Wednesday, 21 March 2012

The Wealth is Not Enough

Acemoglu and Robinson have, on their blog, very kindly responded to the email I sent them.

However, I'm inclined to say that their purported explanation falls short of explaining the empirical puzzle presented.

They resort to what is effectively rentier state theory - resource rich countries can buy off their populations, other ones can't. Unfortunately, this theory has several gaps in it.

1. What about Morocco, Jordan, Bhutan, Swaziland?

These aren't resource rich countries. (current accounts in Morocco, Jordan, Bhutan, Swaziland, all of which hover at or below 0. Note that the recent spike in Bhutan is caused by the building of a large hydroelectric powerplant, the energy from which is mostly exported to India).

Resource wealth can explain Saudi Arabia and Bahrain handily, sure, but how compelling is it as an explanation for Oman? True, Oman has plenty of resource wealth -Oil and Gas exports approached 50% of GDP in 2008-, but its patterns of reform hardly match that of a King buying off his population with reform. Prior to the Arab Spring, the only major threat to Bin Said was the Dhofar rebellion, which began in 1965 under his father's reign. According to Joseph Kechinian, “Oman was not just experimenting with participatory government”, under Qaboos, but in fact it was choosing to “stay well ahead of changing circumstances.”[1] When you look carefully, Rentier State Theory can only explain about half of the puzzle.

Acemoglu and Robinson try to explain this away by saying "The genius of the regimes in Saudi Arabia, Qatar, and the United Arab Emirates has been to use their resources before there was much of a protest movement." which brings us to

2. Libya?
As Acemoglu and Robinson acknowledge, Libya is resource rich. But they say, it has chosen the path of repression, and therefore was doomed to fall. But wait- wasn't the question of whether a state chooses the path of repression or accommodation part of the very thing we were trying to explain in the first place? Why did Libya choose repression and not Qatar? Here the authors cite the UAE, and Saudi Arabia's 'genius' as the explanation for their pre-emptive appeasement. But if this is so, why were regional scholars as recently as 2006 saying things like "the U.A.E actually represents one of the purest autocracies in the world…second only to Saudi Arabia.”[2]

The enormous resources of the U.A.E. and Saudi Arabia is related to their continued preservation, surely- but it seems to me that the resources merely gave these countries the power to make few genuine concessions that threatened the monarchs' stranglehold on power. The same explanation cannot be true for Oman or Kuwait, where meaningful alternative's to the King's power exist. Moreover, that explanation clearly has no relevance in Jordan or Morocco, where resources are lacking. Expanding the sample outside of the Middle East ("Region only begs the question about the factors actually at work… region is merely a summary of factors that have taken on geographical form"[3]) demonstrates that other resource poor monarchies have also managed to survive - such as in Bhutan and also in Swaziland. Rentier State Theory cannot explain why.

Some of these questions I tried tackling, here (warning, this is another shameless plug of my thesis). The most striking snippet of information can be found on the simple table on page 26. Personally, I found most interesting the relationship between the timing of reforms and the age of the King.

[1] Joseph. A. Kechichian, Oman and the world, the emergence of an independent Foreign Policy, p54 (RAND, 1995)
[2] Christopher M. Davidson, ‘After Shaikh Zayed: The politics of Succession in Abu Dhabi and the UAE’ Middle East Policy, Volume 13(1), Spring 2006, p42
[3] Valerie Bunce, ‘Rethinking Recent Democratization, Lessons from the Postcommunist Experience’ World Politics 55(2) January 2003 pp 191-192

Friday, 16 March 2012

Empirical Puzzles from the Arab Spring

On Acemoglu & Robinson's excellent new blog "Why Nations Fail", they point out that the prospects for a peaceful resolution in Syria are bleak, to say the least.

Their post reminded me of an empirical puzzle that I noticed back at Uni. Why is it that Monarchs seem to behave so differently to autocrats when they are faced with rebellions? The Arab Spring (which those who know me will realise post-dates my thesis by some time) provides what seems to me to be clear evidence on this. Looking across the monarchies that have seen protests, Oman, Morocco, Jordan, Kuwait, Saudi Arabia and Bahrain, all have avoided out and out civil war or revolution, generally by buying off their populations and/or with small political liberalisations. By contrast, the dictatorships in Egypt, Yemen, Tunisia, Syria, Libya have been far less succesful, generally avoiding any conciliatory policies and hence often leading to total overthrow or civil war. In fact the only country that seems to somewhat buck the trend is Algeria, which politically as I understand it (which honestly is not that well) is somewhat less authoritarian than most of the other countries that benefitted from the Arab Spring. The case is bolstered still further when we look further at Monarchies outside the Middle East, such as Bhutan, Swaziland and Brunei.

