Economic Myth Busted: In the US, Savings from Lower Gas Prices was Spent on even More Gas!

Remember the popular mantra/incantation “low oil prices equals more consumer spending”? (this applies not only to the US but elsewhere including Philippines too)

Well, in the US, a study debunks the popular myth: savings from lower gas prices was spent on even more gas!

And bizarrely, media and ‘experts’ blame such unexpected course of development on human irrationality!

From the New York Times  (bold mine)

When gas prices fall, Americans reliably do two things that don’t make much sense.

They spend more of the windfall on gasoline than they would if the money came from somewhere else.

And they don’t just buy more gasoline. They switch from regular gas to high-octane.

A new report by the JPMorgan Chase Institute, looking at the impact of lower gas prices on consumer spending, finds the same pattern as earlier studies. The average American would have saved about $41 a month last winter by buying the same gallons and grades. Instead, Americans took home roughly $22 a month. People, in other words, used almost half of the windfall to buy more and fancier gas.

This is not rational behavior. Americans spent about 4 percent of pretax income on gas in 2014. One might expect them to spend about the same share of any windfall at the pump — maybe a little more because gas got cheaper. Instead they spent almost half.

Americans, in short, have not been behaving like the characters in economics textbooks…

The study, based on the spending patterns of about one million JPMorgan customers, does not track the kind of gas consumers purchased. It shows that people bought more gas as prices fell, and that the increase in consumption is not sufficient to explain the entirety of the increase in spending on gas.

Here is what the law of demand says “all else being equal…as the price of a product decreases, quantity demanded increases.” 

"People bought more gas as prices fell..."

Have consumers not been “behaving like the characters in economics textbooks”? Really? Or have consumers not been behaving in accordance to the fictitious outcomes generated from econometric models?

Of course, such econometric models have been constructed principally on the assumptions that humans DO NOT act based on ever changing preferences and values, in the face of an equally dynamic complex environment, that shapes incentives and consequently their actions. Or in short, for the math pedagogues, humans are NOT humans but automatons or robots whose actions are programmed.

But one may retort, they shifted from “regular gas to high-octane gas”.

So why not? Perhaps high octane gas could have been seen as more "energy efficient" (more fuel savings or longer driving mileage). If so then this reinforces, the law of demand.

But refuting the mythological gas-savings-equal-to-consumption-binge meme goes beyond the statistical technicalities.

Yet as I have noted here and many times elsewhere: the economics of spending is MAINLY a derivative of INCOME conditions—secondarily the utilization of savings and of credit—and NOT from the changes in spending patterns or the redistribution of spending from static income.

And as for the perspective of economic punditry versus real world phenomenon, the great Ludwig von Mises warned (Misapprehended Darwinism, Refutation of Fallacies, Omnipotent Government p.120)

Nothing could be more mistaken than the now fashionable attempt to apply the methods and concepts of the natural sciences to the solution of social problems. In the realm of nature we cannot know anything about final causes, by reference to which events can be explained. But in the field of human actions there is the finality of acting men. Men make choices. They aim at certain ends and they apply means in order to attain the ends sought.

Now whose behavior have not been rational…acting humans or ‘experts’ whose views have been shaped by rigid econometric models?

Quote of the Day: The Scarcest Ability Among Economist is Good Judgment

I am thinking that you may well share my view, which I have held for a very long time, that the scarcest ability among economists (and others who purport to have expertise about economic matters) is good judgment. Many economists are obviously very smart, in the sense that they are good at math and can wheel and deal with pretty complex mathematical models and econometric exercises. But this sort of technical ability may — and sad to say, usually does — have little or nothing to do with actually understanding how the world works. What I call good judgment about economic reality seems to depend much more heavily on a combination of (1) mastery of basic applied price theory, the theory of how changes in incentives and relative costs affect actions taken at the margin(s); (2) substantial knowledge of economic history and the institutional context of economic actions; and (3) a level-headedness that keeps the economist from falling in love with what is merely possible (usually in a fairly other-worldly model) and losing sight of what is likely. In other words, most economists and other purported economic experts, notwithstanding their cleverness and mathematical prowess, have no “feel” for how the economy works at all. It’s as if they never see past the trees of technicalities and possibilities to the forest of real economic actions and interactions, not to mention having an appreciation of the relative magnitudes of various factors. This aspect of economics, as the great majority of economists practice the craft, has always put me off, ever since I was an undergraduate; and, if anything, it puts me off even more now, after I have spent half a century trying to do economics right.

(bold mine)

This is from Austrian economist Robert Higgs’ who contributes to what makes for a good economist as published at the Café Hayek (hat tip Mises Blog).

As I have been saying, statistical analysis doesn’t make for economic analysis.

New ADB Chief: Middle Income Trap is a Sham

Based on empirical studies, the new ADB chief proclaims the Middle Income Trap a “myth”

From Asian Nikkei:

The so-called middle-income trap, in which certain countries appear stuck at a middle level of development, is a sham, the new chief economist of the Asian Development Bank says.   

