The Invisible Hand of Population Control

A look at economic freedom, population growth, and the Tragedy of the Commons by Ronald Bailey at reasononline.

Hardin believed that Smith's metaphor of an invisible hand was contributing to "the dominant tendency of thought that has ever since interfered with positive action based on rational analysis, namely the tendency to assume that decisions reached individually will, in fact, be the best decisions for an entire society. If this assumption is correct it justifies the continuance of our present policy of laissez faire in reproduction." As the essay makes abundantly clear, Hardin is convinced that "rational analysis" will prove that Smith's invisible hand leads to inevitable population ruin.

In fact, several recent studies suggest that Hardin might have it backward. Under certain circumstances, there may actually be an invisible hand that leads to an optimum population.
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Norton persuasively argues that Hardin's fears of a population tragedy of the commons are actually realized when the invisible hand of economic freedom is shackled. Many poor countries have poorly specified and enforced property rights. Poor property rights means that many resources are effectively left in open access commons where the incentive is to grab what one can before the other guy gets it. Norton points out that in such situations, more children mean more hands for grabbing unowned and unprotected resources such as water, fodder, timber, fish, pastures, and for land clearing. Lacking the institutional incentives to invest in and preserve resources, this drive to take as much as possible as quickly as possible leads to perpetual poverty.

The inverse relationship between wealth and fertility is quite evident, however, it will be interesting to see how prosperous countries fare as time progresses. Can a society maintain its economic strength while declining in population? More specifically, can the immense welfare commitments of Western nations be upheld by fewer and fewer young workers? An equilibrium will be reached - either by increased fertility, immigration from lands with excess youth, or a decline in benefits and entitlements.

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Perspective

As we all tighten our belts - some more than others, of course - in today's uncertain economy, it is always good to gain a bit of perspective. Check out www.globalrichlist.com and see how you fare against the world. You might not be in as bad shape as you thought.

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Key Concept - Ricardian Equivalence

Ricardian Equivalence is an economic theory that postulates debt-financed government spending will leave demand unchanged. It suggests that it does not matter whether a government finances its spending with debt or a tax increase, the effect on total level of demand in an economy will be the same.

According to the theory, the public will save any excess money received to pay for the inevitable future tax increases. In an extreme case, current generations will save the money and bequeath it to future generations to pay the bill.

The theory, developed by the 19th century political economist David Ricardo (who also was a pioneer in the description of comparative advantage), rests on several key assumptions:

1. A perfect capital market - all players can borrow or save as much as is required at a fixed rate which is the same for all persons at a given date
2. Fixed government spending path
3. Inter-generational concern - The increased taxes may not be paid by the current generation. Current individuals would need to have concern for their descendants.
4. Rational citizens

Obviously these are assumptions that are on shaky footing in our current world, which tends to cause the theory to lose some validity. Since the theory doesn't hold up completely, government stimulus plans can affect the economy, and may explain standard Keynesian theory where bond financed spending has a bigger effect than tax financed spending.

However, while perhaps not perfect, it certainly can explain some behavior that will temper the effectiveness of government stimulus programs. Many people use their stimulus checks to pay down debts, thus leaving more ability for payment of future tax increases.

It also brings up moral issues about financing current spending by writing debt to be paid by future generations that have no say in the process. Even if issuing debt does give an increase in demand for the economy, the recipient of the benefit and the payer of the debt should both be willing participants.

Refs:
wikipedia, investopedia

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Key Concept - Tragedy of the Commons

I am beginning a semi-recurring series of interesting (to me) topics to further explore and consolidate certain "Key Concepts". Up first is the namesake of this blog: "The Tragedy of the Commons".

The term and concept was first officially coined by Garrett Hardin in a 1968 Science magazine article, which I highly recommend. (article here) It describes the inclination for multiple rational individuals to act in their own self-interest in the short-term, even at the detriment of all over the long-term.

