The events of the past few days lead me to think about Herman Melville

From The Confidence Man, Chapter 7:

The stranger was a man of more than winsome aspect. There he stood apart and in repose, and yet, by his mere look, lured the man in gray from his story, much as, by its graciousness of bearing, some full-leaved elm, alone in a meadow, lures the noon sickleman to throw down his sheaves, and come and apply for the alms of its shade.

But, considering that goodness is no such rare thing among men--the world familiarly know the noun; a common one in every language--it was curious that what so signalized the stranger, and made him look like a kind of foreigner, among the crowd (as to some it make him appear more or less unreal in this portraiture), was but the expression of so prevalent a quality. Such goodness seemed his, allied with such fortune, that, so far as his own personal experience could have gone, scarcely could he have known ill, physical or moral; and as for knowing or suspecting the latter in any serious degree (supposing such degree of it to be), by observation or philosophy; for that, probably, his nature, by its opposition, imperfectly qualified, or from it wholly exempted. For the rest, he might have been five and fifty, perhaps sixty, but tall, rosy, between plump and portly, with a primy, palmy air, and for the time and place, not to hint of his years, dressed with a strangely festive finish and elegance. The inner-side of his coat-skirts was of white satin, which might have looked especially inappropriate, had it not seemed less a bit of mere tailoring than something of an emblem, as it were; an involuntary emblem, let us say, that what seemed so good about him was not all outside; no, the fine covering had a still finer lining. Upon one hand he wore a white kid glove, but the other hand, which was ungloved, looked hardly less white. Now, as the Fidèle, like most steamboats, was upon deck a little soot-streaked here and there, especially about the railings, it was marvel how, under such circumstances, these hands retained their spotlessness. But, if you watched them a while, you noticed that they avoided touching anything; you noticed, in short, that a certain negro body-servant, whose hands nature had dyed black, perhaps with the same purpose that millers wear white, this negro servant's hands did most of his master's handling for him; having to do with dirt on his account, but not to his prejudices. But if, with the same undefiledness of consequences to himself, a gentleman could also sin by deputy, how shocking would that be! But it is not permitted to be; and even if it were, no judicious moralist would make proclamation of it.

This gentleman, therefore, there is reason to affirm, was one who, like the Hebrew governor, knew how to keep his hands clean, and who never in his life happened to be run suddenly against by hurrying house-painter, or sweep; in a word, one whose very good luck it was to be a very good man.

I should note that my mother, a retired English Professor and Melville mavin, led me to read this, Melville's last, novel, many years ago.  My understanding is that it is not widely read, but it should be.


 

Chris Christie yearns to be run by the Medicis

Since love and fear can hardly exist together, if we must choose between them, it is far safer to be feared than loved.

Niccolo Machiavelli, The Prince

A California Renaissance?

Here is the preliminary job growth rate by state from July 2011-July 2012, according to the BLS.  States are those for which there was a statistically significant change in employment from July to July.

Note that California outperformed Texas.

Orwell's six rules on writing.

From Politics and the English Language:

(1) Never use a metaphor, simile or other figure of speech which you are used to seeing in print. 

(2) Never use a long word where a short one will do. 

(3) If it is possible to cut a word out, always cut it out. 

(4) Never use the passive where you can use the active. 

(5) Never use a foreign phrase, a scientific word, or a jargon word if you can think of an everyday English equivalent. 

(6) Break any of these rules sooner than say anything outright barbarous.

The problem with the capital gains tax

Tax policy can be frustrating.  A major reason that Mitt Romney pays a lower effective tax rate than many working stiffs is that most of his income comes in the form of capital gains, which is taxed at a preferential rate (the top marginal ordinary income tax rate is 35 percent, while the long term capital gains rate is 15 percent).  It may therefore seem that the easy way to implement a "Buffet rule" would be to match the capital gains rate to the ordinary income tax rate.

There are three policy dilemmas here, along with a practical problem.

