Hackonomics

Tuesday, February 12, 2008 | 07:00 AM

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"The purpose of studying economics is not to acquire a set of ready-made answers to economic questions, but to learn how to avoid being deceived by economists."

-Joan Robinson, Cambridge University

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One of the things that really perturbs me are disingenuous, intellectually indefensible commentary consisting of willfully misleading tripe. Up until recently, that territory has been owned by the WSJ OPED pages. This past weekend, the NYT was seen elbowing its way into the same space.

I call this approach to economic analysis Hackonomics.

An OpEd in the Sunday Times is classic Hackonomics. Unfortunately, it takes little craft to slip junk past the editors at the Times OpEd section. Impressive-looking academic or government credentials seems to be all that is required. (Its a shame they don't have, say, a professor from the Princeton Economics department on staff).

Perhaps there is a fear of looking silly or economically ignorant, rather than asking anyone else about any of these "analyses." What we get instead are pieces like You Are What You Spend. The authors are Michael Cox, and Richard Alm, chief economist and senior economics writer at the Federal Reserve Bank of Dallas. As my British colleagues would delightfully articulate, "their work is shite."

To wit: These two gentlemen press forward the idea that the proper manner to review economic inequality should involve looking not at income differentials. Rather, this Fed duo favors a more direct measure of economic status: household consumption. They claim "the gap between rich and poor is far less than most assume, and that the abstract, income-based way in which we measure the so-called poverty rate no longer applies to our society."

Their analysis is so problematic and their theory so full of holes, that, if time permitted, we could identify errors in nearly every paragraph. That sort of critique is best reserved for serious intellectual analysis of major importance. For Hackonomics, we will simply identify 3 major flaws, and then get on to more pressing and important work.

Let's take a closer look at their arguments:

1. Income Disparity: Abstract? There is nothing "abstract" about income-based measures of poverty or wealth inequality. Merely calling income comparisons "abstract" does not make it so, nor does it make their position any less absurd. Instead, it reads as a transparent attempt by the authors to avoid any income discussion.

Why not discuss income? Perhaps the data is the reason: The share of national income of the wealthiest 1% rose from 14.6% five years ago (2003) to 17.4% in 2005 (Emmanuel Saez, University of California-Berkeley). And since 2005, the wealth disparity has grown even further. 

Indeed, as several commentators have already pointed out, these same authors previously tried to make an income based argument that "the gap between rich and poor is far less than most assume" -- and crashed and burned.

Next attempt, please.

2. Median/Average. The next intellectually corrupt trick is a classic statistical error. The authors look at average -- rather than median -- spending and income by quintile, and determine there isn't much inequality in the United States.

How did Sunday's silliness manage such a feat? They start with a variation of the median/average trick (Bill Gates walks into a bar . . . ). Only this time, the perps are slightly clever. Rather than merely play with "average," they oh so craftily break the spending pools into quintiles. This creates the appearance (see chart below) of relative equality on a per capita basis of spending equality.

RichistanAny statistician in the country will tell you this an embarrassing error of the highest magnitude.

The top quintile have an "average" income of ~$150k and an average spending of ~$70k. But "average" broadly misrepresents the top quintile. This twist ignores the vastly disproportionate income and spending habits of the top 1%, and the even more disproportionate top 0.1%.

Wall Street Journal columnist Robert Frank's book, Richistan looks at the recent unprecedented rise of wealth in the U.S. The top 2 1/2% -- over 7 million households -- have a net worth of $1–$10 million. The top 1/2% -- over 1.4 million households -- have a $10–$100 million net worth. There are now thousands of households -- top 0.1% -- with a $100 million to $1 billion in assets. Oh, and there are now more than 400 billionaires -- the top 0.01%.

