I’ve spent most of the last couple of days at the QUT Creative Commons Conference, with Larry Lessig as the main speaker and featuring the launch of the Australian version of the Creative Commons license. I’ve got enough out of this for weeks of blogging. For the moment though I’ll just mention that there were some very interesting sessions on intellectual property rights in massively multiplayer games like Everquest. This got me thinking that, purely for research purposes, I should give one of these games a try. Fortunately, sanity returned in time. If I need another addiction to combine with blogging, I’ll go for something safe and sensible, like crack cocaine.

The unveiling of the Airbus A380 raises a couple of thoughts (not entirely new ones, and pointing in somewhat different directions). First, this is another example of the US loss of dominance in manufacturing. Boeing has ceded the jumbo jet market it created with the 747 to Airbus, betting everything on the proposition that airlines will want medium size planes like its forthcoming 7E7. Even if this turns out to be true (and limp early orders don’t support the idea) Airbus has an entrant in this market as well (the A350). Meanwhile, by abandoning the 717 (the old DC 9 inherited in the merger with MacDonnell Douglas), Boeing has abandoned the small jet market, the winner here being the Brazilian fimr Embraer. All of this parallels Detroit’s loss of dominance in the car market. And all this despite the big decline in the dollar-euro exchange rate. This suggests that winding down the US trade deficit is going to be a painful process.

The second point is the slowdown in progress in transport. In the 25 years from the end World War II to 1970, passenger air travel went from essentially nothing to the 747 jumbo jet launched by Boeing in 1967. Move ahead another 35 years, and we still rely on the jumbo jet. With the A380, we are looking at what will probably be the state of the art for the next few decades, and it’s … a jumbo jet, only 50 per cent bigger. Of course, there have been improvements in every part of the plane, from composite materials to more efficient engines, but it’s still, in essence, a bigger 747. The same is true, in spades, for cars. For all practical purposes, it looks as though we reached our collective speed limit 40 years ago[1].

So, maybe it doesn’t matter that the US is losing the markets for cars and planes. With firms like Intel and Microsoft it dominates the moneymaking end of the most innovative part of the economy, and with Apple, it provides most of the creativity. On the other hand, you need a lot of iMacs to buy an A380.

fn1. In fact, we’ve slowed down in the interim, with the introduction, commercial failure and ultimate withdrawal of the Concorde.

A decade or so ago, I wrote some modestly successful papers about the design of lotteries and the rationality or otherwise of buying lottery tickets. Having come to the conclusion that buying lottery tickets was (or at least could be) rational, it struck me that, apart from raffles and the odd birthday present, I’d never actually had a ticket in a proper lottery. So I went down to the newsagent on the assumption that I could hand over my money and get a chance at untold wealth. Instead I was confronted with a bizarrely complex lotto form (this was before scratchies, I think). I looked at it and decided it was too much trouble, and I would try to make my fortune the old-fashioned way[1].

Now I’m in a similar position. I’ve told the world the long-term US interest rate has to rise and, correspondingly, the price of US Treasury notes has to fall. Given that I don’t know when this will happen, I’m not willing to risk the unbounded losses of a short position. But I’d at least be willing to consider a modest flutter in put options, if the transactions costs weren’t too high and the settlement date were far enough in the future. However, although I’ve written plenty of papers about the properties of derivatives, the risks they pose to the world financial system and so on, I don’t know where or how to buy them, or what the costs are. The Sydney Futures Exchange seems to consider them too exotic. Any suggestions on easy ways to join George Soros and Warren Buffett will be greateful appreciated.

fn1. That is, as all Australian readers will know without being told, through real estate speculation.

I’m just about to knock off for Christmas, but I have to get ready for a conference at Queensland Uni of Technology early in the New Year where Larry Lessig will be the main speaker. I’m giving a very short presentation, and struggling to improve my understanding of all this, in particular the relationship between the technology of the Internet and notions of social capital. I haven’t come up with anything earthshattering, but I have had some thoughts on which I’d welcome comments.

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The US current account deficit came in yesterday at $164.7 billion for the third quarter of 2004, lower than expected but still a new record. The previous day saw the trade balance for October, also a record deficit. As usual General Glut has detailed coverage.

In the face of all this, long-term interest rates, as measured by the yield on 10-year Treasury bonds, are falling. The rate is currently about 4.2 per cent. By looking at inflation-protected bonds (TIPS) it’s possible to work out that this is made up of an expected CPI inflation rate of 2.5 per cent and a real interest rate of 1.7 per cent. As the Fed has increased short-term rates, the margin between long and short rates is falling, and seems likely to go close to zero.

This makes no sense at all to me. Given the near-certainty of further depreciation of the $US in the long run, who would buy 10-year bonds at rates like this, who would hold them if they had them, and why doesn’t someone like Soros short them? The answer to the first question appears to be “non-US central banks”, the answer to the second must have something to do with institutional inertia. As regards the third, and relying on introspection, the answer may be that the market can remain irrational longer than Soros can remain solvent (certainly that explains my non-participation). Soros took a hammering, if I recall correctly, betting against the NASDAQ in 1998, and the fact that he was proved right in the end is cold comfort.

Since I don’t believe that capital markets are efficient or collectively rational in the short or medium term, this kind of thing doesn’t pose a fundamental problem for my worldview. Still, I can never quite stop being surprised when asset prices are so obviously wrong.

Milton Friedman has a piece in today’s Fin and also[1] in the Oz making the point that, even though many fewer people nowadays professes belief in socialism than did so in 1945, the general movement of policy since the end of World War II has been in a socialist direction, that is towards an expansion in the share of GDP allocated to the public sector. He draws a distinction between ‘welfare’ and the traditional socialist belief in public ownership of the means of production, seeing the former growing at the expense of the latter.

