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Ok, let's talk economics. More specifically, let's talk coffee and drugs.

 

You may have noticed in my last post that Eric Chiang was holding a cup of "Juan Valdez Cafe" coffee and yet, leading up to this trip I mentioned that they ironically don't really have coffee shops in Colombia. Well they don't, really. At least not independent ones. Since Bogota is rather cosmopolitan compared to the rest of the country, what they have is several international coffee chains. You can get Starbucks, the aforementioned Juan Valdez, or even Dunkin Donuts here. So why aren't there cute independent coffee shops in the capital city of the country whose main export is...(drum roll) coffee?

 

One reason is that coffee is a tough crop to grow. Colombia has an excellent climate to do so, but their coffee crop is still highly effected by storms, drought, pests, etc. Consequently, that makes the price of coffee pretty volatile and puts Colombia in a tough spot with their chief export. How do they deal with this problem? They export as much of their crop as possible to wealthy countries that don't have climates suitable for coffee growing.

 

So why the chains? Most of their retail is based in the aforementioned wealthy countries that pay top dollar for coffee imports and they can afford to purchase large quantities of the Colombian coffee crop at high prices just due to their scale. Thus, the little independent shop is edged out. Some clues we've seen as to the economics behind it:

 

coffee 3.JPG

 

 

Ok, the photo's hard to see but this is the menu at a Bogota Starbucks. A tall (12 oz) caramel macchiato is 8,600 Colombian pesos. That's about $2.73 versus the $4.91 gouging that I suffer in NYC. Pretty cheap, right? Well, sort of. You need to take exchange rates into account and particularly that the US dollar has recently become very strong against the peso (Y = pesos to US dollar):

 

colombian exchange.JPG

 

Whereas $1 equals 3,155 pesos now, just a little over a year ago $1 equaled 1,848 pesos. That caramel macchiato would have been $4.65! Since Starbucks is a US company, they don't alter their prices much to account for the exchange rate, and given the purchase power of the average Colombian is still lower than the average New Yorker, that makes Colombian coffee [typically] super expensive for Colombians! How's a little guy to compete?

 

Next up, a [former] major export of Colombia...

As much fun as it is to globe trot at the pace we are, you may ask yourself, "why are they doing this?"

 

Aside from being the Worth author with the most tendered McDonald's receipts, one of the most unique things about Eric Chiang is his philosophy on travel. Essentially, get in, get out, and try to gain as many impressions of world locales as you can. Why? People around the world are faced with many of the same economic problems and yet they solve them in surprisingly different ways.

 

The goal of this trip is to explore just how Colombia, Brazil, South Africa, and Dubai solve their economic problems differently. It's essential to try to comprehend these things in order to begin to understand economics in our rapidly changing world. The general experiences, videos, and photos we take on this trip are going to comprise a new and key feature, "Around the World,"  in the upcoming edition of Eric's book, Economics: Principles for a Changing World.

 

Up next, I'll get in to our exploration of Colombia's economic issues. First though, some photos of Eric indulging his McDonald's craving and sampling some of the local coffee.

 

Fries.JPG

 

Eric Coffee.JPG

Not really a full blown post, but I have to remark that I managed to find a craft beer bar in Bogota within an hour of arriving. What can I say? It's a gift.image.jpeg

So here we are. Myself and Eric Chiang landed in Bogota at 11:30 this morning (EST). We arrived at the hotel at 12:30, which is only 5 miles away. Goes to show you what traffic can be like when a city doesn't have a mass transit system. It will be interesting to compare with Sao Paulo which has a subway system similar to London's.

 

Initial impressions: the country has gone a long way to rehabilitate its image. Customs was actually faster than those in Toronto after coming in from NYC. The city is fairly clean, and although we did see a half dozen military police (some with automatic carbines), it seems like any other bustling South American city. One interesting thing re: mosquitos and Zika virus, the current weather is actually similar to Massachusetts in June. Cool (mid 60's and hazy). This is because Bogota is at 8300' feet altitude: higher than Denver! It's a mountain city and it's most likely too cool and too high to have much of an insect problem.

 

We're now on a quest to learn about Colombia's famed coffee industry and its fictional spokesperson, Juan Valdez. First, here's a shot of the interior of our cab. Big South Park fans down here...image.jpeg

Zero hour. Eric Chiang and I are now on board our Jet Blue flight from Fort Lauderdale to Bogota, Colombia. Incredibly, although the rest of the flight is full, there's an entire row across from us in extra legroom. Jet Blue competes against Spirit airlines for this route (duopoly). As Spirit's business model is based on carriers in largely less developed countries, Jet Blue has to drop their prices extremely low to compete against their single rival. Base fare for this flight was less than the cost to take a shuttle from NYC to Boston. Only $47...