Although it has no formal definition, the "trap" is characterized by the inability of middle-income countries to advance to high-income status. In contrast, low-income economies are said to be able to easily move up to middle-income status and high-income countries are likely to sustain prosperity

"I have looked at the data -- this is ongoing research still -- but the data suggest to me that this is largely a myth: the notion of the middle-income trap," Shang-Jin Wei said in an interview with the Nikkei late last week…

Wei's assertion came after he looked at the economic growth history of "all countries in the world." He grouped them into five brackets: high-income, middle-income, low-income, poor, and extremely poor. He then looked at how they developed starting from 1960 and then 10, 20 and 50 years after.

In any bracket, Wei said, some countries advanced, some dropped, while some stayed the same, suggesting that there is nothing special with the middle-income level.

In 2012, I averred that the Middle Income Trap theory has only been an invention by interventionists or has signified a statist tool, and therefore a myth.

This is an example of how macro statistics can be used to mislead people. Countries essentially don’t fall into “traps”, it is the individual who make or unmake their respective wealth.

What truly restrains people from advancing is when productive resources are diverted into non-productive use. That’s basic, and is a matter of the law of opportunity costs or the law of scarcity.

And what induces non-productive use of resources are insatiable government spending, the welfare state, bloated bureaucracy and trade restrictions, anti-competition laws, bubble policies (or policies which induces consumption), inflationism (QEs) and all sorts of market distorting interventionism. Yes, all of them are interconnected…

In short, the more intervention, the lesser the capital accumulation or reduced economic growth. When politicians become greedy enough to divert much wealth into policy driven consumption activities then productivity diminishes. And that's where the so-called statistical 'trap' comes in.

Theory now supported by evidence.

Chart of the Day: The Fed’s Forecasting Models are Broken

(hat tip Prof John Cochrane)

This Bloomberg article shows that the Fed Chair Ms. Yellen has also been concerned over "broken" inflation forecasting models:

Federal Reserve Chair Janet Yellen is concerned that the standard models central banks use to forecast inflation may be broken.

Behind her disquiet: the failure of the models to foresee the path of prices in the U.S. during the last recession and its aftermath and in Japan during its deflationary period from 1998 to 2012. U.S. inflation has been higher than the simulations suggested, while Japanese price declines proved more persistent.

Yellen alluded to her concerns in a speech last week, saying the Fed has to “watch carefully” to see if inflation picks up as the central bank projects -- and hopes -- during the next few years.

From broken GDP to inflation forecasts, yet whatever the monetary politburo says financial markets seem to believe them. [As a side note: This applies not only to the Fed but to other central banks as well.]

The great Austrian economist Ludwig von Mises tells us why they will keep making the same mistakes:  (bold mine)

In the equations of mechanics we can introduce constants which have been determined with reasonable exactness through empirical experimentation. In this way we can ascertain unknown quantities from given data with an accuracy sufficient for technology. In the field of human action, however, there are no such constants. The equations of mathematical economics are therefore useless for all practicai purposes

Why Nassim Taleb Disdains the Economic Profession

My favorite Iconoclast author and philosopher Nassim Nicolas Taleb disdains the economic profession

The Businessinsider compiled 12 vitriolic quotes by Mr. Taleb on them (hat tip EPJ)

1. An economist is a mixture of 1) a businessman without common sense, 2) a physicist without brain, and 3) a speculator without balls.
2. A prostitute who sells her body (temporarily) is vastly more honorable than someone who sells his opinion for promotion or job tenure.
3. The artificial gives us hangovers, the natural inverse-hangovers. The joys of post-exercise, breaking a fast, meeting a friend, helping someone in trouble, or humiliating an economist are examples of inverse hangovers. Antifragility = series of earned inverse hangovers. They don't come for free.
4. Those with brains no balls become mathematicians, those with balls no brains join the mafia, those w no balls no brains become economists.
5. To have a great day: 1) Smile at a stranger, 2) Surprise someone by saying something unexpectedly nice, 3) Give some genuine attention to an elderly, 4) Invite someone who doesn't have many friends for coffee, 5) Humiliate an economist, publicly, or create deep anxiety inside a Harvard professor.
6. A trader listened to the firm's "chief" economist's predictions about gold, then lost a bundle. The trader was asked to leave the firm. He then angrily asked him boss who was firing him: "Why do you fire me alone not the economist? He is too responsible for the loss." The Boss: "You idiot, we are not firing you for losing money; we are firing you for listening to the economist."
7. Discussing growth without concern for fragility: like studying construction without thinking of collapses. Think like engineer not economist.
8. OPEN DISCUSSION: Back to skin in the game. It looks like skin in the game does not necessarily work because it makes people more careful, rather but because it allows the risk taker to exit the gene pool and stop transferring the risk to others. A bad driver exposed to harm would eventually die and stop killing people on the road; shielded from harm he would keep killing others ad infinitum, as if he were an economist a la JS or PK.
9. Success in all endeavors is requires absence of specific qualities. 1) To succeed in crime requires absence of empathy, 2) To succeed in banking you need absence of shame at hiding risks, 3) To succeed in school requires absence of common sense, 4) To succeed in economics requires absence of understanding of probability, risk, or 2nd order effects and about anything, 5) To succeed in journalism requires inability to think about matters that have an infinitesimal small chance of being relevant next January, ...6) But to succeed in life requires a total inability to do anything that makes you uncomfortable when you look at yourself in the mirror.
10. [On his greatest disappointment]: That I am unable to destroy the economics establishment, the press.
11. Friends, I wonder if someone has computed how much would be saved if we shut down economics and political science departments in universities. Those who need to research these subjects can do so on their private time.
12. Being nice to the wicked (or economist) is equivalent to being nasty with the virtuous.

