A New Deal for Globalization?

by Russ Roberts on June 21, 2007

in Uncategorized

In the latest issue of Foreign Affairs (HT: Fabian Franco and Nathaniel Clarkson), Kenneth Scheve and Matthew Slaughter argue that we need a New Deal for globalization. Here is the summary of the article:

Globalization has brought huge overall benefits,
but earnings for most U.S. workers — even those with college degrees — have been
falling recently; inequality is greater now than at any other time in the last 70
years. Whatever the cause, the result has been a surge in protectionism. To save
globalization, policymakers must spread its gains more widely. The best way to do
that is by redistributing income.

Here is the key empirical claim to support the proposed policy:

Less than four percent of workers
were in educational groups that enjoyed increases in mean real money earnings from
2000 to 2005; mean real money earnings rose for workers with doctorates and professional
graduate degrees and fell for all others. In contrast to in earlier decades, today
it is not just those at the bottom of the skill ladder who are hurting. Even college
graduates and workers with nonprofessional master’s degrees saw their mean real
money earnings decline. By some measures, inequality in the United States is greater
today than at any time since the 1920s.

I didn’t see a source for this claim about different educational groups. I assume it’s true. But three things trouble me about it.

The first is most people would have trouble telling you whether their real income today (or in 2005) is higher than it was in 2000. Most people have higher nominal income. They are unlikely to have a precise idea of the rate of inflation over five years. So unless they look the number up, they’d have trouble giving an accurate assessment of their economic progress over their five years. So I’m not sure that the income numbers of the last five years are creating a political backlash against immigration.

Second, I think most people would have an opinion about how OTHERS have done over that five year period. I think most people think other people are falling behind even if the person answering the question is doing fine. They are pessimistic about others because that is what they hear over and over again—that most people are doing badly. They hear it from the press. They hear it from many politicians.

Third, and this is the most important point, money income is deceptive in a world of expanding fringe benefits.

If your money income, corrected for inflation, stays constant, but your health care benefits rise to cover the rising cost of health insurance, in recent years, you are better off. Why? The increase in your health care benefits just cancels out the increase in health care costs, but those costs are included in the deflator used for money income. So in fact, you have more purchasing power–your real income has increased. I didn’t say that so well. Here’s a better way to see it, from analysis by Gary Burtless:

Comp

I’m not sure you can read the figure but here’s the gist of it. Between 2000 and 2005, compensation for the average worker rose $3000. But money income was only 29% of the increase. The bulk of the increase was in non-monetary compensation—increases in health insurance, pension contributions and taxes for social security.

Instead of finding ways to save globalization with redistribution, maybe we should try educating people about how labor markets work and the importance of fringe benefits.

Of course, these numbers from Burtless are average numbers. It’s still possible that a lot of people didn’t see their standard of living improve between 2000 and 2005. But it’s also clear that just looking at money income is only part of the picture.

Be Sociable, Share!

Comments

comments

100 comments    Share Share    Print    Email

{ 50 comments }

Ben June 21, 2007 at 1:40 am

Globalization has brought huge overall benefits, but earnings for most U.S. workers — even those with college degrees — have been falling recently… Whatever the cause, the result has been a surge in protectionism.

Tut, tut. Are we confusing cause & effect again…?

Nobrainer June 21, 2007 at 7:51 am

There's a good post at Back Talk which compares middle-quintile household income from census data and middle-quintile after-tax (total) income.

CRC June 21, 2007 at 8:49 am

Often missing in the discussions about rising or falling incomes (even in inflation-adjusted terms) is the rising or falling of prices for goods and services. This is presumably captured in the generic inflation adjustment, but is it really?

Recently I read something about how the incomes of people approximately my age compared to our fathers (or parents in general) and that even in inflation-adjusted terms our incomes were lower than our parents.

However, am I worse off than my parents at the same age? Better? The same?

I would say, and I realize I am speaking anecdotaly here, much better off! I have more and better "things" than my parents/family had when they were my age. I have more and better options for things (goods/services/etc.) than my parents/family had when they were my age.

The bottom line here is that discussions about income changes (even when adjusted for inflation) outside of the context of the cost of goods and services that we want to buy with that income is an incomplete story.

In short, I don't necesssarily care (except for the possible psychological aspects of it I suppose) if my income is falling if the prices of goods and services I need or want to consume are falling faster (which appears to be the case for many, but not necessarily all, things).

Methinks June 21, 2007 at 9:14 am

Good point, CRC. Also missing from that calculation of "falling real incomes" is incentive compensation like bonuses and tips (which have become an increasing portion of total compensation) and fringe benefits like healthcar and flex time.