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Our sister organization, Springer, just published Volume 22 of the International Advances in Economic Research, hosting a number of open access articles.

 

Exciting news that a highlighted article relates to the economics of education! It just so happens we are working on the first textbook specifically for the Economics of Education course so it's motivating to see current research expanding  views on efficiency and productivity in education using various approaches to computational methods.While working with authors  Sarah Turner and Mike Lovenheim on this project, I have been inspired by their analogies and passion for the economics of education.

 

In the IAER article, Cristian Barra and Roberto Zotti use "bootstrap technique... to provide confidence intervals for efficiency scores and to obtain bias-corrected estimates" in their research on education. This is interesting to me because I've started to take online coding courses to help me understand the software technology industry publishing is diving into, and this statistical technique, bootstrap, has the same name as this free and open-source HTML/CSS tool that is used to create dynamic websites and apps. As I learn more about web development, it will be interesting to see the crossovers I've learned from economics, business, and now, technology.

 

You can download and read a free copy of Barra and Zotti's article "Measuring Efficiency in Higher Education: An Empirical Study Using a Bootstrapped Data Envelopment Analysis"on Springer's journal site here.

 

Shameless plug: Pls vote for what you think our economics of education textbook should be titled! Register and VOTE HERE.

Originally posted on September 21, 2009.

 

This is an old topic but it is in the headlines again, so I pass this along, from Jeff Friedman:

This “executive compensation” theory of the crisis is now the keystone of the conventional wisdom, having been embraced by President Obama, the leaders of France and Germany, and virtually the entire financial press. But if anyone has evidence for the executive-compensation thesis, they have yet to produce it. It’s a great theory. It “makes sense”—we all know how greedy bankers are! But is it true?

 

The evidence that has been produced suggests that it is false.

 

For one thing, bankers were often compensated in stock as well as with bonuses, and the value of this stock was wiped out because of the investments in question. Richard Fuld of Lehman Brothers lost $1 billion this way; Sanford Weill of Citigroup lost half that amount. A study by René Stulz and Rüdiger Fahlenbrach[3] showed that banks with CEOs who held a lot of stock in the bank did worse than banks with CEOs who held less stock, suggesting that the bankers were simply ignorant of the risks their institutions were taking. Journalists’ and insiders’ books about individual banks[4] bear out this hypothesis: At Bear Stearns and Lehman Brothers, for example, the decision makers did not recognize the risks until it was too late, despite their personal investments in the banks’ stock.

The Stulz and Fahlenbrach abstract reads as follows:

We investigate whether bank performance during the credit crisis of 2008 is related to CEO incentives and share ownership before the crisis and whether CEOs reduced their equity stakes in their banks in anticipation of the crisis. There is no evidence that banks with CEOs whose incentives were better aligned with the interests of their shareholders performed better during the crisis and some evidence that these banks actually performed worse both in terms of stock returns and in terms of accounting return on equity. Further, option compensation did not have an adverse impact on bank performance during the crisis. Bank CEOs did not reduce their holdings of shares in anticipation of the crisis or during the crisis; further, there is no evidence that they hedged their equity exposure. Consequently, they suffered extremely large wealth losses as a result of the crisis.

It's entirely fair to argue that these tests are not decisive.  But still, the evidence isn't there -- at least not yet -- that executive pay was in fact the big problem.

I thank Jeff Friedman for the pointer.

Originally posted on September 3, 2011.

 

John Bogle has a nice piece in the WSJ on Paul Samuelson and the history of the index fund, an great example of how theory has contributed to practice.

[Samuelson's] article “Challenge to Judgment” caught me at the perfect moment. Published in the inaugural edition of the Journal of Portfolio Management in the autumn of 1974, it pleaded “that some large foundation set up an in-house portfolio that tracks the S&P 500 Index—if only for the purpose of setting up a naïve model against which their in-house gunslingers can measure their prowess.”

Presented with that challenge, I couldn’t resist….

 

Bogle launched the First Index Investment Trust but the project was almost stillborn because the initial underwriting was a huge failure. Only $11.3 million was raised, a 93% shortfall from the goal, and not enough to buy [100 shares of ?] all 500 stocks in the S&P 500. The underwriters urged Bogle to cancel but Bogle persevered despite catcalls from Wall Street about “Bogle’s Folly.”