Here is the latest (from Mr. Taleb’s Facebook) 

The problem is that academics really think that nonacademics find them more intelligent than themselves.

For instance when the economic mainstream holds that savings is bad and debt based spending is good, ignoring the fact or reality that ALL financial crisis has been a function of debt, then I share most of Mr. Taleb's sentiment.

Quote of the Day: Economists are about as useful as a fork in a sugar bowl

If you suspected that mainstream economists are useless at the job of seeing a crisis in advance, you would be right. Dozens of studies show that economists are completely incapable of forecasting recessions. But forget forecasting. What's worse is that they fail miserably even at understanding where the economy is today. In one of the broadest studies of whether economists could predict recessions and financial crises, Prakash Loungani of the International Monetary Fund wrote very starkly, "The record of failure to predict recessions is virtually unblemished." This was true not only for official organizations like the IMF, the World Bank, or government agencies but for private forecasters as well. They're all terrible. Loungani concluded that the "inability to predict recessions is a ubiquitous feature of growth forecasts." Most economists were not even able to recognize recessions once they had already started.

In plain English, economists don't have a clue about the future.

If you think the Fed or government agencies know what is going on with the economy, you're mistaken. Government economists are about as useful as a fork in a sugar bowl. Their mistakes and failures are so spectacular you couldn't make them up if you tried…

Why do people listen to economists anymore? Scott Armstrong, an expert on forecasting at the Wharton School of the University of Pennsylvania, has developed a "seer-sucker" theory: "No matter how much evidence exists that seers do not exist, suckers will pay for the existence of seers." Even if experts fail repeatedly in their predictions, most people prefer to have seers, prophets, and gurus with titles after their names tell them something—anything at all—about the future.

This is from John Mauldin and Jonathan Tepper at the Casey Research.

Economic Forecasting: The Mainstream’s Horrible Track Record

Aside from the agency problem, here is another reason why economic and market predictions or forecasts by mainstream "experts" should be taken with a grain of salt.

From Wall Street Journal Economics Blog: (bold mine)

Last month, Singapore’s government announced the economy grew 3.8% on-year in the second quarter. But as late as June, economists polled by the city-state’s central bank were predicting growth of just 1.5%.

Economists got it wrong on exports too: They predicted a nearly flat print in the second quarter, when exports actually fell 5.0%.

The difference was even starker in the first quarter: Economists in March predicted exports would fall 0.5%, but in fact they shrank a whopping 12.5%.

The Monetary Authority of Singapore polls economists at banks and research firms every quarter on key local data such as gross domestic product, exports, currency, inflation and employment. The results are released at the start of every quarter, with the third-quarter survey landing Wednesday.

It turns out that the 20 or so economists who respond to the survey get it quite wrong, quite often.

Economic predictions are never easy. But they become even more complex in tiny Singapore, where trade is more than three times the size of GDP.

Why this is so? The great Austrian professor Ludwig von Mises explained (Human Action page 31): (bold mine)

The experience with which the sciences of human action have to deal is always an experience of complex phenomena. No laboratory experiments can be performed with regard to human action. We are never in a position to observe the change in one element only, all other conditions of the event remaining unchanged. Historical experience as an experience of complex phenomena does not provide us with facts in the sense in which the natural sciences employ this term to signify isolated events tested in experiments. The information conveyed by historical experience cannot be used as building material for the construction of theories and the prediction of future events. Every historical experience is open to various interpretations, and is in fact interpreted in different ways

Even non-Austrian analyst, statistician and author Nassim Nicolas Taleb calls such error Historical Determinism as I previously pointed out

Reading or interpreting past performance (statistics) into the future along with seeing the world in the lens of mathematical formalism (econometrics) are surefire ways to misinterpret reality. 

10 things economists won’t tell you (why you shouldn’t listen to them)

The above can be restated as “10 reasons why you shouldn’t trust economists”

From Marketwatch.com (hat tip Professor Mark Thornton)

1. “We can’t predict the next crisis...”
2. “...but we may help cause it.”
3. “We’re not above a little guesswork.”
4. “Those bold predictions? Blame the testosterone.”
5. “Our measures of prosperity don’t work.”
6. “Ours is a dismal science, but not an exact one.”
7. “We lean to the left.”
8. “We might have an agenda.”
9. “We may as well be speaking Klingon.”
10. “We sell you what you already know.”

Read the explanations here

How Financial Experts Bamboozle the Public

Money pros had been taken to the woodshed according to the Global Association of Risk Professionals. (hat tip EPJ) [bold mine]

Americans would like an apology from Wall Street for the financial crisis.

They probably aren't going to get it.

But how about giving the number crunchers and investment managers a "time out" to reflect a little on the era of financial alchemy and greed that did so much damage?

That's what was happening in Chicago this week, where about 2,000 of the financial industry's quantitative minds and investment professionals gathered for their annual CFA Institute conference. They got some verbal punishment from some of the industry's stalwarts, who were admonishing their chartered financial analyst peers to think rather than allow mindless financial models and dreams of success to drive them to endorse the kinds of aggressive investment decisions that can create riches for themselves -- and destroy wealth for others.

