries to make analytical sense of Piketty's big book, he says:

Ring-ding-ding-ding-dingeringeding!

No, that's not it... He says something like:

Piketty talks a lot about eras, and about times when r--his r, r2--r2 > g, and wealth concentration and the wealth-to-annual income ratio is rising, and times when r2 < g, and wealth concentration and the wealth-to-annual-income ratio is falling. But how much? And in what periods, exactly? Let's see if we can do some finger exercise to figure it out. ...

Cyber War, Cyber Space: National Security and Privacy in the Global Economy

Posted: 13 Apr 2014 08:19 AM PDT

Information technologies and infrastructure play an increasingly important role in daily life. But at the same time, cyber security is becoming increasingly threatened. How does society deal with these conflicting challenges.

This keynote INET panel features speakers Steven Bellovin, Yvo Desmedt, Amir Hertzberg, and Bart Preneel, moderated by Thomas Ferguson.

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