There were four posts yesterday. The first was “People Should Take My Advice:”
So says William Pesek:
Even as Japan’s economy struggles to shake off an April sales-tax increase, lawmakers are mulling another. In a meeting with Prime Minister Shinzo Abe last week, Krugman warned the move could be the death-knell of “Abenomics,” no matter how many yen the Bank of Japan prints. And he’s absolutely right. Raising taxes on households again would further crimp spending and doom any chance of reaching the 2 percent inflation target the government has set for itself.
And strange to say, I agree with this view.
Seriously: I understand that Japan’s long-run fiscal position is problematic, but I don’t think fears of an imminent fiscal crisis make sense — and on the other side, it’s now or never on breaking out of the deflation trap, which is crucial even for the fiscal future. Now is no time to lose momentum on Abenomics.
Yesterday’s second post was “Networks and Economic History:”
Via FT Alphaville, Climateer Investing discusses transportation networks in the industrial revolution, Metcalfe’s Law, and all that. Fun stuff; and I remembered an old piece of mine (from 1998, I think) that manages to combine Metcalfe with Zipf, and might be worth resurrecting. So here it is, in full (not that it’s very long):
NETWORKS AND INCREASING RETURNS: A CAUTIONARY TALE
I just read a terrific little book by Tom Standage, The Victorian Internet, a history of the rise of the telegraph. The story is, just as he claims, a great metaphor for the rise of the Internet; indeed, it is a stunningly close parallel in many respects. Standage uses the story in part to caution against the naive view that the Internet will eliminate nationalism, foster world peace, or promote a new golden age of culture. But the story also offers a more mundane cautionary lesson, suggesting that we should be skeptical about some of the enthusiastic claims about the rules under which the “new economy” works.
One of the key propositions of the “new economy” view is the idea that networks are inherently a source of very strong increasing returns; enthusiasts like Kevin Kelly like to invoke “Metcalfe’s Law”, which says that the usefulness of a network is proportional to the square of the number of people it connects, because that is the number of possible directions of communication. If you think that something like Metcalfe’s Law actually applies, it has dramatic implications for economic dynamics. It suggests, for example, that networks are hard to get started, even when the technology is there, because it isn’t worth investing in a connection unless enough other people are already connected. But once a network passes the tipping point at which connecting starts to happen, it should experience explosive growth, because each successive connection will be more valuable than the one before.
A telegraph example actually demonstrates the force of this argument quite nicely. Imagine a nation consisting of a number of equal-sized cities, each with 100 people. (Numbers are chosen for expository convenience, not realism!) If someone builds a telegraph line connecting two of the cities, it will make 10,000 two-way communications possible (from each of the inhabitants of one city to each of the inhabitants of the other). But when a third city is added to the network, this adds 20,000 possible communications, because the new city can communicate with the 200 people already in the network. And the fourth connection adds 30,000 possible links.
It’s easy to see that in this case investors might be doubtful about the potential business on a single telegraph line; only once several lines had already been built would the economics of building still more become favorable, and then they would become ever more favorable.
The history of the telegraph, however, doesn’t actually look that way. There was explosive growth, all right: the U.S. telegraphic network expanded 600-fold between 1846 and 1852. But the pause between when the technology was ready and the commercial applications began was negligible: as soon as an experimental line between Baltimore and Washington was up and running, investors were up and running too.
Why didn’t investors hesitate? For one obvious reason: cities were not all the same size, and they could start by building lines connecting the biggest cities. A line between New York and Philadelphia already connected a large number of potential customers. And conversely, later lines did not necessarily add more potential communications than the existing ones: they connected to a bigger existing base, but they ran to smaller cities. In short, the inequality of city sizes meant that the network was not all that subject to increasing returns after all.
Of course, this all depends on the distribution of city sizes; but we know something about that. Somewhat mysteriously (see my book The Self-Organizing Economy) the size distribution of cities in the United States has long been quite well described by the “rank-size rule”: the second city has half the population of the first, the third 1/3 the population, and so on. So imagine a country whose biggest city has 120 people, the next 60, the third 40, and so on. And now ask how many possible communications are added when each city enters the network, assuming – as is reasonable – that cities enter in size order.
Well, the connection between the two biggest cities will create 7200 (120 × 60) possible communications. Adding the third city to the network will add another 7200 (180 × 40). Then the network starts to run into diminishing returns: the next connection adds 6600 possible communications, the one after that 6000, and so on. The size of the base to link to keeps getting bigger, but the size of the next city keeps getting smaller, and the latter effect dominates.
The point is not that networks necessarily face diminishing rather than increasing returns; rather it is that increasing returns are by no means guaranteed. Against Metcalfe’s Law must be set DeLong’s Law (after Berkeley’s Brad DeLong, who has made this point several times): in building a network, you tend to do the most valuable connections first. Is the net effect increasing or diminishing returns? It can go either way.
Increasing returns are, of course, more fun to think about – but that is itself a reason for caution. “New economy” types have a tendency to tell great stories, both about the economy and about themselves. Alas, the fact that a story is entertaining doesn’t mean that it is true.
The third post yesterday was “Why the One Percent Hates Obama:”
A peculiar aspect of the Obama years has been the disconnect between the rage of Obama’s enemies and the yawns of his sort-of allies. The right denounces financial reform as a vast government takeover — and lobbies fiercely against it — while the left dismisses reform as symbols without substance. The right accuses Obama of being a socialist stealing the money of hard-working billionaires, while the left dismisses him as having done nothing to address inequality.
On all these issues, the truth is that Obama has done far more than he gets credit for — not everything you’d want, to be sure, or even most of what should be done, but enough so that the right has reason to be furious.
The latest case in point: taxes on the one percent. I keep hearing that Obama has done nothing to make the one percent pay more; the Congressional Budget Office does not agree:
According to CBO, the effective tax rate on the one percent — reflecting the end of the Bush tax cuts at the top end, plus additional taxes associated with Obamacare — is now back to pre-Reagan levels. You could argue that we should have raised taxes at the top much more, to lean against the widening of market inequality, and I would agree. But it’s still a much bigger change than I think anyone on the left seems to realize.
The last post yesterday was “Rage of the Traders:”
Sometimes the absurdity of what passes for economic wisdom surpasses even my highly adapted expectations. I really, truly expected that even Wall Street would consider
PeterPaul Singer’s hyperinflation in the Hamptons rant embarrassing, and try to pretend that it never happened. But no; apparently it’s being passed around eagerly by traders and big shots who think it’s the greatest thing since sliced foie gras.
So what’s this about? Jesse Eisinger at ProPublica tries to make a case for the rage of the hedgies; Eisinger argues that while it’s foolish to claim that the inflation books are cooked, the government and the Fed have created a fake sense of financial health, so the overall perception that it’s some kind of illusion is right.
Sorry, but I don’t buy that.
For one thing, if you want to claim that the stress tests were all fake and the banks were truly insolvent, shouldn’t we have seen a reckoning by now? I’d say that in retrospect it’s clear that many assets really were temporarily underpriced thanks to the market panic, and that once the panic subsided the big banks were revealed to be in better shape than many people (including me) believed.
Beyond that, Eisinger is imputing a reasonable analysis to the likes of Singer based on no evidence I can see. I’d suggest that when Singer talks about a debased currency and fake economic growth, that’s because he really believes that we have a debased currency and fake growth, not as a metaphor for some other kind of economic deception.
And where is that perception coming from? I still think that Brad DeLong’s analysis has it right. What we’re looking at here are traders who looked at historical correlations — while disdaining macroeconomics — and concluded that low interest rates would surely rise back to historical norms. When those rates did no such thing, they looked at the Fed’s intervention — and to them it looked like a big trader distorting markets, London Whale-style, by making huge bets that would surely go bad. So they sat back and waited for the collapse.
And the collapse keeps not happening, because the Fed is not a rogue trader and historical norms for interest rates aren’t relevant in a persistently depressed, deleveraging economy. But rather than acknowledge that they were wrong, let alone that, er, Keynesian macroeconomics has something to teach them, these guys lash out: It’s all fake!
Oh, and really rich people often have no idea when they look ridiculous. After all, who in their entourage is going to tell them?