Friday, December 2, 2011

David Brooks is wrong

A reminder, today, of why I skip David Brooks op-eds

Over the past few decades, several European nations, like Germany and the Netherlands, have played by the rules and practiced good governance. 

November 2003:
Europe's finance ministers have agreed to suspend the fiscal rules that underpin the euro, eliciting sighs of relief from France and Germany, but driving a wedge through the 12-member monetary union and raising fears about the stability of the single currency.

The rest of the op-ed is equally bad. Worth a read.

Saturday, November 19, 2011

Improve cooperation easily

Update: link to NYT story on Philippines' politics

Experimentalists have tried to understand what could increase cooperation in games such as a prisoners' dilemma game. Charness, Frechette and Qin allow for side payements. Dal Bo and Dal Bo show that moral messages have a significant but temporary effect. Goette, Huffman and Meier, in a very interesting paper, show that if people are assigned to some groups, cooperation will be higher between two members of the same group than two members of different groups. You also have papers using trust games, typically of the form:
one agent, the “trustor” (A), can sendsomeor none of anendowmentprovided by the experimenter to another agent, the “trustee” (B), who receives triple the amount sent.Bcan then returnsomeornoneofwhathe or she received to A.
 Ben Ner, Putterman and Ren show that two-way communication improves trust(and trustworthiness) substantially. Charness and Dwufenberg find that the content of the communication is important: bare promises are as good as no communication at all. And that goes on and on.

All this is all good, but here is a more efficient way to prove your willingness to cooperate, provided by Filipino politicians. The background story is that the former president, Gloria Arroyo, is reportedly sick and cannot get treatment for her ailment in the Philippines. She wants to leave, but the current government is afraid she will not come back because of some potential corruption cases against her. Her husband's lawyer found the way to make her return credible:
Earlier in the week, Ferdinand Topacio, the lawyer for Mrs. Arroyo’s husband, said in a television interview that he was so confident that his clients would return if allowed to leave that he would have one of his testicles removed if they did not.
After the arrest warrant was issued on Friday, Edwin Lacierda, a presidential spokesman, said: “The order in the Pasay court has allowed Attorney Topacio to save his family jewels.”. 


Via Charles Blow, Pew had very interesting insights into people's perceptions of their own country. I always felt, without data, that French people had no strong feeling about their frenchness, or that French were less "patriotic"(for lack of a better word) than other countries, say OECD countries. Thanks to Pew, here is a small snippet of data to back this up:
And this makes this graph even more startling:

So this being said, I wanted to have a patriotic moment and put on my French hat for something that has been slightly upsetting me in the past months. A lot of articles have mentioned the widening French/German spreads in bond yields, in parallel mentioning the actual Spanish and Italian yields. This means that in the same paragraph, you hear about a relative value and an absolute value. This has been used as evidence that France is next. There is no denying that the spread has increased
10-Year French/German spread

Now, I haven't seen in any of those articles a way to distinguish whether the widening spread was due to a flight to safety to Germany or an aversion to France risk.  Via MarketBeat, here are the France v. German 10year -bond yield in the last 30 years:
Now, looking at the data, I would actually lean towards the position that France is considered riskier:

German Government Bonds 10 Year
French Government Bonds 10 Year

But I still think that there's an empirical test that has not, and that should, be done so that we can know the whole story.

On a related note, Floyd Norris gives us a nice chart today showing that Germany rebounded quite well from the bottom of the crisis
That's interesting, but here are the Real GDP growth rate quarter to quarter since 2005:
And the quarterly growth rate in German real GDP between 2008Q4 and 2009Q1 was -4% versus -1.5 for France. So yeah, Germany grew quicker afterwards.

The rising cost of financial intermediation

A lot of the recent debate on regulation in the finance industry has revolved around issues of size. How big is too big, in the financial sector? Should the largest financial corporations be taxed and monitored more than others? This set of issues has been dubbed "systemic risk", and a lot of measurement and theory work has gone into it.

Systemic risk, however, is about the size of one financial corporation relative to others. Thomas Philippon, in ongoing research, asks a different question: how big is the financial industry in the US as a whole? In relation to its output, does that size seem reasonable?

The graph above answers the question of the size of the financial sector. It shows the income share of the financial sector. Income is measured as wages and profits; there are some difficulties in obtaining those on a consistent basis, so Philippon looks at different data sources, which correspond to the different lines. Across sources, the message is the same: the income share of finance has changed over time, but it's larger than it ever used to be.

Now, of course, this need not be, per se, a bad thing. Perhaps there are good reasons to allocate a larger share of income to the financial industry. In fact, Baumol showed in 1967 that in a standard neoclassical growth model, the income share of a sector can grow over time if 1) it experiences higher technological progress than other sectors and 2) the elasticity of substitution across sectors is less than one.

The financial sector, however, is not just any type of sector: it does not produce a special variety of goods; instead, it provides intermediation services between different parts of the economy. Baumol's standard explanation for the apparent "superiority" of finance (relative technological progress, elasticity of substitution) does not apply. So Philippon sets out to construct variations of the neo-classical growth model that capture what he deems are the two most important roles of the financial sector: 1) it transfers funds from households to other households, corporate borrowers and the government, and in the process provides monitoring services 2) it provides liquidity services to households, ie it holds their cash and makes it available to them.

He then asks: what path of intermediation costs does the model need in order to match the observed path of finance's income share? This is the same type of approach that Mehra and Prescott took with the equity premium. They asked: given the large observed equity premium, and the comovement of equity values with consumption, what risk aversion is consistent with optimization of rational agents? The answer was: a really high risk aversion. Philippon's answer to his question (what intermediation cost is consistent with the rise in finance's income share in an efficient model of financial intermediation?) has the same flavor: you need pretty steeply rising costs.

How does he get to that answer? He focuses on the balanced growth path of his neoclassical economy with financial intermediation, on which he shows that the the following relationship has to hold:

\[ \phi = \psi_m \frac{m}{y} + \psi_c \frac{b_c}{y} + \psi_k \frac{b_k}{y} + \psi_e\frac{e}{y} + \psi_g \frac{b_g}{y} \]

This relationship links the share of finance to gdp ($\phi$) to the "output to gdp" ratios corresponding to the various functions of the financial sector. For example, $\psi_m$ is the unit cost of intermediation for liquidity services, and $\frac{m}{y}$ is the ratio of total "liquidity services" (in his measure, bank deposits and assets of money market mutual funds) to nominal gdp. The following terms correspond, respectively, to household debt, corporate debt, corporate equity, and government debt. Note that this is a pretty standard decomposition: in a standard neoclassical growth model, labor's income share ($\alpha$) is equal to the unit cost of labor ($w$) times the output share of labor ($h/y$).