The answer to why there is this difference is not immediately obvious.

In the end, I decided not to make this the central puzzle of my thesis, and instead focussed on an associated but more specific problem to do with the distribution of liberalisations within Monarchies (for anyone interested, that work, adapted to be reader friendly and without ugly tables, can be found here, pages 4&5 giving the best summary of what it is about). Given the events that have since happened, perhaps I ought to have focussed on this problem. I've sent these questions over to Acemoglu & Robinson, who were kind enough to write back to me indicating that they might deal with issue in an upcoming blog post. I look forward to reading their views.

Thursday, 15 March 2012

Sri Lanka's Killing Fields, War Crimes Unpunished

This truly horrifying programme documents multiple war crimes in Sri Lanka. Graphic violence, and disturbing throughout, but nonetheless a rare example of important journalism.

Channel 4 Documentary on Sri Lanka's Unpunished War Crimes

Monday, 12 March 2012

Which Macroeconomic Model Best Describes Reality?

Another one of my Quora answers that got traction reproduced here:

1. No economic models accurately describe reality
2. No economic models are very good at making predictions about the future
3. The Smets-Wouters (2003 & 2007) model is considered the best of a bad bunch, the dwarf among pygmies.

Smets-Wouters, 2003 & 2007 is generally considered the most accurate general model of the economy in macroeconomics, when it comes to prediction[1] (note that this is different to 'describes reality most accurately', but I'll get on to this distinction later). It operates in the New Keynesian (or sometimes called the New Neoclassical Synthesis) school of thought, meaning that it takes a 'Dynamic Stochastic General Equilibrium' framework (in other words it works out its equations by examining individual, household maximising behaviour), but incorporates into that framework, multiple frictions, such as wage and price stickiness.

What are the main findings of this model?

While “demand” shocks such as the risk premium, exogenous spending and investment specific technology shocks explain a significant fraction of the short-run forecast variance in output, both wage mark-up (or labour supply) and to a lesser extent productivity shocks explain most of its variation in the medium to long run. Second, in line with GalĂ­ (1999) and Francis and Ramey (2004), productivity shocks have a significant short-run negative impact on hours worked. This is the case even in the flexible price economy because of the slow adjustment of the two demand components following a positive productivity shock. Third, inflation developments are mostly driven by the price mark-up shocks in the short run and the wage mark-up shocks in the long run.[2]

In other words, in the short run, Government Spending, Risk Appetite and technological progress that requires heavy investment to be realised explains output, whilst classical factors like Labour Supply and (to a lesser extent) productivity shocks matter in the long run. Productivity shocks matter less because they are offset by changes in hours worked, so that if people start earning more per hour, they simply choose to work fewer hours.

However, even though this is the "best" model, that does not mean it is very good! In fact, the performance of the model and models of its class are remarkably bad, given their significance in policy making.

The image below shows the performance of these models against the Fed's "Greenbook model" (GB) and against a purely statistical model with no theoretical underpinning (BVAR). Anything below one means that model has more accurate predictions.


Strictly speaking, this has not answered your question. Afterall, you asked "what model describes reality most accurately" - the only answer to that question is that economic models do not describe reality.

The job of an economic model is not to accurately describe reality, but rather, to accurately summarise the relationships between economic variables, such as output and inflation. It tells you what happens to inflation for a given change in output, and it gives you a systematic way of thinking about that relationship, but it does not pretend to give you a "true" story, in the sense that the truth is something along the lines of, well household a,b,c,d had a little bit more money, and they got together and said, lets spend on this on a trip to Paris, and then the airline that provides flights to Paris saw a 7% rise in demand. Since they didn't have the capacity to meet this demand, the board sat down and said "Look, we either raise our prices, or we keep them constant. Raising our prices will earn us more money in the short run, but may ultimately damage our brand". There was 14-5 split on the board in favour of raising prices, so prices went up. And then something similar also happened for groceries, and televisions etc etc. Obviously, no economic model is therefore going to accurately describe reality, in the way that a historical account might do. In general, therefore economists' models are judged on how useful they are, rather than how accurately they describe reality.