The most enthusiastic media comments about the coming underwriting of the index fund came from Samuelson himself. Writing in his Newsweek column in August 1976, he expressed delight that there had finally been a response to his earlier challenge: “Sooner than I dared expect,” he wrote, “my explicit prayer has been answered. There is coming to market, I see from a crisp new prospectus, something called the First Index Investment Trust,” an index fund available for investors of modest means, “that apes the whole market (S&P 500 Index), requires no load, and keeps commissions, turnover and management fees to the feasible minimum, and . . . best of all, gives the broadest diversification needed to maximize mean return with minimum portfolio variance and volatility.”

…Today, the assets of the Vanguard funds modeled on the S&P 500 Index total $200 billion, together constituting the largest equity fund in the world. (The second largest, at $180 billion, are the Vanguard Total Stock Market Index funds.) Investors have voted for index funds with their wallets, and they continue to do so.

Originally posted on March 8, 2010

 

Under certain conditions the pursuit of self-interest leads to the social good even when no one has the social good as their goal.  Under these conditions it is, using Adam Smith’s metaphor, almost as if an “invisible hand” were guiding self-interested individuals to work towards what is in society’s interest.  One of the goals of Modern Principles is to teach students to “See the Invisible Hand,” that is to recognize when self-interest leads to the social good and to understand that this beneficial result is not automatic but depends crucially on the operation of institutions.  Students who can recognize and understand the invisible hand gain an appreciation for what markets can do but precisely by understanding the difficulty of the task that markets sometimes accomplish they also gain a deeper appreciation of  market failure.

 

In See the Invisible Hand (powerpoint slides),  I illustrate the invisible hand and some of the institutions that channel self-interest towards the social good.  (These slides are an extended version of a talk that I also gave at the North Carolina teaching symposium).  See the notes pages for some notes on the slides.  If the embedded video doesn’t work you can find it online here.

Originally posted on June 6, 2011.

 

May 9, 2011- Tyler Cowen shows us through economics that we may not be as innovative as we think we are and urges us to change.

Originally posted on February 10, 2011.

 

Alex Tabarrok’s PowerPoints from his recent talk on the ‘Invisible Hand’ can be found here.

 

Tyler Cowen’s PowerPoints on ‘Teaching Macroeconomics in Turbulent Times’ can be found here.

Originally posted on March 22, 2011.

 

With streams and rivers drying up because of over-usage, Rob Harmon has implemented a market mechanism to bring back the water. Farmers and beer companies find their fates intertwined in the intriguing century-old tale of Prickly Pear Creek.

 

Inevitably, students’ ears will perk up at the mention of beer and brewers…

 

Check out the video below for a great application of the importance of markets aligning self-interest with social interest.                                                                

 

                                                                             

 

Thanks to Chuck Sicotte for the pointer.

Originally posted on January 25, 2012.

 

Here is Angela Dills via Learn Liberty touching on the high points in a case for school choice. This could lend to a class discussion of how competition provides incentives.

 

                                                                              

Originally posted on October 22, 2009.

 

I'm still receiving email pushback on my view that a falling dollar can be good for the U.S. economy.  The critics charge: why not just let the dollar fall close to zero or at least hope for such?  A few points:

 

1. I'm not asking for a specific weak dollar policy (we've already done enough on that front!).  The point is that if the market brings a falling dollar, this outcome can be part of the equilibrating process.

 

2. You don't have to approve of all the policies, or private sector practices (e.g., a low savings rate) that produced the weak dollar.  A weak dollar is still a healthy response, given those constraints.

 

3. Never forget the difference between real and nominal exchange rates.  That answers the conundrum about wishing for a dollar of near-zero value.

 

4. A falling dollar will (often, not always) increase employment in the export sector.  Supply-side, production-based multipliers are the best kind to have and they can outweigh the economic costs of higher import prices.  When the dollar falls, a big chunk of that shift is born by foreign exporters like a tax rather than being passed along to U.S. consumers.  The net effect is that Mercedes-Benz subsidizes job creation in the United States.  And sometimes a falling currency is in fact an efficient form of lump sum taxation in this regard.

 

5. Free traders are usually economic cosmopolitans, which is good.  A weak currency in one country means a strong currency in another and the distribution effect, at least at the first-order level of analysis, is a wash.  So cosmopolitanites shouldn't object to weak currencies per se.  From a global point of view, a lot of currency movements are close to a net wash in efficiency terms, although they may be good for at least one of the countries in the equation.  As a rough rule, weak currencies do the most good where resources are unemployed and there is a realistic elasticity of exports, though it is more complicated than that.