This is not a bad thing per se. I am all in favor of economic freedom and wealth creation. But to pretend that there is little wealth disparity is simply nonsense. 

~~~

3. Comparing Household Consumption:

Looking at Household consumption can yield some interesting insights -- but it matters at what you look at. Our intrepid authors have avoided discussing the expenditures on necessities, and instead went a different way:

"To understand why consumption is a better guideline of economic prosperity than income, it helps to consider how our lives have changed. Nearly all American families now have refrigerators, stoves, color TVs, telephones and radios. Air-conditioners, cars, VCRs or DVD players, microwave ovens, washing machines, clothes dryers and cellphones have reached more than 80 percent of households.

As the second chart, on the spread of consumption, shows, this wasn’t always so. The conveniences we take for granted today usually began as niche products only a few wealthy families could afford. In time, ownership spread through the levels of income distribution as rising wages and falling prices made them affordable in the currency that matters most — the amount of time one had to put in at work to gain the necessary purchasing power.

At the average wage, a VCR fell from 365 hours in 1972 to a mere two hours today. A cellphone dropped from 456 hours in 1984 to four hours. A personal computer, jazzed up with thousands of times the computing power of the 1984 I.B.M., declined from 435 hours to 25 hours. Even cars are taking a smaller toll on our bank accounts: in the past decade, the work-time price of a mid-size Ford sedan declined by 6 percent."

This is, of course, sanctimoniuos bullshit classic economic misdirection.

What the authors are revealing here are not rising incomes or societal similarities of wealth. Rather, their data and cost discussion are about Technology adoption lifecycle (Joe M. Bohlen and George M. Beal, 1957), later refined in Everett M. Rogers' Diffusion of Innovations. New technologies and products come down in price over time, regardless of the state of economic equality in the broader society.

This is  the oldest dodge in economics. That two Fed economists either fail to understand technology adoption cycles -- or worse, have chosen to  willfully ignore it -- simply boggles the mind. If this is the best that Federal reserve researchers can produce, it does go a long way in explaining why our financial system is near crisis.

A quick review of this concept is in order, on the (hopefully) slim chance the rest of the Fed Reserve research group is as abysmally educated in the ways of technology and economics.

All of the above named products -- Washing machines, phones, autos, TVs, VCRs, Cellphones, PCs -- went through a well established adoption model. In the classic definition (see chart below), the first group of people to use any new technology are called "innovators," followed by "early adopters," then the "early majority" and "late majority," and lastly, the "laggards." 
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Technology Adoption Lifecycle

Diffusionofinnovation

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The impact of this adoption process and the manufacturing economies of scale are significant determinant of technology product prices.

Here is a grossly over-simplified discussion of how this works: When the innovators buy a product, they essentially are paying for all of the R&D costs, and other development expenses. You paid 365 labor units for a VCR in 1972 because they were a limited production, custom product that was practically hand made. When a PC cost 465 labor units, chip fabs were nowhere near as plentiful as today -- and the biggest cost in early PCs were the exorbitant chipsets contained in them.

The early adopters pay less than the innovators, as factories get built to mass produce chips or tape transport mechanisms or cell phone keypads. What was a nearly custom made product becomes a merely limited-production, high-end one. Where the innovators paid for the R&D, the early adopters paid for the fabs and factories to be built.

The early majority doesn't get the use of the product for the first few years, but they get a big price benefit of manufacturing economies of scale. Mass production of components bring prices down; successful products attract competition to the space, and soon more manufacturers are cranking out more units. Through competition, prices begin dropping faster and faster. The late majority gets even cheaper prices. Consider the laggards and the VCR today -- they cost about $29 each.

None of this has any relevancy to problems of wealth distribution and inequality in America.

To understand the serious issue of relative inequality, you would not look at technological toys (unless you were idiots). Rather, you would consider the consumption of necessities -- Shelter, food, medical care, clothing, education, transportation. Not only that, but you would not simply review the quantity, but also the quality of the products that get consumed.

Compare the top and bottom quintiles: Who is consuming fatty, high carb foods, and who is eating lots of protein, fresh fruits and vegetables? What about medical care? Do they have reliable access to any sort of family physician, regular check ups, doctor visits, ongoing treatments, preventative care -- or is their medical consumption on an emergency room basis?  What is the quality of their housing like -- safe neighborhoods, with access to good schools? Or something less desirable?

If we are going to use consumption as a measure of economic equality, then look at the quality of essentials; measuring toys ain't the way to go . . .

~~~

4. How do the Affluent Elite Spend?

Since the authors want to look at spending, let's do just that. Only instead of their intellectual indefensible "average" let's see how that top 0.5% spent their cash.

