Archive for November 17th, 2014

50 years of Solow growth model…implications and impact

November 17, 2014

A nice interview of Prof. Robert Solow in McKinsey Quarterly (MQ). The interview celebrates 50 years of both the model and MQ.

The best thing about the interview is that it discusses how Solow model was actually applied to the real industries. What is Solow model? Well it says what matters for growth is not labor or capital but technology. What did the actual evidence show?

The Quarterly: What, if anything, surprised you about the findings of the early MGI studies?

Robert Solow: What came as something completely new to me was that if you looked at the same industry across countries, there were almost always dramatic differences in either labor productivity or total factor productivity. To my surprise, it turned out that most of the time, certainly more often than not, the difference in productivity—in the auto industry or the steel industry or the residential-construction industry in the US and in countries in Europe—was not only substantial but couldn’t seriously be explained by differences in access to technology.

We also found that the productivity differences could not be traced to differences in access to investment capital. The French automobile industry, much to my surprise, turned out to be more capital intensive than the American automobile industry. So it was not that either. The MGI studies instead traced these differences in productivity to organizational differences, to the way tasks were allocated within a firm or a division—essentially, to failures in managerial decisions.

I was, of course, instantly suspicious of this. I figured to myself, “What do you expect a bunch of management consultants to find but differences in management capacities? That’s in their genes. That’s not in my genes.” But MGI made a very convincing case for this. And I came to believe that it was right.

🙂 Gave some legitimacy to the consulting industry..

What drove management? Competition..

The Quarterly: So management was the primary factor in productivity differences?

Robert Solow: Yes, and there was another surprise, for which there was partly anecdotal, partly statistical evidence. If you asked why there were differences that could be erased or diminished by better management, the answer was that it took the spur of sharp competition to induce managers to do what they were in principle capable of doing. So the idea that everybody is everywhere and always maximizing profits turned out to be not quite right.

MGI made a very good case that what was lacking in these trailing industries in other countries—or in the US, in cases where the US trailed—was enough exposure to competition from whoever in the world had the best practice. And this, of course, can apply within a country. We know that in any industry, there is a whole distribution of productivity levels across firms and even, sometimes, across establishments within a firm. And much of that must be due to the absence of any spur to do more.

So an interesting conclusion to me was that international trade serves a purpose beyond exploiting comparative advantage. It exposes high-level managers in various countries to a little fright. And fright turns out to be an important motivation.

The Quarterly: So competing against the global best-practice leaders is a way to encourage your own industry to use best practice?

Robert Solow: Yes, and it goes beyond that, even. Competing as part of the world economy is an important way of gaining access to scale. If you’re a Belgian company or even a French company, it may be that best practice requires a scale of production larger than the French domestic market will provide for French producers.

So it’s important for such companies to have access to the international market. That was not something I had thought of. And I don’t think anyone had—at least I had no reason to think, within economics, that there had been much thought about management activities as a big difference between best practice and less good practice. We had always thought, “Well, people seek profits. And if they seek profits, they’ll have to adopt best practice.” Not so.

He says the future research shd look at productivity in services sector:

The Quarterly: Looking toward the future, are there other issues in economics that MGI’s sector-level approach might be helpful for?

Robert Solow: I would like to see more work on the determinants of productivity and productivity increases within the service sector. To begin with, I don’t think we even have a very clear idea about the relative capital intensity within the service sector or between the service sector and goods-producing sector.

I remember I was once writing something in which I was describing the service sector as being of relatively low capital intensity. And then I stopped and remembered that the following day I had an appointment with my dentist and that my dentist’s office was as capital intensive a 500 square feet as I had ever seen in my life.

So I think the place where the MGI approach is most needed right now is in the service sector. There has been service-sector work within MGI, and outside of it as well, but not as much as is warranted in view of the 70 percent or more of all employment in advanced economies that’s in service industries.

The Quarterly: Are there particular places in the service sector where you’d look first?

Robert Solow: Well, that brings me to another MGI result that I found fascinating. At one point, we were trying to understand the industrial basis, the sectoral basis, for the acceleration and deceleration of productivity growth. And one of the things we found was that the two largest sectoral contributions to the acceleration of productivity growth when it was accelerating and, presumably, to the deceleration when it was decelerating came from wholesaling and retailing.1 Both of them, at the time, were low-productivity sectors and low-productivity-growth sectors. But they employ so many people that a slight improvement in the productivity of retailing makes a large contribution to the increase in national productivity.

There has been some work on that, but I think the work is needed now more in personal services. God knows, in healthcare. And education. Or child care. All sorts of things.

