Mr. Obama, You need Lessons in Economics

Mr. Obama,

Chances are that you haven't read my open letter to you, posted some while ago. Chances are that you will not read this too.

In my previous letter I had a tiny paragraph on banning protectionism. For your convenience, here is the extract:

"Ban protectionism. Open up world trade. Will make you unpopular in America if you do it immediately. But has to be done and will happen whether America likes it or not. If the world has to prosper. Your call."

I am sure you are surrounded by economists of repute who advise you on important matters. I am therefore surprised how you could even dream of taxing outsourcing. The fact that you have been mentioning Bangalore quite often shows you are being misled. The roots of the US economic meltdown does not lie in Bangalore. Nor does Outsourcing to Bangalore or Beijing cause US misery.

One does not have to an economist to understand this. I am not. Fortunately there are many pop-economics books in the market that are very good. I would recommend that you go no further than Tim Harford's The Undercover Economist. Here is an excerpt:

A more extreme example may clarify things further. Think of a country whose government is very keen on self-sufficiency. 'We need to encourage our local economy,' says the Minister of Trade and Industry. So the government bans all imports and patrols the coast to prevent smuggling. One effect will be that a lot of effort will be devoted to producing locally what was once imported: this certainly is encouragement to the local economy. But another effect is that all of the export industries will quickly shrivel and die. Why? Because who would want to spend time and money exporting goods in exchange of foreign currency, if nobody is allowed to spend spend the foreign currency on imports? While one part of the local economy is encouraged, another is crippled. The 'no imports' policy is also a 'no exports' policy. And indeed, one of the most important theorems of trade theory, the Lerner theorem, named after the economist Abba Lerner, proved in 1936 that a tax on imports is exactly equivalent to a tax on exports.

Still wish to go ahead with taxing outsourcing, Mr. Obama?

Husbands beware! Buddyping is here

I discover more Internet via books. I had blogged about this here => Discovering Internet Through Books

The books I referred to in the above-mentioned post were books on Internet. But to find something new and potentially as powerful as twitter in an economics book, now that is serendipity.

The Logic of Life has a delightful chapter that is a play on 'The World is Flat', called 'The World is Spiky'. In this Tim Harford goes on and on about Buddyping.

Now what is Buddyping?

The idea behind BuddyPing is simple and the execution deceptively simple, making something quite complex appear effortless. Text your location to BuddyPing and it will text you back with the location of your friends (if they’re BuddyPing members) and what they’re doing. When your friends login to the system via text, you get a text if they’re nearby, and they get a text back saying you are nearby. The number of friends is limited to the 5 closest friends and “nearby” in Buddyping terms is 10 miles.

For more information go to BuddyPing: The new wave of MoSoSo

Uh oh! I see a danger already: wives can now keep a tab on their husbands 24 x 7.

How CEOs Earn

The Logic of Life by Tim Harford has some interesting information on how CEO's get paid, besides the normal salary, that is. Some of it is common knowledge, but not all.

Here goes ...

[S]ome of the design features of these stock-option-based compensation plans are a little suspicious. Options are often reset when share prices fall: what was once an option to buy shares at a hundred dollars apiece becomes an option to buy shares at fifty dollars apiece, as long as the company is doing badly enough. ... [T]he offer to CEOs seems to be: 'If the company share does well, your options will make you a killing. If the company share price falls, don't worry: we'll make sure you make a killing anyway.'

There are other suspicious aspects of CEO pay. ... [O]ne favourite is the 'reloadable' option, which rewards CEOs if the share prices bounce around a lot, because they can lock in the most fleeting gains. Another is the 'backdating' option, where the companies hand out particularly generous options but disguise their generosity by fibbing about when the option was actually awarded. Economists spotted the backdating by noticing how often options were being handed out just before the share prices rose, making the option very valuable. Either the timing was impossibly lucky, or the official dates were phoney, and the options had been backdated to maximum advantage. ... (One of the most remarkable examples of backdating was at Apple, the makers of iPods and Macs. They granted backdated stock options to their CEO, Steve Jobs, some of which were supposed to have been approved at a 'board meeting' that Apple later admitted didn't actually take place.)