Even if it were true that your income is falling, you do care if the price of goods is falling faster than your income. It would mean that you are relatively wealthier.

Ironman June 21, 2007 at 9:34 am

I haven't looked at 2000, but between 1995 and 2005, real incomes increased across the board and income inequality decreased:

http://tinyurl.com/292lkk

I wonder if the authors are cherry-picking the years of consideration. I seem to recall that 2000 was quite a good year for earning income: very low unemployment, the whole "irrational exuberance" thing, the "dot-com" boom sucking up every college grad with a computer science degree and huge numbers of college students going into computer science because that's where the money was going, etc.

save_the_rustbelt June 21, 2007 at 10:05 am

"…The first is most people would have trouble telling you whether their real income today (or in 2005) is higher than it was in 2000…."

My wife, an excellent nurse with very little empirical research training, can recite exactly what has happened to our real income by comparisons with her "market basket" of goods and services.

Don, why do you assume that most people are dumb or poorly informed? You need to spend some time in the real world with real people.

frances June 21, 2007 at 10:26 am

Good article on the income inequality issue by Gary Becker and Kevin Murphy in AEI's magazine. Seems to contradict some of the assertions in Foreign Affairs article.
http://www.american.com/archive/2007/may-june-magazine-contents/the-upside-of-income-inequality

ben June 21, 2007 at 11:12 am

Isn't "howler" the correct term for ignoring benefits and bonuses?

jn June 21, 2007 at 11:13 am

Here's the thought experiment that I offer people who complain about falling/stagnant real wages and rising inequality.

Which would you prefer in terms of purely material well being (availability of goods and services), to live in 1977 off $100,000 per year, or in 2007 off $50,000 per year?

Now, in 1977, $100k was equivalent to $343k 2007 dollars. Lots of money. But there just wasn't the quality of goods and services available then that there are now.

Home theater? Sure, based around a 20 inch TV with poor color rendition.

Organic food? What's that?

A fancy car? Certainly would be a classic collector piece today, but wouldn't match the comfort, handling or amenities of even a low end car of 2007.

About the only thing that hasn't advanced by leaps and bounds since then is airline travel technology, although prices have dropped precipitously.

The bottom line is, income matters little. It is the wealth and well-being that one can accumulate through that income that matters. Money is just little pieces of paper, after all.

Sam Grove June 21, 2007 at 11:57 am

Why blame globalization in the first place?
How about the ever increasing cost of an ever growing government and its very expensive, um, actions?

HC June 21, 2007 at 12:05 pm

I think what is missing in this discussion is the distinction between aggregate wealth and relative wealth. In term of aggregate wealth society is much better off than it has ever been. Relative wealth, however, is a zero-sum game where some win and some lose, relative to the rest of society. I think that in a period of rapid technological change that we've seen this last decade those who are mose technically and financially literate reap a higher percentage of the benefits. It may well go on longer but won't last forever. But it's also a mistake to assume that people stay in the same economic demographic (as measured by percentile share of wealth). Certainly Bill Gates has moved up in terms of wealth demographic while some trust fund kids have declined.

And to JN regarding his post: I'd rather have $100,000 in 1970 because 1)I can adapt to any environment and 2)I'm a single guy so I think I'd live it up relative to my experience making $50K today.

Methinks June 21, 2007 at 12:56 pm

"Relative wealth, however, is a zero-sum game where some win and some lose, relative to the rest of society."

That's not a zero-sum game. In a zero-sum game, one party has to lose exactly the amount the other party gains.

The less productive you are and the less risk you take relative to someone else, the less wealth you will build. That has nothing to do with zero-sum games.

I think we can agree that the creation of Microsoft did not result in a loss for those people not directly associated with it – especially not a loss equivalent to the gain made by Bill Gates. In fact, if it didn't add value to the lives of people not directly associated with the technology, Microsoft would have failed and Bill Gates would be a working stiff for a company that did add value.

Those taking the risk to create the wealth will have more of it in the end. Otherwise, they wouldn't take the risk and they wouldn't forego the leisure to make their innovations available to everyone else. 80% of all start-ups fail within a few years, btw. However, all of us gain by the value of the things they create and that raises our wealth. Because we took no risk to create products and services that enhance other people's lives, we will benefit less than those who did. But our wealth still increases.

A large gain plus a smaller gain is not zero-sum.