The key idea of the paper is to use this relationship to back out something akin to the "intermediation cost" of finance - in much the same way Mehra-Prescott backed out risk aversion from the equity premium. There are some measurement problems here, related to flows and funds, and which I do not understand, but the idea is to rewrite the relationship above as:

\[ \phi_t = (\gamma_m \frac{m_t}{y_t} + \gamma_b \frac{b_t}{y_t} + \gamma_e \frac{e_t}{y_t} ) \psi_t \]

where now the terms are grouped by, respectively, liquidity services, debt (household, government and corporate), and equity. The term $\psi_t$ represents the average unit cost of financial intermediation, while $\gamma_m$, $\gamma_e$ and $\gamma_b$ represent the relative cost for a particular type of service. The implicit assumption here is that these relative costs are constant over time. (It's very unclear to me why he cannot just estimate the linear relationship above, with "output-specific" costs; it seems like he has all the data he needs).

Anyhow, one can now go ahead and compute a series for $\psi_t$, in what is probably the most straightforward estimation procedure ever: divide finance's share of income by what is, at its core, just a weighted measure of the output of the financial sector.
What he gets from this exercise is the picture below.
What do we learn from this? There are two points worth emphasizing.

First, intermediation costs have been moving in a stable range over the very long run - somewhere between 1.5 to 2.5 percent, ie a cost 1.5 to 2.5 cents per dollar of financial "stuff" produced. That is remarkable, given how variable the different series that go into the construction of the series are.

Second, it's been trending upwards for the better part of the last forty years.

This second fact is the main finding of the paper; and it is puzzling, for two reasons. The first one is that we tend to think of the early 1900's as times when the finance sector was highly monopolistic , and could have extracted higher rents (read: higher income per unit of financial stuff produced) than the current, probably slightly more competitive financial sector. Yet if you look at the graph, intermediation costs were lower then, than they are now. The second reason for which this rise in costs is puzzling is the IT boom. The financial sector invested heavily in IT; today most trade is conducted electronically; even the floor of the NYSE was closed down and replaced by computers. All of this suggests large productivity gains in intermediation, yet according to Philippon's measure, none of these gains were passed through in the form of lower intermediation costs.
So what happened? Philippon sees two possible types of answers. The first one are "efficient" answers. It is possible that the financial sector is providing services that he forgot to account for, and the remuneration of which increased in the past 40 years. Another way to put it is that there is an omitted variable in the decomposition above, which biases upwards the estimates of cost - because the financial sector actually produced more stuff. This other stuff could be services such as providing better information about financial assets. Think about portfolio managers, for example. This should still count as an increase in output - only one that the neoclassical model fails to capture. A second type of explanation is that the financial sector is doing something that would not contribute to an increase in output in any type of model, but for which financial intermediaries are still being rewarded. And indeed, the volume of asset trading has been booming in the financial sector in the past 20 years, suggesting that the increase in the financial sectors' share of income may be linked to a surge in transactions, some (or a lot) of which may not be creating any value added.
To be fair, this is a confusing paper. It sets out to do what Mehra and Prescott did, but in some sense, it only does half of it. The strength of Mehra-Prescott was that they could compare their high estimates of risk aversion to the low micro-founded estimates and say: ahah! there is an order of magnitude of difference; this is a puzzle. But Philippon does not really do this. He has -for now - no direct evidence that contradicts his model-based measure of the cost of financial intermediation. All he can say is that we have a hunch costs shouldn't have increased, especially given the IT revolution. But it's just a hunch. So this paper really needs further exploration of the "other half" of the puzzle: can we directly measure intermediation costs, and if so, have they gone up?

But imagine we do find stable or falling micro intermediation costs. Then we have a major puzzle. Where does might the wedge between macro and micro costs come from? Does it reflect some deep inefficiency in terms of resource allocation? Now, those questions are all fuzzy and predicated on the idea that there actually is a puzzle. But it looks like there might well be one, and making progress on accounting for it seems like a better use of our time than, say, setting up tents and clashing with police in public parks. Although it's probably a bit more austere.

Thursday, November 17, 2011

Guest post: Incremental Technological Growth

This is a guest post written by someone under the pseudonym Nicolas Anelka. This guest is really bad at choosing pseudonyms.

The recent passing of Steve jobs has generated a lot of discussion of the "Jobs" factor, that special something that could explain why the former Apple and Pixar CEO seemed to revolutionize every market and every product segment he laid his eyes onto.

An interesting dissenting voice among the chorus hailing the "genius innovator" in Jobs is New Yorker staff writer Malcom Gladwell. In a recent article in the New Yorker, he makes the point that Jobs did not really innovate, so much as tweak other people's innovations. He didn't invent the mouse and the windows-based UI for PCs; Xerox did, in the 70's. He didn't engineer the first cellphones, or imagine the first 3D movies, or produce the first tablet. The technology underlying all of Jobs' breakthrough products was already there before he came in. His genius, Gladwell argues, consisted in:
[T]aking what was in front of him —the tablet with stylus— and ruthlessly refining it
This view has echoes in the recent growth literature. Gladwell is actually taking his cue from research by Meisenzahl and Mokyr. The authors look at a sample of mechanics and engineers from the British Industrial revolution; they find that a majority of the sample did not contribute to "macro" innovations, that is, the invention of new products and techniques. Instead, they produced "micro" innovations, that is, tweaks and iterations of the other, groundbreaking but imperfect "macro" innovations. Interestingly, 40% of the "tweakers" in their sample did not attend school, but were instead trained through apprenticeship at workshops, the techniques of which they eventually went on to improve on in their own workshops. The widespread amount of tweaking, and the presence of a big workforce with the technical skills to carry it out, was crucial in the Britain's take-off, the authors argue.

Now, for the million-dollar question: is tweaking enough to generate aggregate productivity growth? Yes, argue two recent growth theory papers, one by Lucas (yes, that Lucas) and Moll and another by NYU grad students Tonetti and Perla. Both papers argue, though in different setups, that growth in aggregate labor productivity can be generated just from "unproductive" entrepreneurs replicating the processes and ideas of the "frontier" entrepreneurs, the most productive ones. One can think of it as "beggar-thy-neighbour", or "copycat" growth; another way to view this is through the lens of Gladwell's and Meisezahl-Mokyr "tweaking" concept.

The paper by Lucas and Moll, in particular, is fascinating. In a very simple setup, where firms' only decision is to allocate labor between searching for ideas by observing others, and producing using their own technology, they find that the copycat mechanism is sufficient to generate endogenous growth exactly when the intial productivity distribution has fat tails - that is, when the stock of ideas to discover is, in some sense, infinite. Because finding and adopting better ideas increases the number of firms using good ideas, and in turn, the probability of finding a better idea for those lower down on the productivity scale, there is a positive search externality in their economy: a planner would be keen on introducing a tax that encourages unproductive firms to search, rather than use their own bad ideas to produce stuff.