From a social-democratic perspective, I’d put things differently. There are large sectors of the economy where competitive markets either can’t be sustained or don’t perform adequately in the absence of government intervention. These include human services like health and education, social insurance against unemployment and old age, production of public goods and information, and a range of infrastructure services. In all these sectors, governments are bound to get involved. Sometimes, the best model is private production with public regulation and funding, and sometimes it is public ownership and production. The result is a mixed economy.

Over time, the parts of the economy where competitive market provision is problematic have grown in relative importance. By contrast, agriculture, the archetypal competitive industry, has declined in relative importance as have mining and manufacturing, areas where governments have usually performed poorly.

The result is that the ideological swing towards neoliberalism has done little more than slow a structural shift towards a larger role for government.

fn1. Thanks to Jack Strocchi for locating this

I’ve been reading

“Pay without Performance : The Unfulfilled Promise of Executive Compensation” by Bebchuk and Fried)

For anyone who still believes that executive pay is based on rewarding performance, and encouraging risk-taking, this book should disabuse them. There are loads of studies pointing out, not surprisingly to anyone who reads the papers, that top executives and boards look after each other in a way that rewards failure.

The most telling detail for me is the observation p98, that every single CEO in the S&P Execucomp Database has a defined benefit pension plan. This, while bosses everywhere have been shifting their employees onto defined contribution plans, where they, and not the company, bear all the risk, and while the Republicans in the US are trying to do the same with Social Security.

One thing I would have liked more of is quantitative information about the aggregate magnitude of payments to executive pay, considered in relation to corporate profits. There’s only a little of this in the book, though the authors say here

Aggregate top-five compensation was equal to 10 percent of aggregate corporate earnings in 1998-2002, up from 6 percent of aggregate corporate earnings during 1993-1997.

Given that this excludes various kinds of hidden transfers[1], that non-executive board members extract substantial rents (mostly through favorable corporate decisions rather than in cash) and considering senior managers, rather than merely top-5 executives, as a class, it’s apparent that the total rents income flowing to this group could easily be between 25 and 50 per cent of aggregate corporate profits. If this is correct, it ought to have profound implications for the way in which we model corporations, and the way in which we think about the class structure of modern capitalism.

fn1. It’s not clear whether retirement benefits are counted, for example, and these are as large, in present value terms, as direct compensation. Then there is the observation that executive insiders do remarkably well in trading the shares of their own companies.

In the discussion of the current account deficit, commenter Homer Paxton has emphasised the importance of terms of trade, a point I’ve tended to neglect. As Barry Hughes points out in today’s Fin (subscription required) terms of trade (the ratio of world prices for the things we export to prices for the things we import) have improved steadily throughout the life of the Howard government, making their job a lot easier and meaning that the trade deficit is much smaller than it would be otherwise. Hughes thinks the terms of trade will turn down within the next year.

Meanwhile, the US bond market bubble may be just about to burst. Ever since Bush was re-elected, people have been losing faith in the assumption that somehow everything will come right. The people who really matter are the Chinese and Japanese central bankers who hold about a trillion in US government debt. The headline on this Observer story Japan threatens huge dollar sell-off is slightly alarmist, since the threats are being made by an LDP official, but the explicit reference to the need for higher US interest rates is the first I’ve seen coming out of Japan.

Having been involved in the debate over schools policy for quite a few years, I’m enjoying a bit of schadenfreude following the publication of a couple of regression analyses showing that students at charter schools (publicly funded US schools operating independently from the main public school system) score worse on standard tests than students at ordinary public schools[1]. I don’t have a particularly strong view on the desirability or otherwise of charter schools, but I have long been critical of one of the most prominent rationales for charter schools and other programs of school reform[2].

This is the claim that “regression analyses show that students in small classes do no better than those in large classes”. If you believe this claim, you should believe the same claim with “charter schools” replacing “small classes” since both are supported by the same kind of evidence.
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If you want to see why adjusting the balance of trade will be a painful task for the US, it’s worth reading this generally upbeat article about the revival of the port of New York, thanks to imports from Asia. The money quote, several pages in

After unloading 1,120 containers from the [Hyundai] Glory, the longshoremen reloaded the ship for the return trip. Of 667 containers to be sent back, 419 were empty, being returned to Asia to carry more goods back to the United States. Of the rest, most were stuffed with two of New York’s biggest exports: wastepaper and scrap metal.

Even on the most generous interpretation of comparative advantage, I don’t think returning packaging material and scrap to your suppliers can form a sustainable basis for trade.

If you want to keep up with this topic, bookmark General Glut and Brad Setser

UpdateA comparison with Australia. The picture at container ports here is much the same, which is one reason I always found the focus on improving waterfront efficiency so odd. I’m not a mercantilist, but it doesn’t seem to me that, for a chronic deficit country, our top economic priority ought to be improving the efficiency with which we import things.

For most of the 1990s, our deficit on manufactures (which mostly come in containers) was pretty much offset by surpluses in agriculture (shipped in bulk carriers) and some services like education and tourism. So, we had a roughly sustainable position, with trade in balance. The current account deficit reflected payments to foreign capital and was broadly consistent with a stable ratio of foreign debt and equity to GDP.

In the last few years, however, our manufacturing exports have fallen in a hole, while imports have boomed, producing large and unsustainable trade deficits again (though not as bad as the US). The growing CAD has mainly financed investment in housing, as far as I can see, which is not a good sign as housing services are mostly not tradeable.