Rolf Norfolk June 21, 2007 at 2:03 pm

Generally, I enjoy your take on things, which I find stimulating. Here, though, I raise a few possible objections to the notion of aggregating pay with all fringe benefits as if they could be equated:

1. You can't spend healthcare, and I don't wish to need it, so I'd rather have the cash, please. I'll save what I think prudent, and otherwise try to take better care of myself. When the consequences of risk-taking are more serious, people tend to be more careful.

3. I believe much of the total lifetime cost of it comes in the last few months of life. How much difference does it make? Besides, a not inconsiderable proportion of illness and injury is iatrogenic.

4. Healthcare costs include the cost of highly-skilled doctors, who in the US are paid so very much more than here in the UK, and medical legal insurance and expenses, also huge; and drugs, which are misused and overpriced. I understand that most ailments could be treated by a limited number of medicines, most of which are now out of patent. Maybe there should be more practicing medicine without a license, to provide a little irritating competition. We might call it "de-guilding the Lilley"…

5. The rising bill for healthcare in the US is one of the factors that look set to undermine the country's wealth and possibly halp to trigger a crisis in the economic system – see Michael Panzner and others. If healthcare provision is cut back, will that, too, be included in the pay calculation?

Methinks June 21, 2007 at 2:31 pm

JN,

That's an interesting thought experiment. We ask interviewees a similar question:

Which scenario would you prefer? You make $500,0000 but the guy sitting beside you makes $1,000,000. You make $150,000 but the guy sitting beside you makes $100,000.

MOST people choose the second scenario. They would forego significantly more compensation just to know that they are making slightly more than their neighbour. It boggles my mind.

Paperbox June 21, 2007 at 4:25 pm

Methinks, I don't think it's as surprising as you think because most people would rather be a big fish in a small pond, than a small fish in the big ocean. It's perfectibility within human beings that make us compare ourselves to everyone around us. It doesn't matter if you make 100K in 1970s or 50K in 2000s, as long as we know that someone else is making more, we will be unhappy. Ignorance is bliss, who would be happy with their BMWs if they know a Ferrari is lurking around the corner, right?
Just my 2 cents worth..

jlwillia June 21, 2007 at 5:26 pm

Rolf,

It doesn't matter which method of payment you would prefer. The point is that fringe benefits must be included in the total amount of compensation of an employee.

In fact, receiving some of our wages in fringe benefits makes us all better off. A company has bargaining power that can be used to get fringe benefits for less than any individual person could. An insurance company can mitigate some of its risk if a company purchases insurance for 40 employees rather than those employees purchasing separate coverage. Therefore, companies can get that insurance at a discounted rate.

Let's look at an example. Imagine I get paid $50,000 at Company X with no fringe benefits, and I pay $2000 per year for health insurance; my real wage is $48,000. Now suppose I go to work for Company Y and get paid only $49,000 WITH fringe benefits. My real income has increased by $1000 AND Company Y can pay me $1000 less. Brilliant!

Of course this example is only meant to illustrate the principle….

Methinks June 21, 2007 at 5:58 pm

"who would be happy with their BMWs if they know a Ferrari is lurking around the corner, right?"

ME!!! I would.

You're absolutely correct, of course. But it's also an absolutely stupid way to think. At $500k, you're making more money than almost every other person in the country. So, compared to everyone else, you're very wealthy (if we measure wealth by income). You're just less wealthy than some other miniscule minority of people – in this case, the guy you're sitting beside is in that minority! At $150K, you're a lot less wealthy compared to the rest of the population but you make slightly more than the guy directly to your right.

Preferring scenario B is like saying that you prefer to live poorly as long as Donald trump lives more poorly than I. It's like cutting off your nose to spite your face.

Let's put it another way: would you prefer to be the junior trader making $500K in a firm of very smart traders who will always make more than you will because they're smarter than you or would you prefer to make $150K in a 7th tier firm of people who make less than you because they're all dumber than you are.

A 70% paycut is a pretty high price to pay to feel smarter than you are.

Methinks June 21, 2007 at 6:29 pm

Rolf,

Doctors in the United States are paid more than in the UK. That's true. In fact, healthcare here is more expensive than it is in the U.K., as you point out.

This is because healthcare here is much better than healthcare in the United Kingdom. The U.K. doesn't actually reduce the cost of healthcare. The NHS keeps the price of healthcare down via price controls. Price and cost are not the same. When you cap the price of a good or service, the quantity and quality decline. Hence, the NHS is substandard. 45% of Britons pay for additional insurance to get access to anything approaching standard care in the United States. The difference is that in the U.S. we have the option to buy health insurance or not and in the U.K. you pay for the NHS whether you want to or not.