Wednesday, 29 February 2012

How much profit will the sale of Northern Rock make?

Short Answer, approximately £0.

So the UKFI argue that the sale will be completed for somewhere between £46-48bn, and that the cost of the bailout was £37bn bailout. Sounds like everyone's a winner, right?


Now, before I go any further, I want to make it clear that I don't see this analysis as having any normative significance. I don't think the fact that the sale won't generate a profit means that the bailout should not have occurred. As for whether the sale to Virgin should have occurred, (its worth noting all the 'profit' -ie where the return to the Govt exceeds what the Govt put into it-comes not from the Virgin sale but from winding down the rest of the company) I gather from scanning the report that there were other complicating factors involved that required the Govt to make a deal.

The point is this: an £11bn return after a 10 to 15 year period on an investment of £37bn... looks a lot less attractive than before. On page 6 of the full UKFI report, we see:
"However, this cash is expected to be returned over a period of around 10 to 15 years from 2012 as
Northern Rock (Asset Management) plc is run-down and the remaining Government loan is repaid. This
is equivalent to receiving an annual rate of return on the Government’s intervention of 3.5% to 4.5% per
year and compares to the Government’s estimated notional annual funding costs during the period of
intervention of 3.9%"

In other words, the rate of return is about the same as the interest we've paid on the debt we borrowed to pay for the purchase. So we took on a huge risk, and have no profit to show for it.

(But, to be fair of course, letting Northern Rock go bankrupt would have been worse. However, anyone who tries to spin this as a huge victory for the government is clearly being deliberately deceptive).

Saturday, 18 February 2012

The Stimulus is Favoured by most economists

The IGM Forum produces a poll of a sample of the world's top Economists on a variety of issues. The sample includes a wide variety of opinions, including Alesina, Goolsbee, Acemoglu and many others. The results are supposed to be a quick glance at how the economics profession feels about any given topic. The sample size is 40, for obvious Central Limit Theorem / Law of Large Numbers related reasons. (The short version is that 40 is about the number when a population sample tends to become reliably reflective of the wider population, provided that you're not distinguishing the sample by too many variables).

This is just one of many, many interesting results. The overwhelming consensus among economists is that the stimulus created jobs. More importantly, I suppose, it is also by far the most commonly held view that the benefits outweighed the cost. 78% of those expressing an opinion pro or con said the benefits outweighed the costs. It is worth saying here however that the sample size is somewhat small, since almost 1/3 of those asked did not express a firm opinion either way.

Monday, 30 January 2012

Be Careful with Correlations

Hello one and all,

A friend of mine brought to my attention a blog post from Mike Webb (also a friend), arguing that there was a crisis in confidence in the UK Government. The blog post is a good attempt at rigour, but I'm afraid Mike fell into a simple trap.

The argument is expressed in detail here but I think a not unfair summary is this:

1. Uk Government yields have been closely correlated with Yields from European nations..
2. In the months leading up to May 2010, there was a steep dropoff in that Correlation
3. The most natural explanation for that is uncertainty over the outcome of the election.

Statements 1 & 2 are both true, and statement 3 seems reasonable at first glance. So I can say that I liked the blog post. I particularly liked the effort he went to to double check his findings by comparing across multiple regions - UK compared to Germany, France, Italy etc.

Unfortunately his conclusion, that there was mounting suspicion over UK solvency has only a very superficial link to the data. His predictions entail maximally that UK Government Yields climbed in these months. Minimally, his explanation entails that UK yields behaved in a way that was at odds with a wide range of countries in those months.

With a Bloomberg machine able to run correlations he checks only the correlations between different Governments' yields. Unfortunately, he doesn't bother to show us what happened to the actual yields themselves.

Here are UK Yields in the relevant time period (click on the image to see it blown up):

From the graph, we see that over the period UK yields moved up a bit, down a bit, and actually ended the period that he is referring to (January - April 2010) at about the same level, maybe a tiny bit up.

Now here are the European Yields that he is referring to:

Yes, falling yields, implying pessimism over the economy and as yet no worries about fiscal solvency.

The absence of any rise in UK yields is at least a worry for the argument that investors were getting jittery about UK solvency, Now, one could argue, I suppose: "Well, what happens if there was some, external international event that dragged those other yields down, and would have dragged UK yields down as well, if it weren't for solvency jitters?"