 

6. A weak dollar poses the biggest problems for the EU and other foreign regions.  Still you can see those as real problems and think a falling dollar is OK for the U.S., taken alone.

 

7. Again: blah-blah-blah caveats about the difference between a currency falling as a pure thought experiment and a currency falling as associated with some particular cause.  Blah, blah, blah, etc.  Blah.

 

Daniel Drezner offers related commentary.

Originally posted on October 4, 2009.

 

Matt and Ryan Avent comment, and Matt Steinglass, I'll put some points under the fold...

 

1. Sectoral shock theories of unemployment have a long lineage, including search theory, David Lilien (1982), Fischer Black, work by Steve Davis and John Haltiwanger, Mortensen and Pissarides, plus some recent writing by Michael Mandel and much earlier Franklin Fisher's work on disequilibrium adjustment.  Avent and Yglesias suggest that Kling is making up his own macro but the innovation is simply to call the adjustment process "recalculation," to give it a more Austrian gloss.  Mortensen and Pissarides are sometimes mentioned in the context of future Nobel Prize winners.

Or try Brainard and Cutler (nowadays both Obama-linked), who note sectoral shifts are especially likely to account for unemployment episodes of long duration.  Here is a list of some of the relevant real shocks.

 

2. Ryan's summary of the argument involves several strawmen.  Various polemic phrases are used throughout his post, including "makes no sense" and "nuts."  When you read language like that, it often indicates the writer has not worked hard enough to imagine a sensible version of the idea he is criticizing.

 

3. Here are a few claims I do believe and in most cases I am on the record:

a. The AD shock today is very real, albeit overemphasized by many relative to sectoral shocks.

b. There is an optimum delay on the recalculation process.  An economy can't always do all the recalculation all at once and that is one way of thinking about why some bailouts have been necessary, plus automatic stabilizers.

c. Reemployment does not in general proceed in accordance with an optimum, especially during major shocks.  This follows from many (not all) of the models cited above.

d. The new, on-its-way optimum may well involve new government expenditures in various areas on a permanent basis; pick port security if you want one non-controversial example.

 

You can believe all those propositions, as I do, and still think that the recalculation argument means that, in absolute terms, significant parts of the current stimulus won't be very effective.  As James Hamilton has pointed out, a big chunk of the problem is something other than insufficient aggregate demand and so more stimulus doesn't translate necessarily into better outcomes.  In other words, we're spending lots of money for smaller "bang" than was advertised.

 

You might disagree with those conclusions, combined with propositions a-d, but they're not "nuts."  There's a disconnect between the emotional content of the polemic Avent wants to level and the information content in his post.

 

3. Matt suggests that some of the critiques do not apply to most of the stimulus.  He notes that aid to the states is a big chunk of the stimulus, as is tax cuts and increased transfer payments.  On the transfer payments, see my point 2d; you may or may not like them but most analysts conclude, following the Bush experience, that such programs aren't very good stimulus.  So the recalculation idea doesn't much apply there but the stimulus idea doesn't much apply either.

 

On aid to the states, the recalculation problem applies very directly (Matt says it doesn't but I don't see where in his post he gives a reason for that view).  You can think that some form of state-level aid is necessary, as I do, and still see the recalculation idea as explaining why a big state-level ouch is coming in about two years' time.  When (if?) the stimulus is not renewed, a painful sectoral reallocation will have to take place and right now we are only postponing that pain.  By the way, it would be nice if state governments played along by having a coherent long-run fiscal plan but right now at least half of them are not doing this, thereby worsening the forthcoming ouch.  Wait until you see what happens with state universities in two years' time.  Ouch, ouch, and triple ouch.

 

Overall the recalculation idea does apply to large chunks of the stimulus, albeit not all of it.

 

4. We should be especially skeptical of gdp measures when: a) governments care about those measures especially much, and b) we face trade-offs between temporary and permanent gains and we are choosing the temporary gains.  Fiscal theories of cyclical movements, as outlined by Rogoff and the like, deserve to make a comeback and I predict they will.  In fact you can add those theories to the list above at #1.

The bottom line is this: if you're trying to use the recalculation idea to explain why the fiscal stimulus should be zero, that in my view will fail.  If you're using the recalculation idea to explain why the stimulus has a lower rate of return than many people think, it hasn't much been dented by the recent criticisms.  After all, if the problem were just insufficient AD, a solution would be ready at hand.  But it isn't and it's not just because Obama isn't "tough enough" to propose a bigger stimulus.  It's a genuinely difficult problem to solve.

 

I may soon consider Scott Sumner's very good recent posts on real shocks and the business cycle.