The first policy dilemma is that some capital gains are nominal--they don't reflect changes in purchasing power.  We recognize this problem in other places in the tax code--for example, we adjust tax brackets for inflation every year.  The problem could be solved using indexing--we could tax real capital gains at the ordinary income tax rate.

The second dilemma is perhaps more controversial.  In a Solow-Swan world of economic growth, more savings produce a larger and newer capital stock, both of which are key to growth (Barro and Sala-i-Martin have a lucid description).  If they are correct (and the consensus is that they are), then policies that encourage both savings and flexibility are good policies.  To some extent we do this with our retirement tax policies: so long as savings remain in a retirement fund, their returns go untaxed, even when securities within the fund are bought and sold.  With respect to capital gains policy, this implies that we should discourage the consumption of realizations of gains, but should encourage investment flexibility.  In other words, if someone sells her winners in order to buy a Jaguar, she should be taxed, but if she sells winners in order to reinvest somewhere else, she should not.

The second dilemma creates a third dilemma--the investor who makes smart decisions accumulates considerable wealth, which could lead to disproportionate political power.  Capital gains preferences accelerate this phenomenon.  This is particularly vexing.

Now for the practical problem--the statutory capital gains rate can be considerably different from the effective rate (my approach here follows the argument in Dave Geltner and Norm Miller's Textbook, Chapter 11).  Consider an investment that pays no dividends that grows in value at 10 percent per year in a world with a statutory capital gains rate of 20 percent.  Suppose the investor holds that investment for ten years, and then sells it.  To put some numbers on it, a $100 investment will grow to $259.37 in value.  The capital gains taxes will be $159.37*.2=$31.87, so the net to the investor after capital gains taxes with be $227.50.  The internal rate of return on the investment drops from 10 percent before tax to 8.6 percent after tax.  Consequently, the effective tax rate is not 20 percent, but 14 percent.

If we stretch out the investment horizon to 20 years, the effective rate drops to 10.3 percent; if we reduce it to 1 year, the effective rate matches the statutory rate of 20 percent.  The point is that regardless of the capital gains rate, investors have considerable discretion at determining their effective rate.  So it is almost certain that a behavioral response to a higher capital gains rate would be longer periods of time between realizations, hence lowering the effective rate.  When it comes to figuring out tax policy, nothing is easy.





  

The Seductive Foolishness of a Facebook Phone

The rumors about Facebook making a smartphone have died down -- for the moment.  Facebook CEO Mark Zuckerberg said last month that it wouldn't make sense for Facebook to create its own smartphone.  I'd like to believe that finally put an end to the rumor forever, but you know it's going to be back.  Even when Zuckerberg issued his denial some people claimed he was lying (link). 

People react emotionally to hardware.  The idea of the leading online community making a phone is sexy, and seems intuitively obvious in an age when software giants like Google and Microsoft are making their own hardware.  Of course Facebook is making a phone.  Isn't everybody?

It reminds me of elementary school:

Mom:  Honey, why did you jump your bike off the roof?
Child: (in traction) Everyone else was doing it.
Mom:  If everyone else jumped off a cliff, would you do that too?
Child:  Yes, Mom, as a matter of fact I would.  Jeez, haven't you heard of peer pressure?

Mark Zuckerberg is young for a CEO, but I hope he's not that young.  I think making a smartphone is one of the most spectacularly stupid things Facebook could do.  Even if the product succeeded (which is very iffy), the distraction and business problems it would create could do severe damage to the whole company.  There are other, much easier ways for Facebook to make itself a power in mobile and to extend its dominance in new areas.  I think Zuckerberg and his troops should be concentrating on those enormous opportunities rather than messing around with hardware.

Knowing my luck with predictions, this means Facebook will probably create a phone and make it a huge commercial success.  In that case, you're welcome to come back here in a couple of years and tease me.  But in the meantime, here's why I think the "Facephone" would be a terrible idea, and what the company should focus on instead.