The tragedy of the commons develops in this way. Picture a pasture open to all. It is to be expected that each herdsman will try to keep as many cattle as possible on the commons. Such an arrangement may work reasonably satisfactorily for centuries because tribal wars, poaching, and disease keep the numbers of both man and beast well below the carrying capacity of the land. Finally, however, comes the day of reckoning, that is, the day when the long-desired goal of social stability becomes a reality. At this point, the inherent logic of the commons remorselessly generates tragedy.

As a rational being, each herdsman seeks to maximize his gain. Explicitly or implicitly, more or less consciously, he asks, "What is the utility to me of adding one more animal to my herd?" This utility has one negative and one positive component.

1) The positive component is a function of the increment of one animal. Since the herdsman receives all the proceeds from the sale of the additional animal, the positive utility is nearly +1.

2) The negative component is a function of the additional overgrazing created by one more animal. Since, however, the effects of overgrazing are shared by all the herdsmen, the negative utility for any particular decision-making herdsman is only a fraction of -1.

Adding together the component partial utilities, the rational herdsman concludes that the only sensible course for him to pursue is to add another animal to his herd. And another; and another.... But this is the conclusion reached by each and every rational herdsman sharing a commons. Therein is the tragedy. Each man is locked into a system that compels him to increase his herd without limit--in a world that is limited.

The article raises some very interesting and sometimes rather controversial ideas, the most outstanding being the call to relinquish the freedom to procreate. I'd prefer to highlight some of the other, perhaps less extreme, points:

- There are problems that do not have technical solutions
- It is not mathematically possible to maximize for two (or more) variables at the same time
- Optimal human population is below the maximum population
- The morality of an act is a function of the state of the system at the time it is performed
- An alternative to the commons need not be perfect just to be preferable

While the article is mainly concerned with population growth, the author does mention pollution as an example. In current events, Global Warming certainly fits squarely in the category of a 'Tragedy of the Commons'. The author places global population in the "no technical solution" category; unfortunately, I am more and more inclined to do the same for climate change. Certain parallels are quite striking: as the author cautions against the appeal to conscience, most anti-global warming appeals are decidedly guilt-based. The article posits that these calls are not productive in the long- or short-term.

The long-term disadvantage of an appeal to conscience should be enough to condemn it; but has serious short-term disadvantages as well. If we ask a man who is exploiting a commons to desist "in the name of conscience," what are we saying to him? What does he hear?--not only at the moment but also in the wee small hours of the night when, half asleep, he remembers not merely the words we used but also the nonverbal communication cues we gave him unawares? Sooner or later, consciously or subconsciously, he senses that he has received two communications, and that they are contradictory: (i) (intended communication) "If you don't do as we ask, we will openly condemn you for not acting like a responsible citizen"; (ii) (the unintended communication) "If you do behave as we ask, we will secretly condemn you for a simpleton who can be shamed into standing aside while the rest of us exploit the commons."

My fear is that a solution that is effective, equitable, and enforceable is simply beyond the global community's technical and political ability. This is the true tragedy - "the solemnity of the remorseless working of things".

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Global Trends 2025: Demographics of Discord

The second chapter of the report focuses on a topic that I feel has large implications on societies - past, present and future - and in the coming years will have distinct effects. It has been said that "Demography is Everything", and I feel the report captures several interesting trends that will shape our world.

Two of these trends include:

1. Urbanization
2. Aging Populations in Developed Nations

Urbanization

If current trends persist, by 2025 about 57 percent of the world’s population will live in urban areas, up from about 50 percent today. By 2025, the world will add another eight megacities to the current list of 19—all except one of these eight will be in Asia and Sub-Saharan Africa. Most urban growth, however, will occur in smaller cities of these regions, which are expanding along highways and coalescing near crossroads and coastlines, often without formal sector job growth and without adequate services.

Increased urbanization will have implications in maintaining access to food and clean water. The ability for these megacites to absorb new citizens will also be key. Large groups of unemployed, hungry, and disaffected people are highly unstable and prone to revolt and/or terrorism. These groups could push more and more failing states over the edge.

Aging Populations

Rapidly aging populations will have profound impacts on society. As retirees have fewer and fewer workers for support, a shift will have to occur. Either the society will increase fertility (much easier said than done), import workers through immigration, or benefits and support for the elderly will have to be reduced commensurately. Each of the options have implications on the stability of the nation or region.