In my previous life, when I was naive, I actually believed that CEOs get paid because of the value they generate. I used to think, "How much value they must be generating to get paid so handsomely???" Now I know differently. The CEOs get paid handsomely for the value they have generated before they became CEOs. That must have propelled them to the post of CEO in the first place. So, CEOs reap what they have sowed before they became CEO. Now that cannot be such a bad thing. Or is it?

Of modeling and predictions

Model of a system is not the system. It is an approximation, by definition.

When one models a system, certain assumptions are made, some aspects of the system is taken as invariable or at times independent of each other.

How then is one to determine if the approximation, the model makes sense?

The success of a model depends on its ability to predict. Models can be twisted and turned to fit the existing data and therefore can explain the known or the past in the most brilliant way possible. But if the model cannot predict the unknown or the future, then it is of no use. Einstein's model of the universe is an approximation but makes sense because it could predict certain phenomena that was till then unknown or unexplained. The success of environmental models will lie in its predictability. Unfortunately, we will get to know of the models' success only when it is too late.

I recently read (see here) that reduction in pollution will actually result in increased global warming. How? Pollution causes scattering of light which enables more leaves even those that are not at the top to carry out the process of photosynthesis at increased efficiency. Reduction in pollution will reduce the scattering and hence low photosynthesis resulting in low carbon absorption. So either you die of pollution or due to global warming! Nice!

The book I am reading now, The Logic of Life, by Tim Harford, is also about modeling. The premises are simple but effective. Human beings are capable of reacting to any situation rationally as well as irrationally. The book models the human society as rational and explores various non-economic issues. From what I have read so far, the rational model seems to be explaining the past well. There is no prediction of the future. I am hoping desperately that the book will make predictions somewhere down the line. But I won't be disappointed if there are none. Why? Well, if economic (and financial) models were that good at predicting, we wouldn't be facing the worst global financial crisis of all times, now would we?

Picture courtesy: Tory Byrne

The Institution of Marriage

This happened in the winter of '83.

We were a few months away from graduation. Before the young engineers step out in the real world, colleges usually send them on what is called the 'Industrial Tour'. Since industrial tours involve visiting industries to see how work is actually executed, it should be possible to conduct this tour in and around the city. But no. It had to be a tour of a distant region and in all cases had to involve the dream world, Goa. So here we were a class of some 30-40 students in a train towards Goa to see the industries in Goa on the beaches.

In the train, were two young (older than us, of course) guys. I remember, one was from Holland and the other was from the US. This chap from Holland became very friendly with us. He sand along with us when we were singing at top of our voice, "we shall overcome ...", one line in English and the next in Hindi. After we were all hoarse, this chap from Holland and I got up and stood near the door of the train, talking. This was the first time I was talking to a person not from India, so I was very curious and was extracting information from him about Holland and Europe, and at the same time trying to match the information with my knowledge gleaned from books. I do not remember the details, but I remember just this excerpt...

"Are you married?"
"No. The institution of marriage is dead."

And then he launched into a big explanation why marriage is a dead institution and how he and his girl-friend were perfectly happy living together.

I do not remember the rest. Though I do remember that my friends and I had a whale of a time at Goa. And that all of it was not spent visiting factories.

All this came back to me as I am reading the Logic of Life by Tim Harford. To give you the complete title of the book, it is called The Logic Of Life: The Rational Economics of an Irrational World. (One of my senior colleagues picked up the book when I was not at desk and read a few pages and commented, "This is like a 'Sex Manual'. But that is another story).

The book, among other aspects of life, discusses marriages and divorces, and the rational, economic reasons behind these. The funny thing about the book is that it is not categorized under economics. Rather the back cover indicates that this book belongs to Current Affairs genre of books.

In any case, in 2009, marriages and divorces are still current affairs. People do marry (and divorce.) My friend from Holland was wrong after all. The institution of marriage is not yet dead.