Making a smartphone: The Red Queen's Race

Most people outside the phone industry don't understand how hard it is to make a competitive smartphone.  Mobile hardware is moving at amazing speed, with companies like Samsung packing in new and updated features as quickly as they can.  Many customers are very sensitive to these features.  If you fall even a little bit behind -- say, with a camera that has too low a resolution, or a slow processor -- many people won't buy your phone, unless you discount it to the point where you aren't making any money.

You might be thinking to yourself, "okay, so just make sure you're using the leading components."  That sounds easy, but Samsung in particular specializes in sourcing those new components immediately (or making them itself) and building them into new hardware quickly, all at an aggressive price.  Unless you move extremely fast, you'll find yourself releasing new features at the same time as Samsung is moving on to the next generation.

So you need a hardware organization with close ties to the component suppliers, and with enough money to make advance orders for components that haven't shipped yet.  And you need to hire several complete engineering teams, so a couple of them can be working on future products in parallel while one team brings the latest flagship to market.

All of this is a huge investment.  It's also high risk, because sometimes you'll guess wrong on a component and have to eat its cost.  And at best, if you're wildly successful, all you can do is keep pace with Samsung.  It won't give you differentiation.

And oh by the way, rising competition from Huawei and ZTE in China is probably going to accelerate the process even further.

Then there's software.  A similar situation applies in software, even more so.  Apple and Google are competing to see who can cram more new software features into a smartphone.  For example, Apple adds voice recognition, and Google immediately counters.  If you're not prepared to quickly match all of those features, your phone will end up in the discount bin, the same as if you were behind in hardware.

So to enter the smartphone business today, you need a large software engineering organization creating a huge suite of applications, and updating them frequently.  Plus you'll need to do a large amount of hidden software customization to integrate with the specific features and applications of each major mobile operator.

You can save some of this investment by licensing a third-party operating system.  The choices are Android and...well, Android.  Which is made by your most bitter rival, Google, a company that has shown itself to be willing to manipulate Android to hurt competitors.  So maybe you do like Amazon and build on top of an open source version of Android, one that Google doesn't control.  But in that case you're using software that's a generation out of date, you have to write many of your own applications, and there's still that software integration work with the operators.  You save some time and investment, but not nearly as much as you'd like.

So now you've created a huge hardware and software engineering organization.  You next need to pay for all the parts and manufacturing.  You must create marketing deals with the operators and tech stores (which means hiring a dedicated salesforce).  You need to hire a support staff that responds directly to phone calls and e-mails (something that you, like other Internet companies, don't do).  You have to arrange for repairs and returns.  You need to license a huge range of patents, so Apple won't sue you.  And probably some other details I forgot about.

None of this is impossible for Facebook, but it takes a huge amount of time and investment.  It's not the sort of thing that you can do with a skunkworks team of a few dozen engineers from Apple.  Google, faced with this same situation, decided to buy Motorola.  If you really think Facebook is serious about the smartphone business, then the rumor you need to start is which smartphone company it's going to buy.

I'll kick off the rumors by nominating HTC.

But the real killer problem is that even after you do all of the above, all you've done is make a smartphone that matches the competition.  You still need to figure out what makes your phone so compellingly different that people would buy it instead of an iPhone, Samsung Galaxy, or the latest Google Nexus thing.


Differentiation cures all

Reading all of the above, you might respond, "hey, all of the same conditions applied before Apple entered the smartphone business, but it managed to succeed without making many of the investments you talked about."  And you'd be right.  The iPhone's success shocked the major smartphone players because they assumed the iPhone's relatively poor hardware specs (no 3G!) and missing software features (no MMS!) would make it an afterthought.  Apple succeeded because the first iPhone's differentiation -- real PC-style web browsing -- was so compelling that for many users it outweighed all the other drawbacks of the phone.  RIM did something similar with mobile e-mail years before, so there is a precedent for shaking up the phone industry with breakthrough devices and relatively low up-front investment.  Maybe Facebook can be the next company to redefine the smartphone.