In almost every developed country, the period of most rapid growth in the ratio of seniors (age 65 and older) to the working-age population will occur during the 2010s and 2020s, boosting the fiscal burden of old-age benefit programs. By 2010, there will be about one senior for every four working-age people in the developed world. By 2025, this ratio will have climbed to one to three, and possibly higher.

Large and sustained increases in the fertility rate, even if they began now, would not reverse the aging trend for decades in Europe and Japan. If fertility rose immediately to the replacement level in Western Europe, the ratio of seniors to people in their working years would continue to rise steadily through the late 2030s. In Japan, it would continue to rise through the late 2040s.

The annual level of net immigration would have to double or triple to keep working-age populations from shrinking in Western Europe. By 2025, non-European minority populations could reach significant proportions—15 percent or more—in nearly all Western European countries and will have a substantially younger age structure than the native population (see page 20). Given growing discontent with current levels of immigrants among native Europeans, such steep increases are likely to heighten tensions.

The aging of societies will have economic consequences. Even with productivity increases, slower employment growth from a shrinking work force probably will reduce Europe’s already tepid GDP growth by 1 percent. By the 2030s, Japan’s GDP growth is projected to drop to near zero according to some models. The cost of trying to maintain pensions and health coverage will squeeze out expenditures on other priorities, such as defense.

As I examined here, the U.S. will be (perhaps already are?) facing a serious economic crossroads with regards to our social entitlement programs. It will take strong leadership, clear vision, and the ability for all parties to compromise in order to solve these complex problems. Many in my cohort are assuming Social Security will not be around for retirement and are planning accordingly. This is probably a good idea, but what about the many millions who are not?


Other Global Trends Posts:
Global Trends 2025
Global Trends Update
Global Trends Update II
Globalization and the Crash of '08
Demographics of Discord
Timing is Everything
Winners and Losers in a Post-Petroleum World
Scarcity in the Midst of Plenty
Final Thoughts

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20 city composite of housing prices and how each city compares

Interesting to see the changes (both extremes) for a lot of the cities. Detroit is a bit of an anomaly; they never really took off, but eventually hit the shitter.

The image is not from the article, just thought it was an interesting juxtaposition.

http://www.nytimes.com/interactive/2008/10/28/business/20080624_HOUSING_GRAPHIC.html

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Financial Reckoning Day

Financial Reckoning Day: Surviving the Soft Depression of the 21st Century. William Bonner and Addison Wiggin. Recommended.

I will preface this book review with a disclaimer. The authors have an extensive website (www.dailyreckoning.com) where you can read many articles with much of the same information as in the book. The authors could also be described as 'goldbugs', and many of the articles have a certain late-night-infomercial feel to them. That being said, I found the book to be very interesting and would like to share my thoughts and impressions with you. I highlight the book not for any investment advice - which is surprisingly almost non-existent - but as a history of the Crash of 2008, and other booms and busts throughout the ages.

In my view, Financial Reckoning Day is a history book. Written in 2003, it is a call of warning that our financial system is unsustainable. The authors set out to tell us why.

The first chapter accounts the boom years between Fukuyamas' "The End of History" and the dot-com collapse of 2001. The second chapter draws parallels between military exploits and financial cycles; both Napoleon and Hitler's ill-advised offensive maneuvers are shown related to bull and bear markets. Chapter Three is devoted to John Law, widely recognized as the father of fiat currency in the early 1700s. The fourth chapter gives us a case study 10 years prior to our own boom and bust - the Japanese. And the next chapter is purely devoted to the author's most culpable player - Alan Greenspan. Greenspan received years of accolades as the master of the world's financial markets, and now must share in the blame.

I found the remaining chapters to be the most interesting, as I feel they capture the true reasons for our current crisis. From these chapters I gleaned three main underlying factors: the wide ranging blame can be distilled into Failed Policies, Demographics and Human Nature.