"If you are attracted to a job in finance because the pay is so generous, don't do it," said Charles Ellis, one of the elder statesmen of the profession. "That's a form of prostitution."

Rather, Ellis said, his profession needs to return to the days he knew in the 1960s, when the emphasis was on counseling investment clients and not on churning out esoteric products and pushing people to buy them blindly.

Today the emphasis too often is on "complexity rather than common sense," said James Montier, asset allocation strategist for investment manager GMO. "In finance, we love to complicate. We rely on complexity to bamboozle and confuse."

In the local arena, such conflict of interests has hardly been about “churning out esoteric products” but about the pervasive cheerleading of politically colored quack statistics into “pushing people to buy them blindly”. "Them" here is applied to conventional financial assets.

More on the use of aggregate model based analysis:

Too many in his profession, Montier said, are trying inappropriately to apply physics to investing, where it doesn't belong, and they are ignoring inconvenient truths. Complex mathematics is valued but not necessarily used honestly, he said.

"A physicist won't believe that a feather and brick will hit the ground at the same time, and they won't use models to game the system. But that's what finance does with models," Montier said. "They take them as though they are reality."

Montier, speaking to financial professionals who design, evaluate and sell investment products to individuals and institutions, warned that all professionals in finance need to be thinking more, rather than following the herd.

"Who could have argued that CDOs were less risky than Treasurys with a straight face?" he said. But that's what happened. "Part of the brain was switched off, and people took expert advice at face value.

True. Mathematical and statistical formalism serves as the major instrument used by “experts” to hoodwink the vulnerable public on so-called economic analysis. The public is usually awed or overwhelmed by facade of numerical equations and economic or accounting terminologies.

These experts forget that economics hasn’t been about physics but about the science of incentives, purposeful behavior or human action.

As the great dean of Austrian school of economics wrote, (italics original, bold mine)

Indeed, the very concept of "variable" used so frequently in econometrics is illegitimate, for physics is able to arrive at laws only by discovering constants. The concept of "variable," only makes sense if there are some things that are not variable, but constant. Yet in human action, free will precludes any quantitative constants (including constant units of measurement). All attempts to discover such constants (such as the strict quantity theory of money or the Keynesian "consumption function") were inherently doomed to failure.

Governments love Wall Street models too

Government regulators and the Federal Reserve are guilty, too, of blindly putting their confidence in flawed models, he said. And if his profession and the regulators continue to ignore the dangers of financial concoctions involving massive leverage and illiquid assets, financial companies again will create an explosive brew that will result in calls for another government bailout.

This means because authorities has embraced economic bubble policies as a global standard, which engenders boom bust cycles, we should expect more crisis ahead. Thus the prospective “calls for another government bailout.”

To add, in reality, the government’s love affair with models has been undergirded by an unseen motivation: the expansion of political power.

Every crisis bequeaths upon the governments far broader and extensive social control over the people via bailouts, inflation, more regulations higher taxes and etc...

This legacy quote from a politician, during the last crisis, adeptly captures its essence

You never want a serious crisis to go to waste..This crisis provides the opportunity for us to do things that you could not do before.

Bottom line: many financial experts seem to in bed with politicians to promote political agendas either deliberately or heedlessly. Thus, financial expert-client relations usually embodies the principal-agent problem.

Nassim Taleb would call such mainstream experts as having "no skin in the game", thus would continue to blather about nonsense while promoting fragility.

Finally one doesn't need to be a CFA to know this. As James Montier in the above article said it only takes "common sense" which experts try to suppresss with "complexity". 

I would add to common sense; critical thinking.

IMF to Central Bankers: Keep Blowing Bubbles

The IMF’s advice to central bankers is an example why we can expect central bankers to keep blowing asset bubbles. 

That’s of course until bubbles pop by their own weight, or until the stagflation menace emerges or a combo of both.

But stagflation has been absent based in the econometric papers of the IMF, that’s according to the Bloomberg:

Monetary stimulus deployed by advanced countries to spur growth is unlikely to stoke inflation as long as central banks remain free of outside influence to react to challenges, according to a study by the International Monetary Fund.

In a chapter of its World Economic Outlook released today, the Washington-based IMF said that inflation has become less responsive to swings in unemployment than in the past. Inflation expectations have also become less volatile, according to the report.

“As long as inflation expectations remain firmly anchored, fears about high inflation should not prevent monetary authorities from pursuing highly accommodative monetary policy,” IMF economists wrote in the chapter called “The dog that didn’t bark: Has inflation been muzzled or was it just sleeping?”

Considering the distinctive political-economic structure of each nations, such pursuit of bubble policies will translate to varying impacts on specific markets and economies. For instance, emerging markets are likely to be more vulnerable to price inflation.

And by simple redefinition and measurement of inflation as based on econometric models and statistics, the IMF has given the green light for central bankers do more.

This also means that the IMF has prescribed to central bankers to throw fuel on the inflation fire.

Based on mainstream’s twisted definition of inflation, such as being predicated on demand and supply “shocks”, hyperinflation ceases to exist. 