One of the things that raises the cost of healthcare in the United States is malpractice suits. I'm conflicted about this. On the one hand, most malpractice suits are not won by the plaintiff but cost a lot to litigate. On the other hand, do I really want a doctor to be that much more careless with my liver or kidneys because he knows he will not be liable – or there's a limit to his personal liability? There's no limit to my personal suffering if he removes the wrong kidney!

The price of medication in the United States is also higher than in Europe. This is partly because developing drugs and complying with the FDA's endless testing is expensive and partly because American drug companies (which produce most of the medication in the world) sell the pharmaceuticals to socialist healthcare programs (like the NHS) in Europe at a reduced price. They have to make up for the lost revenue somewhere and that somewhere is the U.S. market. So, if Europe would kindly stop freeriding, we could reduce the price of our meds here a little bit.

However, there is no economic crises brewing in the United States over healthcare – no matter how politically popular it is to wax apopleptic about it. If people want the same relatively crappy level of healthcare available in Europe, they can opt for that already by opting out of life saving measure and stuff like in-vitro fertilization. What people here get indignant about is the cost of heroic measures they expect to be performed on their behalf – measures that would be unavailable to them in Europe. They want viagra, in-vitro, saving 400 gram preemies and brain-dead people and they want someone else to pay for it. They also want the ability to sue the doctors for malpractice but don't want to pony up for the additional cost.

So, we don't have a healthcare driven economic crises brewing here. What we have is a stupidity crises brewing. People living cushy lives who have become so accustomed to advancements most of the world only dreams about that they feel entitled to them.

lowcountryjoe June 21, 2007 at 7:24 pm

I don't agree with Kenneth Scheve and Matthew Slaughter because everybody that lives outside the ivory tower knows that free trade is bad — that voluntary transactions between parties leaves all parties worse off than before; that billions of transactions that have been aggregated is catastrophic for a society/economy. It has to be, Lou Dobbs says so.

But I will agree with Scheve & Slaughter that we should redistribute income — incentives don't matter, especially for those who are losing from free trade as it is. But, sure, tax the living dog out of those who already do have wealth (presumably those who do not engage in dreaded free trade) because incentives do not matter there either.

Oh, and whenever the need arises, one should conveniently shift from a 'real income' argument to an 'income inequality' argument in order to cloud the issue and sensationalize a paternalistic position.

Lee Kelly June 21, 2007 at 7:37 pm

Does it not occur to anybody else that different cultures matter a great deal here? The fact is that not all cultural groups are equally wise at investing whatever capital and skills they have.

One very simple explanation for a rising income inequality is that wealthier people are smarter with their money, which is partly why they are wealtheir in the first place!

If two nations, with radically different cultural traditions had unequal rates of economic growth, would we blame some mysterious defect in the freemarket or simply the different attitudes, behaviours and political preferences of two very different cultural groups?

Now, place those two cultural groups in the same national borders, and what is the difference? None at all, indeed one particular explanation for rising income inequality is that some people don't care about investing their resources, but would rather drink, party and shop away all their cash every weekend.

The situation is worsened by attempts a "redistribution" of wealth, which basically translates a s a subsidy for unproductive cultural habits. I place "redistribution" in scare quotes, simply because income was never distributed in the first place, it was produced.

Methinks June 21, 2007 at 8:03 pm

Well said, Lee. There are behaviours that lead to success and those that lead to failure. "Redistribution" rewards behaviours that lead to failure. And that is the road to poverty for all.

Henri Hein June 21, 2007 at 8:22 pm

Methinks wrote:

"[Relative wealth is] not a zero-sum game"

Yes, it pretty much is. With a constant population, it *is* constant. If you go from position N to position N-1, what happens to the person at position N-1?

Of course, the population isn't constant, but for most people, demographic changes are fairly small and slow in the big scheme of things.

Henri Hein June 21, 2007 at 8:48 pm

"Which scenario would you prefer? You make $500,0000 but the guy sitting beside you makes $1,000,000. You make $150,000 but the guy sitting beside you makes $100,000."

As stated, it sounds ambiguous. The problem is that a dollar is a pretty nominal measure. In the second case, it seems like the dollar is worth more. That makes that scenario more attractive.

If you said, "Would you rather have an income with purchase parity of N, if the guy next to you had a purchase parity of N*2/3, or would you prefer a purchase parity of N*5 if the guy next to you had purchase parity N*10," then the second scenario sounds a lot more attractive.

Methinks June 21, 2007 at 8:56 pm

"Yes, it pretty much is. With a constant population, it *is* constant. If you go from position N to position N-1, what happens to the person at position N-1?"

Nope. In your example, one person's loss is not another person's gain. That would be the condition for a zero-sum game.