That is a stunning conclusion. Growth theory, both empirical and theoretical, has been arguing for quite a while that patenting and in general property rights were crucial in promoting long-run productivity growth, because they guarantee the right incentives for entrepreneurs to invest in Research and Development. Endogenous growth in Romer's (1990) model relies on the assumption that innovators are monopolists in the varieties they introduce; otherwise, under perfect competition, the present value of innovation benefits would be eroded down to zero, and any small research cost would drive entrepreneurs away from innovation. In that sense, copying is unambiguously bad for growth.

Lucas and Moll, on the other hand, argue that copying is good. Of course, these are very different models: R&D models of growth focus on what happens at the margin, while copycat models of growth focus on the average shift in productivity, but totally abstract from thinking of "where" the better ideas come from. Still, it raises the possibility that, after all, patenting and protection of innovation may not always be good things. This is something that I always thought was implicit in the law of, for example, industrial patents in France, that guarantee exclusivity only for a limited number of years. But it seemed to also have mattered during the British Industrial revolution. In the sample of Meisenzahl and Mokyr, 54% of the "tweakers" never deposited a patent. What's more, the authors show evidence that the tweakers actively engaged in the exchange and diffusion of their ideas. That begs the question of what the optimal amount of protection of innovators is optimal, in an economy where R&D costs coexist with "copycat" growth is. That question, to the best of my knowledge, is still open. (But my knowledge of this field is not very good).

One point, still: models of "copycat" growth are not really models of tweaking, in that there is no marginal contribution of the copiers to the innovation they replicate. Steve Jobs did, after all, improve on the dismally cluttered tablets of Microsoft, Lenovo and the like when he introduced the Ipad and its blinding simplicity of use. It's unclear whether allowing for tweaking in those recent "copycat" models would significantly alter their predictions - other than making the planner even more willing to incentivize copying. Still, the "Jobs" growth model hasn't yet been (completely) written. Yes, that was a terrible pun; but then again, it was just a tweak on the widely better, millions of jokes that Jobs' passing spurned.

Friday, November 11, 2011

A post about inequalities

Raghuram Rajan has a piece on Project Syndicate where he echoes David Brooks's column explaining that the inequality we should worry about is the inequality in education, and concludes that
the broken educational and skills-building system is responsible for much of the growing inequality that ordinary people experience
As he says, this relies on this observation:
the single biggest difference between those at or above the top tenth percentile of the income distribution and those below the 50th percentile is that the former have a degree or two while the latter, typically, do not.

For now, let us forget about the affordability of education in the US in particular, which could explain the consequences of income inequality on education inequality(see Mike Konczal for some graphs on the rising importance of student debt, the rise of student loans v. auto loans or mortgages in the last 10 years). The fact is, the inequalities fought by the 99% movement and the ones Rajan is talking about are...not the same thing. Autor, Katz and Kearney show that the rise in income inequalities has been a constant trend since the sixties, and its movement was sometimes uncorrelated with the college premium(especially in the seventies):

This might seem trivial, but they conclude that

These divergent patterns suggest that the growth of inequality is unlikely to be adequately explained by any single factor
Paul Krugman shows that the magnitude is also quite different .  There also has not been a significant college premium compared to high school in the last 30 years(though the previously mentioned paper by Autor et al.. seemed to show a higher change than the graph below)

It is also clear that the very top of the distribution has done far better than the rest. The relative income share of the top-thousandth has increased dramatically compared to the other fellow members of the top 1% club:

I was lucky to attend the INET conference which looked among others to trends in inequalities. What striked me with the explanation of rising inequalities by skill-biased technological change(SBTC) is that it cannot explain a lot of the movement in the income share of the top 0.1% in anglo-saxon countries. Institutions must play a role. Courtesy of Emmanuel Saez, how can you explain the difference in movements between those two graphs via a technological explanation?

It is interesting that at the conference, Arin Dube made the point that the main issue we do not understand is really what is going on at the top 1%(he mostly stressed compensations in the financial sector, but as we'll see below, it is not clear to me that this should be the main point of interest given the job composition of the top thousandth).

In his piece, Rajan also makes the point that
[M]any of the truly rich are entrepreneurs.[M]any of the wealthy are sports stars and entertainers, and(...) their ranks include professionals such as doctors, lawyers, consultants, and even some of our favorite progressive economists. In other words, the rich today are more likely to be working than idle. 
I sympathize with that, looking at the distribution of the top 0.1% in the US, via this awesome paper(pdf) by Bakija, Cole and Heim

However, the US has not a good record on income mobility, measured by, for example, the correlation between a parent's income and her children's.

(This TED talk made the joke: if an American wants to leave the american dream, he should go to Denmark).

The bottom line is that I don't think we can discard income inequalities, and that we can say that most inequalities come from differences in education: not only this is not true, but education reform might not change anything if the problem of income mobility is not tackled in parallel. Finally, Institutions (with a big I because that makes the word vague so I don't have to commit) clearly have an impact.

As a final point, this is not to say that SBTC does not matter. As the FT series on the international middle class squeeze shows, there clearly is a worrying dearth of middle income jobs in OECD countries, leading to median income stagnation and growing inequalities between highest paid and lowest paid jobs.

The fact that different explanations stand for different parts of the income distribution seems to be where research is converging. Dube made the point that

  • Minimum wage and institutional factor are important to explain the divergence in the bottom half of the distribution, say the 10th percentile
  • The problems at the median are better explained by institutional factors such as de-unionization(I am a bit confused that this can explain the changes internationally though. Globalization seems more reasonable, as Autor mentions here about the US job polarization: "Key contributors to job polarization are the automation of routine work and the international integration of labor markets").  

So reforming the education system and job-training programs should definitely be an objective. However, the income inequality at the top of the income scale seems like a big, and easily solvable problem, compared to the huge issue of adapting skills to technology and globalization.

Monday, November 7, 2011

The diversification of global supply chains

Today's New York Times on the impact of Thailand's floodings on hard drive suppliers:
Until the floodwaters came, a single facility in Bang Pa-In owned by Western Digital produced one-quarter of the world’s supply of “sliders,” an integral part of hard-disk drives. 
Last March, in Japan:
Shin-Etsu’s Shirakawa plant is responsible for 20 percent of global silicon semiconductor wafer supply. The plant is located in Nishigo Village, Fukushima Prefecture Shin-Etsu reported that there has been damage to the plant’s production facilities and equipment. 
It was surprising to me that for specific components, concentration seems to be the norm. In particular, Japan was a big object of analysis after last March earthquake

However, the trend seems to be general. Shin et al. discuss the trend towards a single-supplier chain and evoke explanations all, from what I see, related to economies of scale(reputation building, communication, coordination, efficiency in the use of transportation/containers). Kekre et al. stress the benefit in terms of quality control and argue that GM and Ford's adoption of single sourcing led to quality improvement, and show that firms with high quality restrict the number of suppliers.