Interestingly too the IMF hardly see current policies as having “compromised” central bank independence.

Again from the same article:

The BOJ’s new policy “is something that we hope will lift inflation durably into positive territory, which would help the economy,” said Jorg Decressin, deputy director of the IMF’s research department. “We see in no way the operational independence of the BOJ compromised at all.”

This is a rather absurd claim. When central banks buy government debt, they effectively encroach into the realm of fiscal policies. 

Instead of voters determining the dimensions of fiscal policies via taxation, central bank financing of fiscal deficits motivates government profligacy that enhance systemic fragility through higher debts and the risks of price inflation (stagflation) or even hyperinflation.

As fund manager and professor John Hussman notes at HussmanFunds.com in 2010:

Historically, and across the world, the primary driver of inflation has always been expansion in unproductive government spending (think of Germany paying striking workers in the early 1920s, or the massive increase in Federal spending in the 1960s that resulted in large deficits and eventually inflation in the 1970s). But unproductive fiscal policies are long-run inflationary regardless of how they are financed, because they distort the tradeoff between growing government liabilities and scarce goods and services.

For instance, Japan’s government will increasingly become dependent on the Bank of Japan via Kuroda’s “shock and awe” Abenomics policies. This makes Japan vulnerable to a debt or a currency crisis.

And recent interventions on the fiscal space by central banks of developed economies essentially reveals of the closely intertwined relationship between governments and central banks. (charts above from Zero Hedge)

This only validates the hypothesis of the Austrian school of economics that the fundamental role played by the central banks has been to support the government (welfare-warfare state) and the cartelized crony banks, which essentially means that central bank independence is a myth.

As refresher let me quote anew the great dean of Austrian economics explained: (bold mine) [The Case against the Fed page 57]

The Central Bank has always had two major roles: (1) to help finance the government's deficit; and (2) to cartelize the private commercial banks in the country, so as to help remove the two great market limits on their expansion of credit, on their propensity to counterfeit: a possible loss of confidence leading to bank runs; and the loss of reserves should any one bank expand its own credit. For cartels on the market, even if they are to each firm's advantage, are very difficult to sustain unless government enforces the cartel. In the area of fractional-reserve banking, the Central Bank can assist cartelization by removing or alleviating these two basic free-market limits on banks' inflationary expansion credit

Yet here is the IMF’s prescription for more bubble blowing, from the same article:

“The dog did not bark because the combination of anchored expectations and credible central banks has made inflation move much more slowly than caricatures from the 1970s might suggest - - inflation has been muzzled,” the IMF staff wrote. “And, provided central banks remain free to respond appropriately, the dog is likely to remain so.”

As I explained before, inflationism represents a political process employed by governments to meet political goals. Inflationism, which is an integral part of financial repression, signify the means (monetary) to an end (usually fiscal objectives). And when governments become entirely dependent on money printing from central banks, hyperinflations occur.

Just because money printing today has not posed as substantial risks to price inflation, this doesn’t mean such risks won’t ever occur.

And that the current low inflation environment basically implies "free lunch" for central banks.

Price controls, market manipulations (via central bank), the Fed’s Interest rate on reserves (IOR) and even productivity issues have also contributed significantly to subdue price inflation over interim.

And again since monetary inflation represents a process, such take time to unfold via different stages, which is why price inflation tend to occur with suddenness to become a significant threat.

IMF’s reckless advocacy of bubble policies will have nasty consequences for the world.

The IMF experts or bureaucrats, who are paid tax free and are tax consumers, hardly realize such blight will affect them too. 

The existence of the IMF depends on quotas or contributions from members which come from taxes. Such applies to other multilateral agencies such as the UN, OECD ADB or etc, which is why these institutions almost always campaign for more state interventions.

Yet should a crisis of a global dimension emerge, and where a chain of defaults by governments on their liabilities (such may include developed economies, BRICs, Asia and elsewhere), their privileges, if not their existence, will likewise be jeopardized, as governments retrench or have their respective budgets severely slashed or faced with real "austerity". 

Let me venture a guess, such scenarios haven’t been captured by the IMF's econometric models. 

When the late Margaret Thatcher warned that "the problem with socialism is that eventually you run out of other people's money [to spend]", this applies to multilateral institutions too.

Quote of the Day: Government Forecast is No Different than a Medieval Fortuneteller

The problem is that people have been deluded for so long into believing that economics is an actual science… and so it must be true. Well, for a time, so was bloodletting. Or the ‘ethnic sciences’.

We know all of these things are nonsense today. But for some reason, people still haven’t figured out that an economist with a forecast is no different than a medieval fortuneteller.

This is from Simon Black of the Sovereign Man debunking the popular romanticized fiction called government economic forecasting.

Nobel Prize of Economics and the Penchant for Math Constants

The announcement of latest winners of the Nobel Prize in economics, particularly Alvin Roth and Lloyd Shapley seems a yawner.

Critiques Andrew Coulson at the Cato Institute Blog (bold mine)

As the Nobel organization’s website explains, the original algorithm was developed by Shapley and David Gale to optimally match pairs of individuals who could only each be matched with one other person. For instance, optimally marrying-off 10 men and 10 women based on their relative levels of interest in one another. Over the past decade, it has come to be used to match students to places in local public schools (by Roth).