Unless you can show that the person at -1 actually lost that 1 directly to another person who gained 1, then you don't have a zero-sum game. I'll just leave it to you to come up with real world example of such a thing happening.

Of course, then you'll have to explain how aggregate wealth grows when we're playing a zero-sum game.

I'm afraid you've committed the "lump of wealth" fallacy.

Methinks June 21, 2007 at 9:03 pm

Henri,

Don't twist yourself into a pretzel about the nearly infinite iterations of the different scenarios. The questions is asked in the context of the world as it stands at this moment. Besides, how is it even reasonable for you to have have different purchasing power from the guy sitting next to you?

Henri Hein June 21, 2007 at 10:17 pm

"I'll just leave it to you to come up with real world example of such a thing happening."

If somebody surpasses Bill Gates in wealth, would Gates still be the wealthiest person? You seem to suggest that two people can simultaneously be the wealthiest. Obviously I'm missing something.

Henri Hein June 21, 2007 at 10:24 pm

"Don't twist yourself into a pretzel about the nearly infinite iterations of the different scenarios"

I didn't phrase it elegantly, but all I was trying to suggest is that the people responding to your scenarios may simply read them differently. To be honest with you, if I was the interviewee, I'm not sure how I would respond. (Again, this is if the question was stated as above).

The question *could* be read like this:

"Would you rather have $500,000 out of a $1,500,000 economy, or $150,000 out of a $250,000 economy?"

Rolf Norfolk June 22, 2007 at 2:07 am

JLWillia and Methinks:

Thanks for your ripostes. I agree that the UK health system has been not very good at times, though it is improving – but I want to be healthy, not get medical attention. Both the "socialist" (!!) and insurance-based health programs can become a kind of moral hazard – people are failing to take care of themselves because of a safety net. And as you say, they also want things that would once not have counted as medical needs.

I understand that in ancient China, the doctor was paid while the patient was well, but not when he was ill. Are we motivating the consumer and producer in the right ways?

Brad June 22, 2007 at 2:20 am

(I posted this in the wrong thread. Duh!)

I don't know if you've noticed, but you have stumbled on an instance of how statist solutions will be presented to us for the next 10 years: "To save globalization, policymakers must spread its gains more widely. The best way to do that is by redistributing income."

The formula is: "To save {good freedom thing] we must [do statist thing]." I first noticed this on Free Exchange (The Economist Blog) when a recent guest blogger got into it with Kling over health care. One of Larry Summers' co-authors, but that blog is down and the name escapes me. Anyway, he said that to save capitalism, we need more progressivity in our tax system.

More solutions I predict we will hear:

"To save the First Amendment, we must not allow the depiction the prophet Mohammed in any disparaging way in our media."

"To save our right to travel freely, we must register when moving from state to state."

"To save our right to sell goods on the Internet, we must collect sales taxes for all 50 states."

etc.

Mesa EconoGuy June 22, 2007 at 3:03 am

I knew this would happen:

Methinks (fellow trader) is correct. Single trades are zero-sum; overall wealth is not. More market participants bid up the market. Quite nicely.

Moreover, Tom Clancy made the British “health care” system famous (if I recall correctly) in Red Rabbit with his reference to open arthrotemy surgeons literally taking lunch (with a pint) with a patient on the table.

Since I’m fairly relaxed now, after about 1.5 litres of Chard, I’m curious if Rolf would trust me with a neat scalpel (I was pre-med, 1,4-5 bis-phosphate for you), after my excoriation by my Department of Motor Vehicles superior?

lowcountryjoe June 22, 2007 at 8:06 am

"Single trades are zero-sum; overall wealth is not. More market participants bid up the market. Quite nicely.'

This is not a true statement: even single trades are not zero sum. If, for example, you look at a stock trade, yes it is true that the monetary value of that transaction is zero sum [and that is only at that precise moment in time]. However, it does not take into consideration the preferences [economics] that each party makes that leads to the decision to trade. If I am a seller in this transaction, I may have a pressing need to be totally liquid because I am using the proceeds to purchase something else that I desire very much…if I am a buyer then I may have been eyeballing the stock for sometime and the valuation is at that moment making the stock a great bargain in my opinion. Stepping into the shoes of both parties, the transaction makes sense, our preferences are being satisfied, and the total economic profit is not zero sum.

And, ALMOST by definition, the more participants that join the market, the more they are willing to be buyers trying to satisfy their own particular preferences while making their valuation and speculative plays [unless of course they are savvy short sellers just entering the market]. It is still not zero sum just because a monetary value has been assigned in the market.