There are two problems with this for Facebook:

1. You're not Apple.  Although Apple was not a phone company, it was a world-class consumer hardware manufacturer with a fanatical focus on user experience and quality.  RIM had many years of pager experience before it made the first BlackBerry.  Neither company made a tweaked phone; they brought a different set of system design practices to the phone industry.  The iPhone alone didn't defeat Nokia and Motorola, they were beaten decisively by Apple's business processes.  Facebook lacks that sort of process differentiation, especially relative to Google.

2.  What possible differentiation in a Facebook phone would be so compelling that it would make the iPhone and Android obsolete?  Almost by definition, an innovation that great is something that I can't imagine today.  Maybe Mark Zuckerberg can, and if so I salute his vision and welcome our new Facebook overlords.


Which future do you want to live in?

The other issue Facebook needs to consider is what industry structure is best suited to its future. 

There's a future scenario in which the usage of the web becomes more and more dominated by smartphones, and in which smartphone users are limited to a selection of apps and websites manipulated by the smartphone manufacturers.  In other words, the web becomes a series of walled gardens rather than than the open environment it is today.  If you believe that scenario is destined to happen, and if you believe the only way to have a role in smartphones is to make your own hardware, then of course Facebook has to make a smartphone.  It's dead otherwise.

But I don't think that's how the future works.  It's not a fixed destiny, it's a set of possibilities.  Our own actions shape the future and call it into being.  The more powerful and persuasive an organization or individual is, the more it can do to shape the future.  And Facebook is a very powerful, persuasive company.

I think the best future for Facebook is one in which the web, including the mobile web, stays open to software-only innovation.  In this world, customers choose which websites and web apps they want to use, without being forced into a particular choice by a hardware manufacturer.  This would enable Facebook to run on all smartphones, keeping the company focused on expanding its network and adding new features and services to it.  In other words, Facebook could keep doing what it does best, rather than pouring money into a new set of skills and gambling that it can out-compete Samsung and Apple on their home turf.
   
If Facebook creates its own smartphone, I think it makes that open future less likely.  A Facebook phone would encourage other software companies to make proprietary phones, further closing off software openness.  And it would make the other phone companies much less likely to cooperate with Facebook.  Today, smartphone companies will fall all over themselves to work with Facebook.  Even Apple is actively integrating Facebook with the iPhone.  How long will that last once Facebook starts selling a phone?  Instead of Facebook everywhere in mobile, we could end up with Facebook noplace except on the Facebook phone.


Beware the Ides of Flash

Right now, Facebook is so popular that Google can't prevent it from working with Android.  The more that Apple integrates with Facebook, the more pressure Android licensees will feel to match that integration, even if Google discourages it.  But if Facebook were kicked off iPhone, Google would have a much freer hand to disadvantage and exclude Facebook from Android. 

This is my biggest concern about the Facebook phone idea.  The company could easily produce a phone that is just good enough to scare away its other phone partners, without being good enough to dominate the smartphone market.  The Facebook phone could call into being the exact industry structure that Facebook wants to avoid.  That's why I see it as hideously high risk, a bet-the-company move that should be taken only when there's no other chance to survive.
   
And Facebook has other choices.


What Facebook should do

In ecology, the most successful species are not the ones that adapt best to the environment, they're the ones that reshape the environment to match their needs.  That's what I think Facebook should be doing.  Instead of competing with smartphone manufacturers, it should run a series of integration experiments with them.  Facebook's early efforts in that direction were not very successful (link), but that's why I'd put more resources into them -- there's a learning curve.

Facebook's goal should be to get the handset companies competing with each other to build Facebook more and more deeply into the phone.  How about creating a set of Facebook integration requirements, and a "Facebook Ready" logo for complying phones?

In addition to integrating the core Facebook functions, Facebook needs to bring along the Facebook economy.  The challenge for Facebook is not just to transfer its content to mobile, it's to make available the full ecosystem of third party apps and services that make Facebook so powerful on the desktop.  I know some of the smartphone manufacturers don't want anything that looks like a third party platform on their phones, but Facebook is one of the few web companies popular enough to force it.  Provide the full ecosystem to some phone manufacturers, and the others will be forced to follow suit.