The problem is that this approach to “school choice” correctly assumes that the better public schools have a fixed number of places and cannot expand to meet increased demand. So it’s about finding the least-awful allocation of students to a static set of schools—a process that does nothing to improve school quality.

Meanwhile, there is something called a “market” which not only allows consumers and producers to connect, it creates the freedoms and incentives necessary for the best providers to grow in response to rising demand and crowd-out the inferior ones. It also provides incentives for innovation and efficiency. But instead of advocating the use of market freedoms and incentives to improve education, some of our top economists are spending their skill and energy tinkering with the increasingly inefficient, pedagogically stagnant status quo.

Forehead… meet desk.

I am reminded of the great Professor Ludwig von Mises who rebuked mainstream economic practitioners for their penchant to falsely model human action into a subset of natural science.

Professor Mises (From Theory and History): (bold mine)

But it is not permissible to argue in an analogous way with regard to the quantities we observe in the field of human action. These quantities are manifestly variable. Changes occurring in them plainly affect the result of our actions. Every quantity that we can observe is a historical event, a fact which cannot be fully described without specifying the time and geographical point.

The econometrician is unable to disprove this fact, which cuts the ground from under his reasoning. He cannot help admitting that there are no "behavior constants." Nonetheless he wants to introduce some numbers, arbitrarily chosen on the basis of a historical fact, as "unknown behavior constants." The sole excuse he advances is that his hypotheses are "saying only that these unknown numbers remain reasonably constant through a period of years."  Now whether such a period of supposed constancy of a definite number is still lasting or whether a change in the number has already occurred can only be established later on. In retrospect it may be possible, although in rare cases only, to declare that over a (probably rather short) period an approximately stable ratio--which the econometrician chooses to call a "reasonably" constant ratio-prevailed between the numerical values of two factors. But this is something fundamentally different from the constants of physics. It is the assertion of a historical fact, not of a constant that can be resorted to in attempts to predict future events.

Well such so called ‘prestigious’ recognitions have seemingly been directed to the ideas and symbolisms (e.g. European Union as awardee for Peace) which promotes the interests of the establishment.

Quote of the Day: The Spurious Idea of Measuring Value

The basis of modern economics is the cognition that it is precisely the disparity in the value attached to the objects exchanged that results in their being exchanged. People buy and sell only because they appraise the things given up less than those received. Thus the notion of a measurement of value is vain. An act of exchange is neither preceded nor accompanied by any process which could be called a measuring of value. An individual may attach the same value to two things; but then no exchange can result.

This is from the great Ludwig von Mises from his magnum opus Human Action Chapter XI Section 2 p.204. (hat tip Mises Blog)

This is in accord to yesterday’s quote of the day where Professor Deirdre McCloskey bashed the notion of using mathematical formalism to measure “happiness”.

Quote of the Day: The Folly of Measuring Happiness

What the economists could measure pretty easily, though, was the money you have for buying sandwiches or paying the rent. Income is not your happiness and doubling it will not make you twice as happy—but it does measure your capability for action.

That’s from a lengthy critique, by Professor and author Deirdre McCloskey, on experts who fallaciously attempt to “engineer a happy society”

Quote of the Day: Blinded by Science

Even some from the mainstream gets it.

Finance is often said to suffer from Physics Envy. This is generally held to mean that we in finance would love to write out complex equations and models as do those working in the field of Physics. There are certainly a large number of market participants who would love this outcome.

I believe, though, that there is much we could learn from Physics. For instance, you don’t find physicists betting that a feather and a brick will hit the ground at the same time in the real world. In other words, they are acutely aware of the limitations imposed by their assumptions. In contrast, all too often people seem ready to bet the ranch on the flimsiest of financial models.

Someone intelligent (if only I could remember who!) once opined that rather than breaking the sciences into the usual categories of “Hard” and “Soft,” they should be split into “Easy” and “Difficult.” The “Hard” sciences are generally “Easy” thanks to the ability to perform repeated controlled experiments. In contrast, the “Soft” sciences are “Difficult” because they involve trying to understand human behaviour.

Put another way, the atoms of the feather and brick don’t try to outsmart and exploit the laws of physics. Yet financial models often fail for exactly this reason. All financial model underpinnings and assumptions should be rigorously reviewed to find their weakest links or the elements they deliberately ignore, as these are the most likely source of a model’s failure.

That’s from GMO’s James Montier (source Zero Hedge).

Mr. Montier also discusses the psychological aspects of people’s predisposition for mathematical or science based models: particularly “complexity to impress” (The penchant to signal “intelligence” to acquire social acceptance—my opinion) and “defer to authority”.

And here is the warning against being blinded by science from the dean of the Austrian school of economics the great Professor Murray N. Rothbard,

Not only measurement but the use of mathematics in general in the social sciences and philosophy today, is an illegitimate transfer from physics. In the first place, a mathematical equation implies the existence of quantities that can be equated, which in turn implies a unit of measurement for these quantities. Second, mathematical relations are functional; that is, variables are interdependent, and identifying the causal variable depends on which is held as given and which is changed. This methodology is appropriate in physics, where entities do not themselves provide the causes for their actions, but instead are determined by discoverable quantitative laws of their nature and the nature of the interacting entities. But in human action, the free-will choice of the human consciousness is the cause, and this cause generates certain effects. The mathematical concept of an interdetermining "function" is therefore inappropriate.