A study by a Prince & Associates last summer (2007) detailed the spending habits of the upper economic strata. They found this group spent their money as follows:

<p><p><p>Super Rich Plan to Increase Spending According to New Elite Traveler/Prince & Associates Summer Spending Survey </p></p></p>

    Dollars Spent Category - 2007 Spending per Affluent Elite Household
                        Category           Category
                        Spending           Spending
    Summer Spending        *       2007       *      2005    Change 2007/2005
    Activity               %      $ Spent     %     $ Spent  $Change %Change
    Yacht Rentals        10.60%  $384,000    9.50% $317,000  $67,000  21.14%
    Redecorating         44.90%  $129,000   30.90%  137,000  ($8,000) -5.84%
    Villa Rentals        15.70%  $106,000   13.80%  $79,000  $27,000  34.18%
    Experiential
     Excursions          25.80%  $103,000   22.70%  $79,000  $24,000  30.38%
    Jewelry/watches      73.70%  $94,000    63.20%  $63,000  $31,000  49.21%
    Luxury Cruises       47.50%  $92,000    43.10%  $71,000  $21,000  29.58%
    Charitable Giving    97.50%  $82,000    98.40%  $52,000  $30,000  57.69%
    Vacation Home
     Rentals             12.10%  $82,000    11.80%  $64,000  $18,000  28.13%
    Out-of-Home Spa
     Services            67.70%  $61,000    48.70%  $49,000  $12,000  24.49%
    Summer
     Entertaining        93.90%  $56,000    92.40%  $39,000  $17,000  43.59%
    Luxury Hotels        95.50%  $48,000    93.40%  $36,000  $12,000  33.33%
    Luxury Resorts       84.80%  $41,000    82.60%  $23,000  $18,000  78.26%
    At-Home Spa
     Services            53.50%  $38,000    47.40%  $26,000  $12,000  46.15%
    Apparel/accessories  92.40%  $34,000    86.80%  $16,000  $18,000 112.50%
    Audio/visual         51.50%  $31,000    50.70%  $14,000  $17,000 121.43%
    Wines and Spirits
     for Social
     Entertaining        86.90%  $24,000    77.00%  $19,000   $5,000  26.32%
    Wines and Spirits
     for Personal
     Consumption         84.80%  $17,000    74.30%  $11,000   $6,000  54.55%

                                  2007             2005     $Change  %Change
    Total Luxury Summer
    Spending/Household       $622,202.02        $399,187.50 $223,015  55.87%

    *Percentage of those surveyed spending in this category
Survey of Households with Net Worth $10 Million +

~~~

$384,000 for Yacht Rentals? $94,000 on Watches? Don't forget Redecorating costs: $129,000. All that spendiong sure can work up a thirst! ($41,000 for Wines and Spirits).

Gee, it sure looks like we have some spending income differentials!

It is true - the rich are different: They spend a whole lot more money on luxury items than the rest of the country!

~~~

Bottom line: This is one of those absurd situations, where after you look at all the facts, and analyze the deceptive way the authors construct their arguments, you simply have to call Bullshit.

 

10chartlarge



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Sources:
You Are What You Spend
W. MICHAEL COX and RICHARD ALM
NYT, February 10, 2008
http://www.nytimes.com/2008/02/10/opinion/10cox.html

Super Rich Plan to Increase Spending
Elite Traveler, Prince & Associates Summer Spending Survey
May 18, 2007
http://tinyurl.com/ysda7x

Richistan
Robert Frank
Crown, 2007

Technology adoption lifecycle
Joe M. Bohlen and George M. Beal,
1957

Diffusion of Innovations
Everett M. Rogers
1962

Income and Wealth Inequality   
Emmanuel Saez
University of California-Berkeley
http://elsa.berkeley.edu/%7Esaez/

Tuesday, February 12, 2008 | 07:00 AM | Permalink | Comments (69) | TrackBack (1)
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Listed below are links to weblogs that reference Hackonomics:

» Hackonomics, Part II from The Big Picture
A quick follow up to last week's Hackonomics discussion, where we looked at how little alleged wealth inequality there is in America. Part of our critique was that dividing the US into quintiles was a variation of the median/average error, and only ser... [Read More]

Tracked on Feb 21, 2008 12:31:22 PM

Comments

Jesus!

Remind me not to piss you off!

Posted by: Mike | Feb 12, 2008 8:11:51 AM

The comments to this entry are closed.



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