The monetary value and the use of money just elimanted the double coicidence of wants and is prefeable to barter because it saves the parties from spending time seeking out people to transact with.

I think a sharp economist with his own blog should have been a tad bit more careful with his language on this one

matt m June 22, 2007 at 9:19 am

2000 was a year of (excessive?) economic optimism and an outlier in many studies. It's not a good base year for comparison. A scientific approach would use a broader range of data, and not attempt to make a point by selecting a five year range that is probably not normal.

The article also makes it's case by rhetorical shenanigans, using group statistics but referring to individuals: "Even college graduates and workers with nonprofessional master's degrees saw their mean real money earnings decline." In reality, the wages for these groups may have dropped, but not for all, or even most individuals, as individuals moved between groups in that time frame. By positing a hypothetical person, it makes the claim sound like all people in those classes experienced wage losses.

Methinks June 22, 2007 at 10:34 am

"people are failing to take care of themselves because of a safety net."

Rolf, I see what you mean and I couldn't agree with you more! IMO, we're misusing the concept of insurance to mean that we should make all healthcare costs collective. Personal responsibility has fallen by the wayside.

Methinks June 22, 2007 at 10:56 am

Henri,

"If somebody surpasses Bill Gates in wealth, would Gates still be the wealthiest person? You seem to suggest that two people can simultaneously be the wealthiest."

I've suggested no such thing. What I suggest is that the person surpassing Bill Gates in wealth is not confiscating any of Bill Gates' wealth to do so. That person would have to create more wealth than Bill Gates to surpass him. Creating more wealth than someone else is not a zero-sum game.

I'm still waiting for you to explain how aggregate wealth can grow when we're playing a zero-sum gain.

"I was trying to suggest is that the people responding to your scenarios may simply read them differently."

That's true. They often do and they ask me questions about the circumstances. I'm as interested in the questions that they ask as I am in the answer that they give. I want to see their thought process.

"To be honest with you, if I was the interviewee, I'm not sure how I would respond."

Well, refusing to answer an interview question you don't like is pretty much going to mean that you don't have a chance in hell of getting the job. Since every firm on Wall Street plus management consulting companies ask these kinds of questions for analytical positions, you're toast. I won't hire a trader or an analyst who can't deal with questions unless they are presented in his preferred way. The real world is not that accomodating.

Methinks June 22, 2007 at 11:40 am

Mesa,

I have to agree with LC Joe. I understand why you would think that any single trade is zero-sum but that's not a great way to think about it. You're just thinking about it too narrowly.

For a simple example: If I think I might have edge in a long position in security A, I might hedge my beta exposure by shorting security B. I'm happy to lose money on my short position because I'm just trying to reduce the volatility while capturing alpha in my long position. The ability to hedge against beta moves also means that I can take a larger position in security A. So even though I might lose on my short because the market moves up, I win on the trade because I realize my theoretical edge – and in larger quantity because I was able to hedge the vol. The person long security B gained exactly the amount I lost, that's zero sum. But because the short in security B was only one leg of my two leg trade, I didn't lose. I got more alpha with reduced volatility and he won on his his beta bet. It's a win win.

Here's a more abstract way to think about it: If you don't hedge but take lots of smaller positions (long or short) in securities in which you have theoretical edge, you will win more than the calculated edge on some and lose on others. But, if you only trade when you have theoritical edge, you will make that theoretical edge in the long run – over thousands of trades. However, if you refuse to take the chance of getting unlucky on some trades, you will never be in the position to realize that theoretical edge in the first place. In essence, all of your trades are part of a larger trade – the alpha capture. Stat arb in a nutshell. We used to say "if you never lose money, you're not doing enough trades" (i.e. "you're leaving money on the table").

Mesa EconoGuy June 22, 2007 at 1:59 pm

True. Plus, derivatives such as options have magnified, non-zero sum outcomes. The overall gist is that in buyer/seller transactions, people interpret the outcomes in binary winner/loser scenarios.

I was “dumbing it down” for the general public…..

Methinks June 22, 2007 at 4:16 pm

"people interpret the outcomes in binary winner/loser scenarios."

Tell me about it! That's how we end up with yahoos in Washington screeching about "income distribution."

My husband is an options trader. When friends in completely unrelated professions would ask him to explain his work, he would dumb it down for them. Invariably they would exclaim "OH! I get it! So you're an insurance salesman???!!" That's when I learned about the dark side of dumbing things down! LOL.

Dcik King June 22, 2007 at 4:27 pm

The point is not that you can spend health care benefits.

The point is that the CPI deflater includes in substantial part the health care premiums, so that must be included in total income.