Well lets look outside of Europe for a moment:

Ah yes, they all went up, slightly.

In other words, the drop off in correlation he refers to is explained only by a decline in Bond Yields in European countries. One would be very hard pressed to argue that suddenly investors got jittery over UK yields- There's no actual evidence for this in the data whatsoever.

So next time you look only at correlations, remember to actually look at the things you're correlating, before you jump to any conclusions!!!

Tuesday, 24 January 2012

Scattershot Thoughts

Hello all,

Sorry I did a bit of a disappearing act there for a while, you know work happened, life happened.

Anyway, I think its about time for me to pen some thoughts about the future, what with it being the first of the month and all that, a great opportunity to pontificate & predict etc.

Well, politically of course 2012 is a big year - its election time in the States. Obama vs Romney/Gingrich/Santorum/

Well, the Republicans are doing an awfully bad job of choosing their nominee this year.

Anyway, in keeping with the spirits of this blog, which is trying to use models to predict political outcomes, we have a few different models which we can bring to bear on this:

  1. Median voter Theorem

  2. Economic Referendum

  3. The guy that's taller

So most readers of this blog will be familiar with 1. & 2., whilst 3. is the controversial theory based on the simple empirical observation that since the television was invented in the 1920s, the tallest guy has tended to win the U.S. presidential election.

Median voter theorem unambiguously predicts Obama. Obama places jobs above the deficit as his prime concern, like the majority of the population. Obama supports a balanced tax&cuts approach to the deficit, like the vast majority of the population. Obama supports action on climate change, like the majority of the American population. Obama supported the repeal of Don't ask, Don't Tell, like the vast majority of Americans. The list goes on. In fact, Obama's attempt to occupy all of the mainstream Conservative positions has been so succesful that its driven the Republican party into the fringes of its base. With a Gay Soldier being booed in a Republican debate for no reason other than being Gay. So, Median Voter Theorem definitely scores this for Obama.

The Economic Referendum theory is a bit less clear. The basic principle is that the election is treated as a referendum on how well the current president is handling the economy. Until recently, it was obvious this theory would have predicted Romney would walk away with it. However, a few tantalising hints at a recovery (but no actual recovery yet as far as I can see) would suggest that the answer is not obvious. Part of the problem is that the theory isn't as simple as "Unemployment <7% = Incumbent elected, Unemployment >7% = Challenger elected". Partly its about directional movements etc. I would say, that if the economy continues to improve and growth hits 2% +/- 0.3% then this would score it for Obama. Anything less than 1% scores it for Romney. Between 1% to 1.7% is ambiguous.

Mitt Romney is a shade taller, so the third theorem, that the taller guy always wins, would call this for Romney, by an inch.

I'm assuming Romney wins the Repub nomination, which looks likelier by the day.

Sunday, 1 January 2012


I wanted to use the new year as an opportunity to pen some random thoughts about the new year. This is, afterall a blog thats supposed to be 1/3 about trying to use models to forecast the future and then using the data to improve the accuracy of our models.

So here are some thoughts:


2011 has seen some really great additions to mainstream consumer web technology. Quora began to take off but still hasn't quite managed to make it mainstream. Google Plus exploded onto the scene but since then traffic trended downwards. Facebook continued its unabated storm to glory. Airbnb also had a break this year. Its more or less consolidated its dominant position now. Dropbox is supposedly running at a mental $5 Billion valuation! From a personal perspective, my friends have finally signed up in droves to twitter.

So, I think 2012 will be another hot year for tech startups. Facebook will IPO though, which will drive stock prices through the roof for a while before it all calms down again. The startups we come across this year will find that their success is made through their ability to forge real connections between people. Android's persistent growth will eventually begin to drive Google Plus this year I think - Google plus signups will stabilise and then begin to trend upward, slowly


Unfortunately, all economists are predicting slow growth irrespective of their school of thought. Luckily for us however, the source of that slow growth varies and so we can therefore attempt to test some of the differences in views.

  • Austrians, like Ron Paul are predicting economic catastrophe, in the form of "unexpected inflation and a collapse in the value of the dollar".
  • British Politicians across the board have been predicting anaemic growth, although for different reasons. The Labour Party Line is that the Treasury Bond yields will fluctuate with the health of the economy (bad economy = low yields, and a strong economy will see higher yields). Conservatives are saying yields will stay low provided that the economy remains on top of its deficit.