An article in the Financial Times last April made a good summary of the fact that we are still in a transition phase.

First, the degree of diversification varies by sectors, depending notably on complexity:

It is in sectors such as carmaking, and the manufacture of construction equipment and electronics that the repercussions of last month’s disaster have been most marked. Suppliers in Japan(...)specialise in making parts hard for other businesses to create.
Though it is not clear that complexity is the main factor:
In electronics, about 80 per cent of basic component production, along with a great deal of final assembly, is based in China. The situation is similar for clothing and footwear. In such industries, there are few opportunities to mitigate the consequences of a disaster in south China of the type that gives Mr Cox nightmares. But in other sectors, particularly in engineering, where expertise in production is spread more widely and pricing pressures are less intense, many companies are instituting strategies to insulate themselves at least partially.

Interestingly, increasing labor costs make diversification easier with high-cost countries becoming attractive again, and this reduces the incentive to outsource production:
The trend towards localism in manufacturing is embodied in a gleaming new $6.8bn semiconductor manufacturing complex near Albany, New York state.
Finally, the diversification of the supply chain might be the final objective, but has still a long way to go:

Companies at the cutting edge of supply-chain planning have set up data systems to complement their multiple networks. These enable them to remain abreast of problems in various locations, using spare capacity from plants elsewhere to provide extra parts. Swiss-Swedish industrial group ABB has 5,500 suppliers linked via data networks and transport connections to assembly factories spread globally. Control of the flow of parts is devolved to 450 supply chain experts based in 40 countries, who ABB feels are best placed to match supply to fluctuations in local demand.

Wednesday, November 2, 2011

Emerging countries and US financial markets

FT Alphaville reads a UBS report showing that emerging markets and the G3(US, Europe, Japan), have highly correlated financial data. The first graph shows the long term bond yield spread over short-term interbank rates in both groups

They point out that the macro data are highly correlated in terms of rates of growth(e.g. inflation or real GDP growth). 

I am currently writing a paper with an awesome coauthor on the impact of some political shocks on emerging markets' bond spreads over US Treasuries. One part of the paper looks at the determinants of emerging market spreads. When you consider "global" variables, such as the 3-month swap rate or the rate on corporate BAA bonds(sometimes seen as good substitutes for emerging market bonds), the fit is quite amazing. Below, I show results of some regression of EMBI spreads(emerging bond market index by country, from JPMorgan) on long term and short term treasury yields, corporate BAA bond spreads and the 5-year swap rate, a commodity index and a volatility index. Each column is a country at a different date(note the small number of observations in the first column). The fit is quite impressive.

The high explanatory variables of global/US(yeah, global=american, haven't you heard of the World Series?) is definitely not new. Uribe and Yue(2006) find that variations in US spread, along with innovations to country spreads(i.e. shocks to local bond yields) explain 85% of the variation in specific country spreads. They argue:
Most of this fraction, about 60% points, is attributed to country-spread shocks. This last result concurs with Eichengreen and Mody (2000), who interpret this finding as suggesting that arbitrary revisions in investors sentiments play a significant role in explaining the behavior of country spreads.
Hund and Lesmond(2008) report that "Conversations with emerging market bond dealers and hedge fund managers confi rms that it is not uncommon for them to hedge their risk in US equity markets, most usually the liquid S&P 500 futures market, but occasionally in the more volatile NASDAQ market", which might explain the correlation.

I feel that it is quite understandable why bond spreads or stock markets are highly correlated in the two groups, if we assume that investors have an international strategy and capital flows can move easily from one investment to another. It is more puzzling to see the high aggregate correlation in the UBS report in GDP growth:

Monday, October 31, 2011

Savings Rate and Disposable Income

There has been some discussions about the fall in the savings rate for three consecutive months. From last week:
On average, consumers put 3.6% of their hard-earned dough into savings in September, the government reported Friday. It marks the lowest level of saving since December 2007, when consumers stashed away only 2.6% of their income.

The NYT, via Moody's sees two possibilities:
Scott Hoyt, an economist at Moody’s Analytics who specializes in consumer spending, said there were two competing hypotheses as to why the savings rate had dropped. “One is that consumers have just decided that they need to spend — they need to replace the car, the appliance, they want a new wardrobe.” The other, he said, is that the data, which is often revised months down the road, is simply incorrect.
Some consulting firms are optimistic
"We view the decline in the savings rate as consistent with consumers taking a longer view on income trends and not adjusting to the drop in real disposable income in the third quarter," economists from RDQ Economics said.
But if we assume that the savings rate falls with income and that incomes are fallin, well,  the savings rate must fall

The link with real consumption on durables is less clear, though present

Dean Baker thinks it is, indeed, faulty data.

It is more likely that wages were understated in September and indeed the whole third quarter, which means that income growth would be stronger and that the savings rate would be higher.
Baker also points out to a timing effect for car purchases(yep, those are durables). As Reuters reports
U.S. auto sales in October are expected to have hit the highest rate in at least eight months

Car sales were depressed in the second quarter because os shortages related to the earthquake/tsunami in Japan. The third quarter sales were strong as manufacturers had big sales incentives to make up for lost ground.
To have an idea of where the savings rate "should" be, here is the historical rate via Calculated Risk:

To be continued...

Sunday, September 25, 2011

Mark Bittman's war on junk food

Mart Bittman had another complaint about junk food following last month's long article on why we should tax it. Today, he explained that junk food was actually more expensive than "better food" and so that the difference in prices is not the reason why junk food is so popular.

I have a couple of problems with his argument. First, he argues that the main problem is that people do not want to cook. But this can be explained as a price problem: once you account for the cost of cooking(and not only the concrete costs of utensils and all, but also time), is it clear that fast food is more expensive than, say, organic food?

Second, Bittman links junk food and tobacco in an interesting way. First, he explains that junk food is addictive:
A 2009 study by the Scripps Research Institute indicates that overconsumption of fast food “triggers addiction-like neuroaddictive responses” in the brain, making it harder to trigger the release of dopamine. 
This leads him to argue that "real cultural changes are needed to turn [the problem] around". For him, the question is "How do you change a culture?" and he explains that this is what the tobacco market has done since the late nineties "Smoking had to be converted from a cool habit into one practiced by pariahs". The weirdest part, for me, is when he argues that we should "give [our children] the pleasures of nourishing one another and enjoying that nourishment together".

First, I have a problem with the "cultural" argument, because it seems to be quite vague, and also intractable. Indeed, how do you change a culture? More problematically, what is culture? Who decides what "culture" is the target culture?