This would give Facebook not just an application on smartphones, but a mobile platform that it can grow rapidly and in new directions, as it did on the desktop.  Instead of competing at the commoditized hardware layer, Facebook can compete at the platform and UI layer where most of the profitability is.  It's the right place for Facebook to fight, but it's all put at risk if Facebook makes its own phone.

Trending is dangerous

Niall Ferguson is horrified at the prospect that total Chinese GDP will catch the US in 2017.  Let us leave aside for a second the fact that if China's total GDP matches the US', its people will still be less than 1/4 as affluent, or the fact that maybe it would be a good thing if the most populace country in the world had living standards comparable to ours.  So far as I can tell, his 2017 projection comes from assuming growth in China will continue over the next several years at the same pace it has experienced since 1989.  Such projections are always problematic.

Let me give one example.  From 1890 until 1920, Los Angeles population grew by about 11 fold, from  50 thousand to 576 thousand.  If one assumed that this would continue, Los Angeles' population 90 years later, in 2010, would have been 576,000*11^3, or about 766 million, which is a shade under the population of the entire Western Hemisphere.  Its actual population is around 4 million.

Is this absurd?  Of course.  But I have been seeing similar forecasts based on similar foundations since I was in college (when a very well-known professor projected that the USSR would have a larger economy than the US by the year 2000).    This kind of "analysis" has been driving me crazy for years.

For this first time ever, I have put a blog post on my syllabus

It is Yves Smith's review of The Big Short.  That I have just done this now probably shows how behind the times I am.

Lall, Wang and da Mata find that reducing land use regulation in Brazil would increase the formal housing supply, but not necessarily reduce slum formation

I just finished a two day visit to Sao Paolo, where officials are concerned that constrained housing supply is exacerbating the size of favelas.  This lead me to read Lall, Wang and da Mata:

In this paper, we examine the effects of land use and zoning regulations on
housing supply and slum formation across Brazilian cities between 1980 and 2000. We
find very low price elasticities of housing supply in the Brazilian formal housing market,
which limits formal housing supply adjustments in response to demand increases, and is
linked with growth of informal settlements. The imputed Brazilian formal housing supply
elasticity is similar to those in Malaysia and South Korea, which have been regarded to
have restrictive regulatory environments.

We also find that land use regulations that manage densities – in particular,
minimum lot size regulations, have important effects in terms of housing supply and slum
formation. Contrary to conventional wisdom, lowering minimum lot size regulations do
not lead to a reduction in slum formation. If city population growth were exogenous and
households did not consider local regulations in their migration and residential location
decisions, then lowering minimum lot sizes would allow cities to accommodate more
residents into formal housing developments – and unambiguously reduce slum formation.
However, when we consider that regulations are a part of household migration
and residential choice decisions, the exact effects of lowering regulatory standards are not
obvious. In fact, our model suggests that the net effect of land regulations depends on the
extent to which new formal housing supply absorbs demand, both from current informal
sector residents and population growth induced by lowering regulations. Our estimation
strategy considers both effects, and we find that cities that lowered minimum lot size
regulations from the Federal stipulation of 125 m2 experienced higher growth in the
formal housing stock. However, this was also accompanied by higher population growth
from migration, and the resulting city population growth was higher than the formal
housing supply response, exacerbating the slum formation problem.

Local innovations that increase access to land for the poor – such as flexible land
sub divisions – are welfare enhancing as they allow houses with different specifications
to be available in the market, thereby allowing low income residents to benefit from
services that meet their preferences (and affordability). However, if some cities offer
improved access to land compared to their peers, these cities are likely to
disproportionately attract (poor) migrants. If the induced population growth is higher than
formal housing supply adjustment, informality is likely to grow. Cities that absorb
migrants increase welfare – and in this context the challenge is to identify strategies that
increase formal housing supply relative to population growth. The econometric results
should not be viewed as a failure of flexible zoning to reduce slum formation. Rather, the
focus should be on identifying pre existing distortions in the land and housing market that
reduce the formal housing supply response to additional demand. 