Quote of the Day: The Value of Superfluous Fluff

Some economists like to believe (although this belief has blessedly faded in the recent decades) that economics is an edifice built on the rocks of mathematical theory and statistical empiricism, and everything else is superfluous fluff. McCloskey (1983) thoroughly strafed that conceit, pointing out in “The Rhetoric of Economics” that the research and analysis of economists is built on uncertain and subjective judgments, and often uses, among its rhetorical tools, analogy and metaphor, appeals to authority and to commonsense intuition, and the use of “toy models” counterbalanced with the choice of supposedly illustrative real-world episodes.

Economic arguments rooted purely in mathematical formalism or statistical analyses are superb at specifying the steps leading to the particular conclusion. However, cynical economists (but I repeat myself) know that a model can be built to illustrate any desired conclusion, and that if the data are tortured for long enough, they will confess to anything. Persuasiveness requires a multidimensional argument that reaches beyond formalism. As McCloskey (1983) wrote: “There is no good reason to to make ‘scientific’ as opposed to plausible statements.”

That’s from economist Timothy Taylor on the issue of editing economists (hat tip Professor David Henderson).

Phony and manipulated “tortured” models function as standard instruments used to justify social controls through public policies. Think anthropomorphic global warming, Keynesian stimulus, mercantilism and etc…

Quote of the Day: Mathematics Diminishes Economics

Mathematics, seemingly so precise, inevitably ends in reducing economics from the complete knowledge of general principles to arbitrary formulas which alter and distort the principles and hence corrupt the conclusions.

That’s from the great Murray N. Rothbard, who discussed the origins of the methodology of praxeology or human action from J.B. Say.

Outside the promotion of self-esteem, mathematics via econometrics and or statistics serves as intellectual cover to what is truly heuristics based biases.

Understating the Internet’s Contribution to the Global Economy

The Economist writes,

MUCH of the world may still (or again) be in recession, but the internet keeps growing—and so does its economic weight. In the G20 countries, the internet economy will grow at more than 10% annually for the next five years and by 2016 reach $4.2 trillion, or 5.3% of GDP—up from $2.3 trillion and 4.1% in 2010, according to a recent report by the Boston Consulting Group (BCG). But there are big differences between countries. Britain leads the pack. Its internet economy is now bigger than its construction and education sectors, mainly thanks to the popularity of e-commerce. To paraphrase Adam Smith, the country has become a nation of digital shopkeepers. China and, to some extent, India stand out thanks to internet-related exports in goods and services, respectively. South Korea and Japan are also strong in both e-commerce and exports. Europe punches below its weight, mainly because its internet economy is held back by a lack of a single digital market. If the European Commission succeeds in creating one, the old continent may be able to pull ahead of the new one by 2016.

My research is done principally through the internet and this has been facilitating much of my transactions executed on a traditional non-internet based platform. The newsletters I send to my clients have also been internet based.

Aside from my newsletters, the web perhaps also plays a role in the information acquisition of my clients for them to decide on their financial markets transactions—but the degree of application may likely to be different.

Have these been captured by statistics? Apparently not.

Attempts to quantify the internet’s contribution to the economy has been grossly misleading for the simple reason that much of what the internet contributes—access to information, knowledge, connectivity, communications and the ensuing productivity it brings—cannot be measured.

Testament to these has been the impact of the internet to the Arab Spring or popular Middle revolts of last year.

Professor of business and technology Soumitra Dutta in an interview with Knowledge@wharton says that the internet has enabled changes in people’s social relationships and norms that has contributed to last year’s Arab Spring upheavals.

Technology has empowered individual citizens, and of course this pushes against various constraints, whether it is political constraints, or gender constraints. The same thing is happening in the rest of the world, by the way, the Middle East is not unique in this. So what this calls for is not a retreat from technology, but a more enlightened approach to understanding how technology interweaves with social values and norms. Eventually, social norms are going to be influenced and changed by widespread use of technology, but that's the way society largely develops.

And to repeat a quote which I earlier posted from Jeffrey Tucker,

That the Internet has vastly increased productivity is the understatement of the century. The Internet has given birth to products and services that have never before existed — search, online advertising, video games, web-based music services, online garage sales, global video communications. Moreover, the main beneficiaries have been old-line industries that seem to have nothing to do with the Internet.

The most difficult-to-quantity aspect of digital media has been its contribution to the sharing of ideas and communication throughout the world. This has permitted sharing and learning as never before, and these might be the single most productive activity in which the human person can ever participate. The acquisition of information is the precondition for all investing, entrepreneurship, rational consumption, the division of labor and trade…

No amount of empirical work can possibly encapsulate the contribution of the Internet to our lives today. No supercomputer could add it all up, account for every benefit, every increase in efficiency, every new thing learned that has been turned to a force for good. Still, people will try. You will know about their claims only thanks to the glorious technology that has finally achieved that hope for which humankind has struggled mightily since the dawn of time.

The appeal to quantify the internet into statistical accounts falls into the same fallacious trap as in the treatment of human action as natural sciences.

As Mark Twain scornfully said,

Lies, damned lies and statistics.