Second, although the addictive component of junk food is a nice way of to see that junk food is similar to, say, tobacco, I don't understand the follow-up. It is not clear to me that the objective, and the effect, of the anti-cigarette campaigns were to transform people into pariahs. It seems to me that there was a campaign of information and an increase in costs so that people would be better informed of the consequences(e.g. pictures on cigarette packs), and so that the externality cost would be internalized by consumers(increase taxes on packs). I am not sure there was a culture war against cigarette.

This being said, even if one accepts the cultural argument, I think Bittman has his policy prescription wrong. It is not clear to me that you need a big cultural shift. Malcolm Gladwell has a nice discussion of the cigarette problem in The Tipping Point. First, smoking and depression are closely related, and anti-depressants have a significant impact on the rate of smoking quits. Second, addiction is not instantaneous and it affects people differently(e.g. here).  You can wait years before being addicted, and some people can smoke regularly and never get addicted. This means that the share of nicotine content in cigarettes can be lowered slightly and have huge impacts. More importantly for the argument here, Gladwell says that
We've been obsessed with changing attitudes toward tobacco on a mass scale, but we haven't managed to reach the groups whose attitude needs to change the most. 
For cigarettes, informing and increasing prices are ways to make the "market" better. Targeting nicotine levels and using anti-depressants are ways to solve the addiction problem. The former thing was what makes me more sympathetic to Bittman's first argument in favor of taxing food, and also argues in favor of the new health care law requirement that calories be posted(there is evidence, however, that that does not work. But it is not clear!). On the second point, well,  apparently nicotine and junk food both act on the level of released dopamine, so hopefully we can find ways to target addiction.

I want to conclude on another link, slightly related. As I mentioned above, calorie posting on menus does not seem to work especially for low-income people, which is, I believe, the population that Bittman wants to target. Interestingly, in their new book, Abhijit Banerjee and Esther Duflo explain that when people are budget constrained and cannot afford the desirable number of calories, giving them extra money will not lead them to spend all of this money on food, and the food they'll purchase will be less "efficient" in terms of calories("television is more important than food!"). They refer to a recent paper by Jensen and Miller who ran a randomized-controlled trial showing that "households that received subsidies for rice or wheat consumed less of those two items and ate more shrimp and meat(...) Remarkably, overall, the caloric intake of those who received the subsidy did not increase". Duflo and Banerjee seem to argue in favor of paternalistic policies, such as giving way fortified foods to parents and more generally, providing more directly better-quality food to poor families. It is not clear, however, that this is what they would advocate in a country with better institutions. Interestingly, they mention the information problem:
They[The poor] often behave as if they think that any change that is significant enough to be worth sacrificing for will simply take too long. This could explain why they focus on the here and now(...)
This is clearly not specific to any category of people. The instantaneous pleasure of junk food or of cigarette, and the general short-termism, affects everybody except George Clooney. This means that we do not compute the real costs of short-term behavior(and Banerjee and Duflo show evidence that the poor, for instance, would like to constrain their future behavior on health the same way anybody would like to have a commitment device for new year's resolutions). So improving information and, more controversially, increasing costs(also because of the externalities we're talking about), is still fine with me.

Thursday, September 15, 2011

You're beautiful, no matter what they say

Is being beautiful good or bad? The question is important, because it will help us know whether Greg Mankiw will write an editorial on whether we should tax them(I am a fervent advocate of his proposed tax on height)

I don't have an answer to the question, but there are several things to think about. First, Hamermesh and Abrevaya had a working paper at NBER last month arguing that beautiful paper are happier. Should we accuse them of Captain Obviousness? It's not clear. As they mentioned, there are two ways beauty could affect happiness: indirectly through "market-related" outcomes, and directly, because beauty is awesome. They find that indirect channels are more important:

Among both men and women at least half of the increase in satisfaction/happiness generated by beauty is indirect, resulting because better-looking people achieve more desirable outcomes in the labor market (higher earnings) and the marriage market (higher-income spouses). That relatively more of the impact among women is direct, not mediated through the effects of beauty on market outcomes, might help to explain gender differences in people’s attitudes about their own looks.
Interstingly, there are a lot of discussion on whether beauty has a positive impact on "market-related outcomes.". PsyBlog lists 5 benefits and 5 problems with being hot. For instance, the Halo effect means that attractive people are seen as better in various unrelated characteristics. Beautiful people are paid more. Hot athletes are paid more(" a “good-looking” quarterback like Kerry Collins or Charlie Frye earned approximately $300,000 more per year than his stats and other pay factors would predict.") Apparently, through other characteristics, attractive people are more persuasive. Men are more ready to forgive attractive women after an apology. Hamermesh(again) finds that beauty improves earnings in China but that investing in beauty is extremely costly(not only because it has decreasing returns to scale), and so advocates for protection of less beautiful people

However, being too pretty has negative impacts. Mostly, it is related to a couple of things:

  • People don't like you because you're too hot: attractive people have problems in job interviews when the interviewer is of the same sex(apparently mostly a woman problem). Also, you scare people. A friend of mine told me of a cameraman on a movie set asking Natalie Portman out, and she said yes because nobody dared asking her out. Unconsciously, hot people are considered less suitable for long-term relationships. Women are less ready to forgive attractive women after an apology
  • People think you are less competent: basically, if you see two identical persons only differing in how attractive they are, you discount the quality of the pretty one on the criteria that you(consciously or unconsciouly, opposing the halo effect) think are positively affected by beauty(or this is what Bayes tells you). Attractive women are discriminated against in masculine jobs, again, consciously or unconsciously

Finally, an interesting dynamic was underlined in a recent OkTrends blog post, which might underline a last problem with being objectively hot. It is summed up in this picture:

Girls get more private messages on OkCupid when there's debate on whether they're attractive, one possible reason being that guys think they have more chances(competition is less fierce).

Wednesday, September 14, 2011

Why Spain?