Two important issues for future research emerge from this analysis. First, to
understand why some cities deviated from the federally stipulated minimum lot
specification of 125 m2 to favor low income housing development. And second, to
identify sources of land and housing supply distortions that reduce the elasticity of formal
housing supply.

One fact about the Sao Paulo context: according to officials, the vacancy rate in the formal sector there is about 13 percent, suggesting excess housing supply.  But the construction cost of the minimum size house allowed under Brazilian law is simply too high for many Brazilians to afford.  Allowing smaller houses to be constructed would almost certainly improve housing welfare.

While I don't like the finding, I feel compelled to report that Matt Kahn finds liberals are more likely to be housing NIMBYs

I just caught up with his JUE paper on the subject.  The abstract:

Traditional explanations for why some communities block new housing construction focus on incumbent home owner incentives to block entry. Local resident political ideology may also influence community permitting decisions. This paper uses city level panel data across California metropolitan areas from 2000 to 2008 to document that liberal cities grant fewer new housing permits than observationally similar cities located within the same metropolitan area. Cities experiencing a growth in their liberal voter share have a lower new housing permit growth rate.

The paper is quite thorough, using a wide variety of specifications, and the results are quite robust. 

My research (and that of many others) shows that impediments to homebuilding are the largest cause of expensive houses.  By impeding home construction, liberals are contributing to the rent being too damn high.  Needless to say, this hurts low income households more than anyone else.

Holmes and Watson teams--an entirely subjective judgment

Basil Rathbone and Nigel Bruce--not good
Nicol Williamson and Robert Duval--OK
Douglas Wilmer and Thorley Waters--Oy
Jeremy Brett and Edward Hardwick--great
Vincent D'Onofrio and Katherine Erbe--very good
Robert Downey and Jude Law--OK
Benedict Cumberbatch and Martin Freeman--really great
Jonny Lee Miller and Lucy Liu--kind of eager to find out

Transit Oriented Development in Thailand (h/t Hasan Ikhrata of SCAG)

Why Paul Ryan is dangerous

I was on a panel with him at the University of Wisconsin last year.  Unlike his running-mate, he comes across as well-informed, and he knows how to play to his audience.  He is actually personally quite charming...just very, very wrong.

Who should be held harmless for deficit reduction?

At some point, once the unemployment rate really starts to fall, the US needs to get on a steady-state path to deficit reduction.  A question worth asking is what part of the income distribution should contribute to this reduction.  Certainly the one percent should make the major contribution, but it is hard to see how it can close the gap by itself.

The current budget deficit is about $1.3 trillion.  According to IRS SOI data for 2009 (the most recent available), households in the top one percent paid income taxes of $318 billion in that year (see Table 5).  Because that was an anomalous year, let's go back to 2007, when the top one percent paid the most is had paid under current law, which was $451 billion. If we adjust that for five years of CPI growth, that translates to about $497 billion in current dollars.  This means that doubling taxes on the top one percent would get us less than halfway toward closing the budget gap.

Of course, lower unemployment will mean less money going to unemployment insurance, and will add to the number of taxpayers, and these will help reduce the deficit.  But the taxing the one percent alone will not be enough--so how low do we go?  I would certainly hold the bottom two quintiles harmless--whatever mix of tax and spending changes come along, that group should be left no worse off than before (because they received no net benefit from the policies of the past decade or so).  How one divides it up among the rest?  I am not sure.

I don't understand Glenn Hubbard's Arithmetic

He says he wants federal spending to be reduced to 20 percent of GDP, along with "revenue-neutral" tax reform.  (I think revenue-neutral tax reform is code for reducing the after-tax income of the bottom half of the country further, because after all, Wall Street has suffered too much at the hands of ...well, never mind that for now).

The problem is that according to OMB, current revenues are less than 16 percent of GDP (see Table 1.2).  So is Hubbard advocating a steady-state budget deficit to GDP ratio of four percent per year in perpetuity?