The Myth of the Middle Income Trap

The Economist writes,

The forces of economic convergence are powerful, but not all powerful. Poor countries tend to grow faster than rich ones, largely because imitation is easier than invention. But that does not mean that every poor country of five decades ago has caught up, as today’s chart shows. It plots each country’s income per person (adjusted for purchasing power) relative to that of America, both in 1960 and in 2008. The chart appeared in the World Bank's recent China 2030 report. If every country had caught up, they would all be found in the top row. In fact, most countries that were middle income in 1960 remained so in 2008 (see the middle cell of the chart). Only 13 countries escaped this middle-income trap, becoming high-income economies in 2008 (top-middle). One of these success stories, it should not be forgotten, was Greece.

This is an example of how macro statistics can be used to mislead people. Countries essentially don’t fall into “traps”, it is the individual who make or unmake their respective wealth.

What truly restrains people from advancing is when productive resources are diverted into non-productive use. That’s basic, and is a matter of the law of opportunity costs or the law of scarcity.

And what induces non-productive use of resources are insatiable government spending, the welfare state, bloated bureaucracy and trade restrictions, anti-competition laws, bubble policies (or policies which induces consumption), inflationism (QEs) and all sorts of market distorting interventionism. Yes, all of them are interconnected.

As the great Professor Ludwig von Mises wrote, (bold emphasis added)

Each authoritarian interference with business diverts production, of course, from the lines it would take if it were only directed by the demand of the consumers as manifested on the market. The characteristic mark of restrictive interference with production is that the diversion of production is not merely an unavoidable and unintentional secondary effect, but precisely what the authority wants to bring about. Like any other act of intervention, such restrictive measures affect consumption also. But this again, in the case of the restrictive measures we are dealing with in this chapter, is not the primary end the authority aims at. The government wants to interfere with production. The fact that its measure influences the ways of consumption also is, from its point of view, either altogether contrary to its intentions or at least an unwelcome consequence with which it puts up because it is unavoidable and is considered as a minor evil when compared with the consequences of nonintervention.

Restriction of production means that the government either forbids or makes more difficult or more expensive the production, transportation, or distribution of definite articles, or the application of definite modes of production, transportation, or distribution. The authority thus eliminates some of the means available for the satisfaction of human wants. The effect of its interference is that people are prevented from using their knowledge and abilities, their labor and their material means of production in the way in which they would earn the highest returns and satisfy their needs as much as possible. Such interference makes people poorer and less satisfied.

In short, the more intervention, the lesser the capital accumulation or reduced economic growth. When politicians become greedy enough to divert much wealth into policy driven consumption activities then productivity diminishes. And that's where the so-called statistical 'trap' comes in.

Bottomline: the so-called Middle income trap represents a macroeconomic hooey.

iPhone Shows How Trade Statistics are Flawed

I earlier pointed out that statistics hardly captures the realities of the swiftly shifting trade dynamics brought about by globalization as exemplified by the iPhone.

Here’s an update. From the Wall Street Journal Blog

The iPhone provides a good example of the problems with the way trade is currently calculated. The Apple device features hardware from all over the world, but because it’s manufactured in China that country gets credit for the entire wholesale export cost. According to research from Kenneth L. Kraemer of the University of California, Irvine, Greg Linden of University of California, Berkeley, and Jason Dedrick of Syracuse University, each iPhone sold in the U.S. adds $229 to the U.S.-China deficit. Based on 2011 cellphone activations from AT&T, Verizon and Sprint, Apple sold around 30 million iPhones in the U.S. last year — accounting for about $6.83 billion of the U.S.’s $282 billion 2011 trade deficit with China.

But the researchers note that such estimates overstate China’s contribution. Though the iPhone is assembled in China, most of its component parts come from elsewhere. Separate research by Yuqing Xing and Neal Detert for the Asian Development Bank Institute noted that for the iPhone 3G just about 3.6% of the wholesale price came from China, the rest could be attributed to inputs from companies in Japan, Germany, Korea and even the U.S. (Read more about that study here.)

The iPhone is just one example. This same phenomenon is happening all over the world in products ranging from cars to children’s toys. In an attempt to better gauge which countries are benefiting or losing the most through trade, the Organization for Economic Co-operation and Development and the World Trade Organization announced that they will be working on a project that identifies where value-added flows are coming from.

More confirmatory evidence where human action cannot be quantified.

This only validates Professor Ludwig von Mises who wrote

The impracticability of measurement is not due to the lack of technical methods for the establishment of measure. It is due to the absence of constant relations. If it were only caused by technical insufficiency, at least an approximate estimation would be possible in some cases. But the main fact is that there are no constant relations. Economics is not, as ignorant positivists repeat again and again, backward because it is not "quantitative." It is not quantitative and does not measure because there are no constants. Statistical figures referring to economic events are historical data. They tell us what happened in a nonrepeatable historical case. Physical events can be interpreted on the ground of our knowledge concerning constant relations established by experiments. Historical events are not open to such an interpretation.

To add, the deepening of the information age will further complicate trade dynamics as commerce will become increasingly more about niches and specialization or decentralization.

Lastly, the other implication is that using flawed trade statistics to argue for political actions (such as protectionism) is like shooting oneself in the foot.