Human Nature

Which of mankind's greatest achievements and failures cannot be attributed to factors of human nature? The fallibility of man allows us to do both unimaginable good but can lead us to unspeakable despair.

Greed is highlighted in nearly every financial article these days. While it is mostly used to describe evil CEOs and corporations, we must not forget the individual. Was not greed a factor in the unqualified homebuyer's decision to purchase a home he could not afford? How about the "flippers" and other investors that wanted to make a quick buck in the real estate market? If not only greed, perhaps it is vanity that has led the average American to spend every dollar they earn - and more.

Vanity is a nagging voice imploring us to "keep up with the Joneses". Certainly if they can afford new cars and European vacations, we can too. Heck, don't we deserve it? Vanity has also invaded our psyche - we are the smartest, most technologically advanced beings to ever walk the earth. We have solved so many of the world's problems...why should we think the economy cannot be tamed.

Another dangerous human characteristic is a crowd or mob mentality, also known as "groupthink". It can reduce a normally level-headed person to do amazingly illogical acts. As these groups begin to think the same thoughts, "irrational exuberance" can take hold. Investors throughout history have fallen prey to this phenomenon. The difference today? Global communication allows for the entire earth to have access to the same information. Every man can now be a part of every boom..and bust.

Demographics

Perhaps one of the most frightening factors is the cold hard fact of demographics. As noted in this post, finance can be distilled down to one concept - old people lending money to young people. When there is an imbalance in demographics, there tends to be an imbalance in financial markets. As you may know, there was a global spike in births after the conclusion of World War II. The "boomers" get a whole chapter just to themselves. Four interesting statistics:

1. Average age of American baby boomers on January 1, 2001: 46
2. Average amount in retirement account: $50,000
3. Number of years at 6% growth to reach comfortable retirement income: 63 years
4. Amount in U.S. Social Security Trust Fund: $0

Besides the large effect that the aging population will have on Social Security and health care benefits, they will continue to exert an inherent downward pressure on both the housing and stock market. As people age, they stop working and earning - and begin selling. When there are more sellers than buyers, prices fall. The alternative is to continue working until later in life...which is an undesirable thought to most of us. However, as life expectancy has increased, does it not stand to reason that we would have to work longer as well?

Failed Policies

The frightening aspect of our situation is that 2 of the 3 factors I have listed have little to no solution. And while governments around the globe scramble for new policies, there is certainly the distinct possibility to actually do more harm than good.

The authors place most of the blame on Greenspan's policies; and fiat currency in general. As for fiat versus a commodity-based system, I do not have the background to have an informed opinion. From my limited research, there are positives and negatives to both systems - as with most things in life. While there are booms and busts in fiat currency systems, there have been similar 'panics' in gold, silver, and other commodity-based economies. The world seems to have adopted central bank guided fiat currencies, and I don't really see a shift away from that.

Much of the blame is then laid at the feet of Alan Greenspan. After the tech stock boom of the late 1990s, interest rates were slashed and kept low. This allowed for massive amounts of cheap money to flood into the real estate market. With easy and inexpensive money available to nearly anyone with a pen, home prices soared to unrealistic levels.

Other policies that fueled the fire were mandates to make home loans available to subprime borrowers. This was accomplished by a plethora of innovative new mortgages and the implicit backing of Fannie Mae and Freddie Mac by the federal government through the U.S. department of Housing and Urban Development. Fannie and Freddie were subsidized to take on more and more subprime debt, and the American public was more than willing to oblige.

Lack of government oversight is also blamed in the Crash of '08. There were, no doubt, cases of predatory lending. The process of purchasing a home is a daunting one and can easily be manipulated by the unscrupulous. Perhaps the most unregulated entity...the exotic derivatives market that has been likened to the world's largest casino. Credit Default Swaps, packaged as a way to hedge against risk, seem now more like insurance fraud. There will most likely be sweeping reform in this and other areas of the financial sector in the coming months.

As one can see, there is plenty of blame to share. I, too, have benefited and become somewhat entangled in the credit boom and subsequent bust. Now with the stock market plunging and other areas of the economy showing signs of deep recession, we can only hope we all can find a way to recover in an expedient fashion. As for "Surviving the Soft Depression" as the book claims, I found no hard advice. Basically, the authors suggest you sell stocks and buy gold, but it would seem too late for that. Anyone have a time machine?