Nice bit..Calls himself an ordinary macroeconomist…hope most of us really ordinary economists also believe the same..



Underemployment vs. unemployment…Why overeducaton is as much a problem as undereducation?

November 17, 2014

Brian Clark, Clement Joubert and Arnaud Maurel raise an important issue. When we link labor markets to education the focus is on how undereducation leads to unemployment and so on.  We hardly look at the other side of the story which is how overeducation leads to underemployment where people do not get the jobs as per their education levels. There are ample stories of this kind as well where graduates run taxis and so on.

The authors raise this concern from an American perspective but could be a more global problem as well. Much of the work we do hardly requires knowing just basic skills of 3 R’s (reading, (w)writing and (a)rithmetic).  Unless you get into rocket science kinds of work, just basic is more than enough. But we are really required to pile on more and more degrees just for the sake of it. It is funny how you need an advanced MBA to sell shampoos, hair oils, balance accounts and so on. One can just do all these tasks by just being a simple graduate. But then this is how it is. The society forces us to spend our time more and more on getting education which does not add much value overtime.

Plus with rising costs of education, students have additional burden of debt on their heads. This is how the authors start the post:


Central Bankers and bahavioral biases

November 17, 2014

Andy Haldane of BoE discusses the issue in this speech.

He first lists the behavioral biases and then suggests what central banks can do to overcome the biases:

Preference biases – where the decision maker might put “personal objectives over societal ones, such as personal power or wealth”   

Myopia biases – “people differ materially in their capacity to defer gratification” and studies suggest that people who show greater patience “outperform their impatient counterparts in everything from school examinations, to salaries, to reported life satisfaction”. 
Hubris biases – over-confident individuals are “more likely to be promoted to positions of influence” but tend to pursue “over ambitious targets” like “undertaking over-complex company takeovers. That way nemesis lies”

Groupthink biases – people tend to adapt their view to confirm to those around them and also have a “tendency to search and synthesize information in ways which confirm their prior beliefs”.     
There is little doubt that central banks have suffered from either all or some of these biases over the period with hubris bias being the biggest.
BoE (and others in their own ways) have tried to get out of these biases:
To tackle preference bias, the Bank’s does not set its own objectives.  It has three policy making committees – for monetary policy (MPC), financial policy (FPC) and prudential regulation (PRA Board). In addition, “to ensure the actions of the Bank’s policy committees are well-aligned with society’s wishes” their targets are “set ex-ante in legislation by Parliament acting on behalf of society”. 
To prevent myopia, the Bank of England has been made independent from government when choosing how to set monetary and financial policy to achieve their respective objectives.  These decisions have been given to an institution “whose time horizon stretches beyond the political cycle”.  Andrew suggests that central bank independence has been successful at taming “the inflation tiger” but he warns that “as some countries are finding today, the tiger is capable of biting back” in the form of low and falling inflation expectations. Andrew notes that while inflation expectations in the UK have held up pretty well, this is something he is “watching like a dove.”
To guard against Hubris at the Bank, “all policy decisions … are made by Committee rather than an individual” which “provides some natural safeguard against over-confidence bias”.  Andrew notes that external MPC members have contributed importantly to the diversity of opinion on the committee “on average they have been around twice as likely as internals to dissent from monetary policy decisions”. 
Finally to ward off groupthink, each member of the policy committees is individually accountable for their vote or view, and this should encourage “a variety of analytical perspectives”. That said Andrew notes that analysis of MPC minutes suggests that they did not devote enough time to discussing banking issues in the run up to the financial crisis, something that in hindsight, “looks like a collective analytical blind-spot”. He argues that despite all the changes to the Bank’s policy responsibilities since the crisis, “it is too soon to tell whether any remaining blind-spots remain”. Also, in his view “improvements to the Bank’s forecasting process have some considerable distance still to travel”.
Have these committees worked? I mean it just has people with very similar backgrounds trained in the same kind of economics. How can views be any different? We make a big deal of dissents. Have these dissents dissuaded the chief of the central bank from taking a different path? All we have is hype around dissents, nothing more nothing less. Groupthink continues despite committees
Much of fight against inflation was brought during highly comfortable global times. We are now seeing serious limitations on what central banks can achieve on inflation as well. Despite so much easing, deflation pressures remain in most adv economies. This is against expectations that we will have high inflation due to these policies by many experts. The  standard ideas have just failed really. But hubris continues..
All these biases can only be avoided if alternate schools of thought are encouraged in economics. The subject should be more interdisciplinary and humble. Just by saying we have committees and encourage diversity, it does not happen.  When most students are made to think in one standard way, diversity is just a myth and groupthink a reality..

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