In a country where the incomes average $40K and the health care benefits average $5K, if general prices do not rise but health care rises by 20%, and incomes do not rise but companies cover the health care premiums, average income will remain $40K, the inflation will be reported as 2.2%, so the person will be told he's poorer but his health care benefit is now worth $6 and he is in fact no poorer; he can buy just as many widgets as he used to be able to buy, even though inflation is reported as 2.2% .

This is in fact realistic. Health care premiums have been rising faster than other costs. Some of this is quality improvements; the deflaters are notoriously poor at counting these [it's a political as well as a technical problem to do so].

-dk

Objectivist June 24, 2007 at 2:54 pm

A New Deal for Globalization? Forget it. People these days are crazy. Things are exponentially better than they were a generation ago, and yet people think they are getting a raw deal, because the media and the lecturers tell them this (guess who's making money off of fabricating bad news?). Seriously. The problems can all be traced to government interference and to barriers to free market competition. We need to eliminate our price supports and subsidies, get rid of our welfare state, cut taxes, deregulate, and let things take care of themselves. And another thing; replace current taxes with a poll tax!

Will C. June 24, 2007 at 4:22 pm

One reason that measured incomes are declining has to be that more of the population is retired than ever before. As an estate planner I see those incomes decline dramatically. But the standard of living does not change. Another reason is the influx of new folks into the country at the bottom of the scale. You just cannot look at the raw numbers and draw a valid conclusion. You have to go beneath them.

Bruce Hall June 24, 2007 at 7:30 pm

Will C.,

fortunately for U.S. statistics, the former State of Michigan has been relegated to "territory" status and the grinding economic collapse does not have to be recognized.

So, the 49 remaining states are, on average, doing well. The new Territory of Michigan will lose about 500,000 residents over the next decade and previously high-paying, high-benefit jobs will be allocated to the U.S. trading partners several thousand miles west of Hawaii.

lowcountryjoe June 24, 2007 at 11:32 pm

Not to worry, Bruce, there will be some kind of government bail-out of the large businesses that make up the supply-side of Mighigan's economy. If not an outright subsidy that — no doubt — brings a retalitory reaction from a WTO member it will be a 'restucture' of labor agreements and pension fund promises. Oh, let's not kid ourselves on the restructuring — it is a certainty that the promises will be kept but the real change is going to be just who is on the hook for picking up the tab. You can almost feel the size of your take-home pay shrinking.

Rolf Norfolk June 25, 2007 at 4:04 am

Globalisation (if free from protectionism) means that international wage rates must tend to converge. This means that the USA and the developed world generally must improve its economic efficiency, if it is not to lose most of its money and become dirt poor.

One aspect of economic efficiency is the heavy cost of healthcare, however funded, and we must find ways for people not to become chronically ill or disabled. Self-indulgence, self-neglect, self-harm and selfish risk-taking add to other people's burdens, in a society that is (thank goodness) not completely callous and indifferent. So there must be some collective decision-making about this, without cheap shots about "socialism" (my mother's family were refugees from the Communists, so please don't ask me to go on). Not all collective enterprises are "socialist" – look at your city's sewerage system and the US highway network.

Speaking of the latter, transportation is a further area in which there is much waste of resources, and it is interesting that Warren Buffett and George Soros have recently bought into railway companies. (Has anyone factored the economic cost of death and disability – including progressive cardiovascular degeneration – into road traffic?)

Another aspect of economic planning is pensions, currently a vexed area on both sides of the Atlantic. But how can people save money for retirement when their debts are crippling them? Why have we allowed banks to inflate house prices? So much money is tied up in houses, and so unproductively, when it should be powering business to create wealth.

In a national emergency, Americans have historically been willing to band together and work for the common good. Are you willing to recognise the present state of affairs as such an emergency?

Objectivist June 25, 2007 at 9:18 am

The present state of affairs are not an emergency; they merely illustrate the insolence of the general populace. If health care was all private, then the public would be forced to be adults, to not mess themselves up and be masochistic. So no, I do not support collectivist solutions. Collectivism anywhere will lead to totalitarianism everywhere.

Rolf Norfolk June 25, 2007 at 9:53 am

I would still respectfully suggest to "Objectivist" that collective solutions do not necessarily lead to totalitarianism, indeed can be a defence against it. Presumably Objectivist does not possess a private one-user-only highway, railroad or sewage plant. George Washington's army was made up of volunteers, but was a collective working for a common aim. Individual versus society is a false dichotomy; individualism is only possible within a legal framework that defends rights and liberties, including property.