A friend of mine asked me why Spain, which has a low debt-to-GDP ratio, was attacked by the market in the same way Italy is.  For the debt/GDP ratio,  here is the evolution over the last decade, via Eurostat(Spain is in pink):
Now, as I mentioned here before, Paul Krugman, Martin Wolf and Paul De Grauwe convincingly argue that Spain and Britain have a similar trend in debt to GDP ratio(though as I mentioned earlier, the maturity profiles of the two countries might also be a factor) but Spain pays a far higher interest rate on its 10-year bonds because they do not have the option to devalue their currency. Now, the comparison with Italy is trickier. First, a graph of 10-year bond yields since the beginning of the year: 
Now, here is what I quickly answered(with some probable mistakes along the road, sorry)
  • I think there are several things that matters. First, without talking about the papers  I am currently reading, there are various weird things about Spain. Unemployment is extremely high. It fell because of the construction bubble before, but Spain usually had an unemployment rate of more than 15%. Now it's around 20, I think, with a 40% unemployment among young people. Structurally, they have problems. Second, their banks are indebted. Spain had the majority of failed banks in the two stress tests the EU has conducted. Third, Spain provinces are quite independent from the central government and there's no cooperation. The central government has less power than other countries to control public debt. Try this article from today with Google Translate.
  • Now, actually, debt to GDP is not a big factor in bond spreads, from what I gather from articles, so it is not clear we should look at those numbers. A recent  NBER paper has that debt/taxbase has a significant impact, though.  Growth prospects are important, and you see that Italy, Greece, Spain have structural pb(I think it's less the case with Ireland). We don't know what are their comparative advantage(although tourism is probably one of them). Trade is important, and Spain had a HUGE trade deficit in the second part of the decade. Exports gets you reserves and helps you pay your debt, especially if it's dollar denominated. Being in the Eurozone also means that the terms of trade(how much imports you can pay for a given amount of exports) have been quite bad for a while. This is the trade balance, via Eurostat again: 

Update(09/15/11): I forgot to list a couple of things. First, via Brad Plumer, the list of countries with the highest share of small businesses is quite amazing

Still, it does not say anything about Spain vs. Italy, which both rank at the top. A report by the IMF has some nice numbers and figures. For instance, in 2007, Spain had the second highest current account deficit, after the US(numbers are not adjusted by GDP)
(Source: IMF, World Economic Outlook database, as of August 21, 2007.)

If you go look at table 3 of the report, you'll see that Spain has one of the lowest reserves to GDP ratio.

Finally, on the structural problems in Spain and the fact that restoring competitiveness appears to be hard, the graph of startups in the last 5 years is telling:

Saturday, August 6, 2011

Update on the rating agencies

I mentioned in yesterday's post that Treasuries had a special status in the rules of institutional investors. The NYT has the details today:

[B]ecause Treasury bonds have always been considered perfectly safe, many rules prohibiting institutions from investing in riskier securities are written as if there were no possibility that the credit rating of Treasuries would be less than stellar.
Banking regulations, for example, accord Treasuries a special status that is not contingent on their rating. The Fed affirmed that status in guidance issued to banks on Friday night. Some investment funds, too, often treat Treasuries as a separate asset category, so that there is no need to sell Treasuries simply because they are no longer rated AAA. In addition, downgrade of long-term Treasury bonds does not affect the short-term federal debt widely held by money market mutual funds.

Also, James Kwak thinks along the same lines as I wrote, but in a far better and more concise way:
S&P downgrading the United States is like Consumer Reports downgrading Coca-Cola. Consumer Reports is a great institution. For example, if you want to know how reliable a 2007 Ford Explorer is going to be, they have done more research than anyone to figure out the reliability history of every single vehicle. Those ratings are a real public service, since they add information to the world. But when it comes to Coke and Pepsi, everyone has an opinion already, and no one cares which one, according to Consumer Reports, “really” tastes better. When S&P rated some tranche of a CDO AAA back in 2006, it meant that some poor analyst had run some model fed to her by an investment bank and made sure that the rows and columns added up correctly, and the default probability percentage at the end was below some threshold. It might have been crappy information, but it was new information. When S&P rates long-term Treasuries AA+, it means . . . nothing. And if any serious buy-side investor were tempted to take S&P’s rating into account, she would be deterred by the fact that the analysis that produced the rating included a $2 trillion arithmetic error.

Debt ceiling and deadlines

The debt ceiling saga of the last couple of months was a shame, but it produced some interesting discussions. First of all, my view is that the problem is mostly a problem of institutions. The debt ceiling is a rigid limit set up on borrowing for spending that has already been allowed. As a rigid limit, it is not robust to an unforeseen increase in borrowing, say because you are in a Great Recession. It is also not robust to a change in the Congressional norms: the increase in polarization has made the debt ceiling an hostage-taking situation, in the words of the Senate Minority leader himself(that is to say that comparing Republicans to hostage-taker is not as counterproductive, or stupid, as calling them terrorists)

In this sense, it is close to the filibuster rule, that allows 40 members of the US Senate to block a legislation or a nomination they disagree with. The filibuster somewhat worked(and that is still debatable) when Senators were nice to each other. Actually, the rule was made with the idea that senators were nice people in mind(see, for instance, Koger's great book) and that they wouldn't dare use the rule abusively.

Both rules have the problem of being extremely rigid. As Bruce Bartlett pointed out in the case of the debt ceiling:
It is permanent law and can be abolished only by repeal or by a ruling by the Supreme Court that it is unconstitutional
And there's also a reason why the main option to get rid of the filibuster is called the "nuclear option".

One interesting thing to come out of the debt ceiling debate is the discussion about deadlines. Tim Geithner announced on May 3rd that the Treasury would hit the debt ceiling on August 2nd. There has been some debate along the way on whether this was a hard deadline, or whether the ceiling would have been hit a couple of days earlier or later, but basically, everybody considered August 2nd as the last day when Congress should come to an agreement.

Now, what happened with the debt ceiling was a pretty good illustration of why deadlines are sometimes bad. As Dan Carptenter wrote in the Washington Post, deadlines create various problems. I'll quote the article in length

Deadlines can’t make decisions for us
Delegating a decision to another group and giving it a deadline can also be a form of procrastination or avoidance. Many deadlines are simply not met. The European Union has for two decades tried to use deadlines to speed up the implementation of its directives, to little effect. From 1995 to 2002, almost 60 percent of the implementation decisions in the Netherlands, for instance, missed the E.U. deadlines.

Deadlines ratchet up stress, limit creativity and force mistakes.

“bad” stress can cause the human heart to respond inefficiently to pressure and can lead to avoidance of the task at hand. Another psychological study shows that as a deadline approaches, group participants disregard those who voice contrarian opinions.

Carpenter's research "found that medications approved right before these deadlines were considerably more likely to be pulled from the market or have significant warning labels attached later on."

Deadlines can slow things down.
Once a decision-maker misses a deadline — and many, many deadlines are not only missed, but are expected to be missed — there is usually much less incentive to continue speedy work.
Many deadlines are missed, leading to disenchantment and poor coordination.
 An externally imposed deadline interrupts a person’s or group’s independent work schedule.

You can find other interesting practical examples of those issues. In a recent article in Foreign Affairs, David Victor and Kassia Yanosek argue that  the imposition of deadlines created short-termism incentives for potential investors in alternative sources of energy.
 Every few years, key federal subsidies for most sources of clean energy expire. Investment freezes until, usually in the final hours of budget negotiations, Congress finds the money to renew the incentives -- and investors rush in again. As a result, most investors favor low-risk conventional clean-energy technologies that can be built quickly, before the next bust. 

Apparently, Carmen Reinhardt thinks that the problem that we saw with the debt ceiling deadline is international(yeah, not really convincing):

Ms. Reinhart said countries often did the greatest economic damage by agreeing on cuts at the 11th hour, in the desperate rush to complete a deal, without sufficient attention to the particulars.“That’s when politicians make the worst decisions often — they cut the things that would yield short-term revenues,” Ms. Reinhart said.

It's hard to say that deadlines are always bad, as any student would tell you. So when is a deadline desirable? I don't want to say something stupid(if I haven't done so already), and it's late so I'll think about it before blogging...

Friday, August 5, 2011

Ratings agencies

I was going to blog about rating agencies tonight, and I guess that now I actually have a nice justification for it. S&P just downgraded the US credit rating by one notch from AAA to AA+. There are two big questions related to what I wanted to write about:
- Does it matter?
- Should it matter?

I was mostly going to blog on the second one as a follow-up to my post 2 weeks ago on polls and forecasts. As I said there, you have 2 possible objectives for those institutions: they can inform(tell you what the state of the world is now) or predict(what the state of the world is going to be). The latter is more complicated. Today's example is quite good to understand that: the very fact of downgrading the debt puts the US(and the world ouh lalalala) in uncharted territory. Thus, it is clear that the downgrade is not supposed to be a forecast, and it should be an assessment. But as Ezra Klein points out, S&P is actually trying to make a forecast on how the deficient US political system is going to deal with the rising debt.  That's one reason why S&P is probably in the wrong. It is not their job to forecast the US credit rating. Jared Bernstein said on MSNBC tonight that the agencies are there to tell us whether it's safe to invest in certain sovereign or corporate bonds. I disagree.  Their job is to inform of the current situation. And the current situation is clear: the US is creditworthy and the only problems are long-term And that's also why there will be no movement as a consequence of the downgrade. As Felix Salmon noted yesterday after the international market crash
if there ever were serious doubts about the USA’s creditworthiness, they’re gone now. The 10-year bond is yielding less than 2.5%: there are no worries in evidence there. 
More generally, it is really important to wonder why we are using rating agencies. At the time being, with private agencies, we cannot consider them as forecasters. The rating agencies have interests that are not aligned with perfect forecasting. The main issue in financial markets is that they are paid by the issuers of the securities that are rated. More generally, private forecasters usually have competitive and reputational incentives that lead to biased forecasts. Those two things actually have opposite effects. The former problem is discussed by George Henry

[A] technique for seeking attention is to produce a forecast that departs sharply from
the consensus
The reputational factor, instead, might lead agencies to herd, as suggested by Scharfstein and Stein
 herding may become more or less of a problem as a manager’s career progresses. One the one hand, there is apt to be less uncertainty about the manager’s ability, which should reduce the incentives for herd behavior. On the other hand, later in a successful career, wages are probably higher above the outside alternative. . . This latter effect can increase the propensity to herd. 

Usually, the evidence points to the latter. Owen Lamont showed that, for instance, that
ex post forecast accuracy grows significantly worse as forecasters become older and more established.
Errors are growing worse as the forecaster ages, which would point to a strong reputational incentive.

The bottom line is this: if you have private rating agencies, you don't want them as forecast, because their objective is not to have a perfect forecast. You want to use their ratings as information. Again, given the flawed incentives, you will have to adjust the information. Interestingly, this is what people in credit rating agencies will tell you, apparently. In an interview to Liberation, the left-leaning French newspaper, Carol Sirou, president of S&P for Europe, Africa and francophone Middle East,  argues that :
Nos notes sont dans le domaine public, chacun est libre de s'y référer ou pas. Mais le fait est qu'aujourd'hui, nos décisions sont souvent amplifiées et entraînent certains comportements, liés à l'anxiété ambiante. Trop d'acteurs utilisent nos notes comme seul critère de décision. Nous sommes favorables à ce qu'ils considèrent aussi d'autres paramètres. 
What does it mean in practice? The fact that rating agencies should not be used as forecast, but that their decisions should be evaluated as a partially informative signal by investors, means that ratings should IN NO WAY BE IN INVESTMENT RULES.  That is also why I don't really like when rating agencies are blamed for the pains in Europe for instance. We shouldn't care. The problem seems to be mostly political, and legislative.

As pointed in several papers(e.g. Steiner and Heinke(2001)), what you actually see is that downgrades have an impact when the downgrade is from investment grade to junk, and only then. Basically, the downgrades are useless, and their only effect is through the regulations that impose a sell-off by pension funds required to invest in certain categories of financial assets. All is told in the figure here:
You are interested in the lighter curve, which shows the "cumulative abnormal return"(CAR) around a downgrade. The downgrade occurs at time 0 in the graph. You can estimate what should be a "normal" return from the past. Given this prediction, you look at the actual value, and you get a day by day abnormal return(the black thingy). The CAR is just the sum of abnormal returns. What you see in the graph is that at the time of the event, the downgrade has been priced in, and the sudden fall just after the event is just an overshooting, since the situation goes back up after 15 days. Actually, as Steiner and Heinke put it(italics mine, obviously):
In the long run(which is what institutional investors are about!) the investor is better off not to sell the bond on the announcement day because there is a positive cumulative excess return from day 1 to day 90 of 0.526%.
You also see evidence that the size of the downgrade(how many notches) does not matter, evidence for the fact that ratings actually provide few information, and that their only impact is through the constraining rules imposed on institutional investors.

My bottom line, in theory, is this: ratings should not be in the rules. There should not be rules restricting investment to triple A bonds. This does not make any sense.

On the US problem now, it's actually clear, I think, that nothing is going to happen, for a couple of reasons. First, as mentioned above, investors not subjected to binding rules on what they could invest in will not react. As you saw yesterday, people were still flocking to Treasuries during the market crash, while the downgrade has been in the making ever since Barack Obama announced the agreement on the debt ceiling. Reuters most recently reported on a JP Morgan study showing that
The number of investors that are restricted to by Triple A mandates is minimal. Expectations are that around USD40bn could be pulled from US Treasuries as a result of force selling. 
[JP Morgan] see[s] little direct impact of a downgrade in the short term, but the medium term impact is Treasury yields in the range of 60bp higher than otherwise, which is a significant cost to the Treasury.
Third Way has a somewhat larger increase in yields, at 75bp. Fitch does not care
Second, the problem is, again , the downgrade from investment-grade to junk. AAA to AA+ does not matter. As Felix Salmon reported
“the long-term credit performance of ‘AAA’ rated versus ‘AA’ rated issuers,” says Fitch, “is statistically negligible”.
Third, there's nowhere else to go. The US issues 59% of triple A sovereign debt. The other AAA countries(yep, France) do not look that attractive right now.
Fourth, Treasuries have a special role in certain institutional investors(can't find the link, sorry). Basically, those investors can invest in Treasuries not because they're triple A, but because they're Treasuries. Because a downgrade does not change the name of the bond, there will be no impact for them.

Etc, etc... Bottom line: no biggie. I am taking a risk, I don't like making predictions. Well... I should probably start at some point.

Saturday, July 23, 2011

Terrorism, Extremism and other bad stuff

Update(07/25): evidence is mounting that Breivik was part of a larger group and that one of his objective was to create a revolution. That something I would qualify as terrorism...

When I somewhat disagree with two of the most interesting people on the intertubes, Glenn Greenwald and Juan Cole, I feel really sad inside. So let me expose my sadness.

Norway's double-disaster yesterday led to some comparison between the treatment of an attack by a Muslim and by a Blond Norwegian. On this, I completely agree with the first part of Glenn Greenwald's post(until the part on the definition of terrorism). Linking yesterday's attacks to Al-Qaeda because the methods employed are the same is quite a weak link, for instance. The initial statements of some media(TV and newspapers) were quite bad given what we know now. Also, as Juan Cole says:
In 2008, only one terrorist attack out of hundreds in Europe was committed by radical Muslims. In 2010, according to Europol [pdf], 7 persons were killed in terrorist attacks. Some 160 of these attacks that year were carried out by separatists. The number launched by people of Muslim heritage? 3.

Where I am more doubtful is on the fact that yesterday's crime should be considered as terrorism, and that it is not qualified as such just because the guy is blond. The same argument was made when some guy crashed his plane on an IRS office last year.

My feeling is that those guys are crazy. They might have an extreme ideology. But it is not clear that they are trying to instill terror. One of Al-Qaeda's specific objective is to create fear. After Osama Bin Laden's death, there was discussion on whether he has won or not, because of the cost of the Iraq and Afghanistan war, the increasing security costs(e.g. passenger screening). They pride themselves in low-cost actions leading to high-cost reactions:
In his October 2004 address to the American people, bin Laden noted that the 9/11 attacks cost al Qaeda only a fraction of the damage inflicted upon the United States. "Al Qaeda spent $500,000 on the event," he said, "while America in the incident and its aftermath lost -- according to the lowest estimates -- more than $500 billion, meaning that every dollar of al Qaeda defeated a million dollars."
Calling an act a "terrorist" act implies that the act was not the goal in itself, but that the goal was to instill fear that it could be repeated. That is why the plane crash in the IRS building is hard to qualify as "terrorism", for instance.

At FirstPost, a security specialist at NYU in London asks the key question about the Norwegian bomber/shooter:
"The next key question is whether he was acting alone, or whether he is part of a group."
Indeed, the group thing makes the act repeatable, and makes the act part of a larger objective. Before calling the act a terrorist act, this information is key. Now, today, Blake Houndshell tweettussed a document that surfaced on the internet with a blurry origin. The document seems to be some kind of manifesto, which would make the act part of a more global plan. That would be terrorism.

In the end, that's probably a question of terrorism. But I feel that before we know the true motivation for yesterday's disaster, saying that the media is bad because they don't call the guy a terrorist is not a good point.

The difference between polls and forecasts

Update(07/25):  " I realized that polls and forecasts are close. They take coarse signals, and try to derive the "state of the world'' from them." says basically nothing. Sorry

I am going to write a couple of posts on polls and forecasts, because this is one of the topics I am working on right now. Basically, I want to understand what information  we can get through polls. The motivation was quite simple:

  • Polls are used and have predictive power(Nate Silver relied on polls for the 2008 election)
  • Polls are often wrong(The French election of 2002 did not exactly go as expected. The Dewey/Truman contest in 1948 did not go as expected either)
The conclusion of that was that polls are partially informative, and it could be interesting to try to understand how much information is actually conveyed. So this led me to think about polls. Then I realized that polls and forecasts are close. They take coarse signals, and try to derive the "state of the world'' from them.

Let me give just two quick examples of what I mean by polls and forecasts. Polls are all the number you see that tells you the share of the vote Obama get in 2012 or how many people want to raise the debt ceiling. Forecasts try to predict what GDP growth will be in 4 months.

Polls and forecasts provide various incentives. The initial discussion on rational expectations equilibrium, by Grunberg and Modigliani(1954), started with the question on whether there exists an accurate forecast. The issue is similar to the Heisenberg principle: once the poll or the forecast is out, it changes the information set. This means that even if it was "accurate" in the first place, the very act of its revelation will probably make it inaccurate. If the polls are saying that the National Front is at 30%, some people might consider turning out at the polls while they would have stayed home otherwise.

Is that a problem? My feeling is that it depends on the goals of polls and forecasts.  Polls and forecasts seem to differ in their objective.

In theory, we want the poll to provide accurate information, in my opinion. The reasons polls and forecasts are made is in order to provide information. In forecasts, this seems obvious. Decisions are based on forecasts, and we can assume that the better the information, the better the decision. One issue here is that if a forecast changes decisions, it might change some assumptions on which the forecast is based, thus making the forecast inaccurate, and the decision inefficient. Therefore, the forecast is more about rational expectations: it has to take into account the impact it will have on the very assumptions it is based on.

In polls, things looks different. Why do we have polls in the first place? Polls measure the state of the world at a moment in time. From these, decisions are made. For instance, political candidates might change their platform. The decision to take a vote on an issue might change. A company might change its motto or its product. This means that the poll should provide the ex-ante accurate information, and should not care about its impact on what it polled. Agents will react to the poll, and in a perfect and infinite world, we could probably assume that this back and forth between agents and polls will end up in an equilibrium. The issue is that this infinite world does not exist: we do not have an infinite time for polling, and the agents are not infinitely rational.

Therefore, forecasts aim at being accurate ex-post while the polls only aim at being accurate ex-ante. Those are the criteria on which they should be evaluated.

Why is this relevant? I started thinking about rating agencies, given the fuss about their behavior in the European debt crisis and the raise of the US debt ceiling. Here is a primer. Rating agencies are not a real problem. The incentives are bad, of course, when they are paid by the agent they rate. However, the main issue is that their rating are taken into account by law. For instance, one big issue of the last couple of weeks was that the ECB wouldn't accept Greek bonds as collateral if Greece was considered in default. Some pension funds can only invest in tripe A bonds, from what I understand. 

This is the real problem. Even with the negative outlook on US debt by Moody's and S&P, the interest rate on US Treasuries did not move. If there are no rules to force them to invest depending on ratings, investors might not care about the rating agencies, if they think their rating is not just. My gut feeling is that rating agencies are "polls", and should be treated as such: they provide information at a date in time, and agents might respond to it. But there should be no strict constraint in how people act on this information.