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Crash of 2008: Credit Default Swaps, Part II

This article sums up one of the underlying reasons for the financial troubles that the world is currently experiencing. As I noted in this post, derivatives - namely Credit Default Swaps (CDS) - have played a pivotal role in the global economy's dizzying expansion...and subsequent downfall. This article explains the scheme in more detail.

Around the world, banks must comply with what are known as Basel II regulations. These regulations determine how much capital a bank must maintain in reserve. The rules are based on the quality of the bank's loan book. The riskier the loans a bank owns, the more capital it must keep in reserve. Bank managers naturally seek to employ as much leverage as they can, especially when interest rates are low, to maximize profits. AIG appeared to offer banks a way to get around the Basel rules, via unregulated insurance contracts, known as credit default swaps.

Here's how it worked: Say you're a major European bank... You have a surplus of deposits, because in Europe people actually still bother to save money. You're looking for something to maximize the spread between what you must pay for deposits and what you're able to earn lending. You want it to be safe and reliable, but also pay the highest possible annual interest. You know you could buy a portfolio of high-yielding subprime mortgages. But doing so will limit the amount of leverage you can employ, which will limit returns.

...

Although AIG's credit default swaps were really insurance contracts, they weren't regulated. That meant AIG didn't have to put up any capital as collateral on its swaps, as long as it maintained a triple-A credit rating. There was no real capital cost to selling these swaps; there was no limit. And thanks to what's called "mark-to-market" accounting, AIG could book the profit from a five-year credit default swap as soon as the contract was sold, based on the expected default rate.

...

It was a fraud. AIG never any capital to back up the insurance it sold. And the profits it booked never materialized. The default rate on mortgage securities underwritten in 2005, 2006, and 2007 turned out to be multiples higher than expected. And they continue to increase. In some cases, the securities the banks claimed were triple A have ended up being worth less than $0.15 on the dollar.

Even so, it all worked for years. Banks leveraged deposits to the hilt. Wall Street packaged and sold dumb mortgages as securities. And AIG sold credit default swaps without bothering to collateralize the risk. An enormous amount of capital was created out of thin air and tossed into global real estate markets.

...

AIG's largest trading partner wasn't a nameless European bank. It was Goldman Sachs.

I'd wondered for years how Goldman avoided the kind of huge mortgage-related writedowns that plagued all the other investment banks. And now we know: Goldman hedged its exposure via credit default swaps with AIG. Sources inside Goldman say the company's exposure to AIG exceeded $20 billion, meaning the moment AIG was downgraded, Goldman had to begin marking down the value of its assets. And the moment AIG went bankrupt, Goldman lost $20 billion. Goldman immediately sought out Warren Buffett to raise $5 billion of additional capital, which also helped it raise another $5 billion via a public offering.

The collapse of the credit default swap market also meant the investment banks – all of them – had no way to borrow money, because no one would insure their obligations.

Now the only place for these institutions to get capital is the Federal Reserve. Unfortunately, very few folks believe that the recent $700B 'bailout' package will have the intended result. Markets around the globe fell decisively this Monday. One reason: perhaps there just isn't a way to replace the credit...

There's no way to replace this massive credit-building machine, which makes me very skeptical of the government's bailout plan. Quite simply, we can't replace the credit that existed in the world before September 15 because it didn't deserve to be there in the first place. While the government can, and certainly will, paper over the gaping holes left by this enormous credit collapse, it can't actually replace the trust and credit that existed... because it was a fraud.

And that leads me to believe the coming economic contraction will be longer and deeper than most people understand.

The author then gives some investment advice, which I am unsure of the impartiality or validity. I don't feel that this should detract from the explanation of the situation, however. There seem to be many people hawking gold these days - who knows if any drastic maneuvers are a good idea. Bottom line, we may be in for some rough times in the years ahead, and it may be a good time to seek professional investment advice.

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