One threat currently facing the US is that it has a major trading partner that is not sufficiently careful to defend intellectual property rights. At a news conference on 12 April 2005 in Beijing, William Lash, US Assistant Secretary of Commerce, estimated foreigners' loss from intellectual piracy in China as $60 billion a year (quoted in James Kynge's "China Shakes the World", Chapter 3, note 5). This is an example of a right that no individual can enforce.

lowcountryjoe June 25, 2007 at 11:40 am

"Globalisation (if free from protectionism) means that international wage rates must tend to converge. This means that the USA and the developed world generally must improve its economic efficiency, if it is not to lose most of its money and become dirt poor."

Absolute rot, at least to the degree that you're suggesting here. One obvious factor that keeps the convergence in check: the home country's rule of law regarding property right. You cannot stop there, though. Two other huge things that are not so obvious yet have just as much of a profound effect are: 1) purchasing power parity 2) productivity of production inputs such as labor and capital equipment.

"I would still respectfully suggest to "Objectivist" that collective solutions do not necessarily lead to totalitarianism, indeed can be a defence against it."

While this statement is essentially irrefutable, as written, because of the word "necessarily", there are many problems with collective 'solutions'. Many times there is never a choice to opt out of the 'solution' if you happen to be a dissenter or have found yourself in the minority of people who oppose the 'solution' because the costs borne to you not proportionally to everyone else’s.

Perhaps the biggest problem, historically speaking, is that the people who usually initiate and enforce the 'solution' have found ways to shield themselves from participation from it. Or, at the very least, have found ways to compensate themselves rather lavishly for being the architects of collectivist ingenuity.

Rolf Norfolk June 25, 2007 at 12:14 pm

Despite "lowcountryjoe"'s somewhat insulting tone (could we discuss these things with greater courtesy, please?), I agree with him – to a degree.

There are certain modifying factors to wage convergence, for example the cost of transportation, brand loyalty (including chauvinism), servicing issues, and uncertainties about enforcement of contract; but other things being equal, if the same thing is available more cheaply elsewhere, then in an efficient market the buyer will go for it. That, surely, is not absolute rot but basic economics. The transfer of wealth from the USA is enriching the Chinese and this is and will be reflected in rising wage rates. It may take a time (everything does), but the Chinese will become richer and the American poorer. Property rights are as good as the power to enforce them, and I worry about this when the US economy is becoming so indebted to and dependent on outsiders.

I also agree – to a degree – that political leaders will tend to find a way to exploit the demand for collective action. This is why I admire the American Constitution and hope that it will hold up in the political storms that face us all. The Constitution doesn't ensure that politicians will behave honourably, selflessly or with restraint; it assumes the opposite and puts in checks and consequences. But the fact remains that some things can be done on an individual basis, and some with the agreement and assistance of others.

Methinks June 25, 2007 at 1:57 pm

"But the fact remains that some things can be done on an individual basis, and some with the agreement and assistance of others."

Right you are! I doubt you'll find a single person to disagree with that. However, your statement – taken in the context of all that your wrote on this thread – implies that you are confusing "collectivism" and voluntary "agreement and assistance".

Free individuals follow their own path, directed by their free will and come to voluntary agreements with other free individuals when cooperation is required.

In a collective, the individuals necessarily loses the freedom to come to individual, voluntary agreements because the group must act as one for a single purpose. The individual's preferences and subjugated to the groups. The individual loses the ability to come to any or most volunatry arrangements with other members of the group.

It is far more efficient for a central body, like the government, to run a military, police and the court system. But you may notice that the thing those systems have in common is that none of them have to take into account individual needs and preferences. The law is uniform for everyone, the police enforce the law in a uniform way, and the job of a soldier in the military is not to exercise his judgment but to carry orders passed down from a central command.

Notice what you get the moment government tries to centrally plan areas of our lives where individual needs and preferences are paramount – like healthcare. Every patient is different, every need is different, every desire for care is different. The task of predicting and planning for so many different needs and preferences is impossible and what you get is the mess that characterizes collective healthcare.

Lee Kelly June 25, 2007 at 2:52 pm

Since there is understandable confusion, it is worth stating that individualism is not opposed to the formation and maintenance of collectives, only coercive collectives.

Jon June 25, 2007 at 2:54 pm

I think there is a bit of confusion over the use of the term collective … and I'm not sure the Washington's Army example stands up to a strict scrutiny of the deifnition of the word, at least not the context in which Objectivist was using it.

Here is what I want:
A private insurance system where you have a list of services you wish to receive from them. This gives you, the consumer the ability to limit what you want covered, and pay the rates ONLY for what you want covered.

Previous post:

Next post: