The EGB BLOG

Economics of Global Business

Reflection time and why economics is hard

After the exam it’s always a good time to be thinking and ask ourselves why are we doing what we are doing.

Well the Wall Street Journal never disappoints. Last week there was this article about the role of PhD economists (like myself) in making policy. This is all in the context of recent announcements of the Trump administration to appoint Stephen Moore and Herman Cain (both without high-level, formal economic training) to the Borad of the Federal Reserve.

Ok, so what’s the big deal. The issue is about some perception of elitisim and having a PhD puts people out of touch…hence we don’t want those guys in charge. Well here is a nice quote from Stephen Moore espousing this view:

“Mr. Moore has a master’s degree in economics but despises the Ph.D. economists who staff the Fed: [Moore said] “It’s filled with hundreds of economists who are worthless, who have the wrong model in their mind,” he said in an interview last year. “[Moore said] They should all be fired and…replaced by good economists.”

Jeez, that makes me feel good. :(

But the article correctly points out the key issue:

“The debate, rather, is whether economics and economic models are useful tools for central bankers. Economics isn’t just complex equations and forecasts. It is also a way of disciplining your thinking, making sure things add up, asking when one variable changes if others are also changing, ensuring your assumptions and predictions don’t contradict each other, and testing your hypotheses against alternative hypotheses and evidence. Plenty of non-economists adhere to that discipline and plenty of degree-carrying economists don’t.”

Read that in bold. Read it again. This is the point of EGB. Read the stuff in bold again.

This is also why it is hard. It’s not about the Cobb-Douglas production function (blah blah blah)… It is hard because we are having to train our thought process about the economy to work in a systematic and coherent way. That’s the goal. And guess what, we are making good progress towards it.

Seeing the cost of trade policy in action

In my T/Th class we discussed these slides from my trip in Argentina in 2016/2017 with my family. Did not discuss this in the M/W class, but important to look at.

Here is the amazing thing. This slide deck has pictures of identical products. One in a toystore in Moreno just outside of Buenos Aries. Look through it, they are shocking. 500$ for a lego city fire boat! 50 in the US!

I bring this up as it highlights some aspects that anti-trade policy can lead too that lie beyond the standard argument in the Ricardian model. Here is the issue:

One thing that trade leads to is more variety. What you do not see in the shelves is that variety is quite limited. It is not like what you see when you would walk into a Walmart. Variety is good in-and-of itself (trade allows me to try new things!), but it has extra benefits:
More variety leads to competition. And more competition leads to lower prices. In the Argentina case, I think this is the core issue. Yes there is about a 30-40 percent tariff on toys. There is also a value added tax of about 20 percent. But this does not account for the full price difference. Why is the price so high? It has to be about competition. The tariff restricts competition, this leads to less variety, and in turn allows suppliers to charge higher prices. Think, the toy store owner says “this is the one lego I got, and if you want it, this is the price…500$”
The other thing not seen in the photos is the type of competition that exits. In Argentina, there is a domestic “lego-like”. These are much cheaper and poorer quality. Here is the issue, the lack of competition allows producers like this survive. And this is not what we would like from an efficiency point of view as the best allocation would have people, capital, etc. working in the most productive/high quality firms.

One final thought. All these mechanisms are different relative to the Ricardian model of trade. Their, trade is about getting lower prices for the same goods. And this works purely through comparative advantage. This is nice, but as this discussion above argues, trade also affects the nature of competition and lets to good benefits.

Seeing Comparative Advantage in Action

In class we talked about the article regarding NAFTA (and Trump’s plan to scrap it). This article is great as I think it really highlights what specialization according to comparative advantage looks like. Here are some choice quotes to think through:

“Mexican workers in a Foxconn facility assemble Dell computers that were designed in Texas and will be sold all over the world. Low labor costs keep Dell on a competitive footing with global competitors like China’s Lenovo. Because of that, Dell can employ thousands of highly paid engineers and salespeople in the United States.”
“If a product uses really sophisticated materials like high-strength steels and advanced composites, and more sophisticated processes,” Mr. Swiecki said, there’s a better chance you can find the people with the skills needed in the United States or Canada. Meanwhile, the lower price of labor-intensive parts imported from Mexico helps control the cost of the overall automobile and makes it more competitive with cars built in Europe or Asia.””

In both these examples, we (the US) specialize according to our comparative advantage: engineering, sales, intricate production processes. Why? we have high levels of education and skill. Mexico specializes in assembly, because they are low skill tasks. Yes, we could do both task very effectively, but we are better off by specializing in what we are really good at.

While this all is great. We should not forget that this pattern of specialization comes with costs…principally the displaced workers who do not have the comparative advantage. Here is the quote:

“it’s fine to say that Dell is a more competitive, successful company by assembling computers in Juarez, which creates more high-paying jobs for the people who design and sell those computers. But that isn’t much solace if you were one of the 905 people who lost jobs at the plant in Winston-Salem, N.C., doing that same work.”

Ok so how do we think about this. As the article suggests, the narrative that trade hurts some people is not wrong. But the solution is not to get rid of NAFTA, but find ways help those who are disadvantaged from trade while preserving the gains that come with it.

Fall Economics Electives

Interested in more economics. Here is the departments selections of electives. Feel free to ask me questions about what may be of interest.

How to do better on exams—Pro Tip Edition

After the exam I talked with some of the students that performed well on the exam and asked “how did you study, what helped” and here are some of their thoughts (with light editing):

“I think that doing the practice exams early on to figuring out what concepts I understood or was confused about was very helpful. The practice exams also helped me understand how to approach the questions in terms of syntax, which is important for me because a lot of times on exams my main issue with tests is understanding what the question is actually asking since every professor/exam tends to have different ways of wording things. One thing that really saved me on the exam was going over the GDP as value added/wages/consumption worksheet from class because it not only helped with the final question but also tied in with all of the concepts related to that chapter.”
“I studied by first reviewing all the slides and making a cheat sheet. I also did all of the problems that were given. I felt that the practice midterms were definitely the most helpful. Personally, I did all the practice midterms once before the day of the exam, and then again right before the exam.”
“All I did was looking at all the lecture notes and doing all the in-class excises. Then I did the practice exam twice, once during the review and once before the exam.”
“So on top of the obvious tips of looking over the slides, I really tried to understand why certain things happened opposed to just what should happen. I also studied with people and would try to discuss the concepts on a deeper level. In general, I just try to understand why because you can only apply the theories if you understand why.”
“My cheat sheet is very formula-heavy, which is the way that I interpret the relationships between the variables. I also think that’s the best way to explain my answers clearly. If I’m particularly confused about a concept, I will first apply the formula, then think about the problem in a common-sense manner to see if my interpretation makes sense.”
“In regards to the tips of studying, I think asking questions and doing the practice exams are the two most important things. After finishing the practice exam, I spent time trying to understand the logic of the questions I got wrong and make sure I know how to solve similar questions. When I don’t understand something, I either ask you or my friends for help until I understand it.”
“I did exactly what you said. You told us to use the practice exams as a guide rather than a benchmark test and to read the textbook and notes. Other than that, I really tried to understand the assumptions we have made throughout class. For instance, on the TFP problem, it was really crucial for me to understand that the production function has constant returns to scale and that labor and capital are fixed. So the problem was really about understanding what it means to be productive- increased output with the same level of inputs. I used the same intuition that you did…using the equations MPL and MPK with increased Y and same inputs to find the conclusion”

A couple of things that I see in these answers. One is using the practice material in a way to really understand the logic behind the answers. Its more that just seeing things, but asking yourself, do I see how this stuff fits together. Another theme that I like was working with others. Verbally explaining things to each other, working through the kinks is a great way to work towards a better understanding of what is going on.

I hope this helps!

Take a step back and reflect on how much you have learned…

After the first midterm is always a good time to reflect on the growth you have achieved. We’ve covered a bunch of stuff and in the videos below I hope you see how much you now understand about the economy.

The videos below are from a 60 minutes interview with the Chairman of the FOMC, Jay Powell. We will learn a lot more about him and how monetary policy is set (this was all in the headlines this week), but let’s hear what he as to say about the economy.

The full interview is below (its not too long 14 mins) and worth watching the whole thing. What is interesting from our standpoint is minute 3:30 and on…the question to him is about how fast can our economy grow. How would you answer that question before you started the class? And now? How does Chairman Powell answer it?

Here is a clip and he is talking about labor force participation (and lack there of it) and it’s consequences.

Again, just think about the idea that when people work, we all benefit. And it’s also worth reflecting on the consequences of when people do not participate in the labor market.

Really cool stuff. Look forward to talking with you about these issues and more after the break.

More on technological change, growth and connecting it with class

What is TFP? Why is it important? The key issue is that this is the one thing that is able to beat diminishing returns (which capital and labor are subject too). And without improvements, living standers…think real wages will not increase. Do you know why…how do wages relate to Y/L…

Here is a short video discussing a recent book that tackles the question about the future of US (and other developed countries) economic growth and specifically technological change (TFP.)

The logic of the author’s argument fits very well with what we have been doing in class the last couple of days. We showed how growth is connected with growth in productivity. His argument is that in the past we saw amazing technological innovations that increased productivity and, thus, GDP and leads to rising living standards.

Today—his argument goes—technological advances such as smart phones, improvements in computers, social media, artificial intelligence, etc., will have less of an impact on productivity growth than the innovations in the early 20th century (e.g. flush toilets, electricity). Thus, we should NOT expect growth in living standards like we experience in the past 100 years. What do you think?

Week in Review (3/1)

It went by fast…a couple of things:

We spent time discussing how GDP is spent, i.e. how our production/income is allocated to spending on consumption, investment, and then government.
We arrived at this nice insight, that in equilibrium, the real interest rate adjusts to equate savings (by me and you) with investment (by firms).
In the T/Th class we walked through some examples in the context of the GND. So what does an increase in government spending do, well it lowers public savings as the government is buying more stuff. National savings equals public and private savings, so this means that national savings will fall. Then with the bullet above, this implies that the quantity of investment in the economy falls.

This is what economist would call “crowding out” where public economic activity replaces private economic activity, in this case higher G means less investment. Empirically how much crowding out takes place is open to debate, but this insight is very important to keep in mind when thinking about government spending.

Week in Review (2/22)

It was a short week, but we made a bunch of progress…

Talked about how the rental rate on capital is set so that it equals the marginal product of capital of MPK = R/P. Moreover, we argued that what capital receives should be equivalent to the real interest rate, “r.”
We looked at how the real interest rate (as measured as the difference between the one year nominal rate minus the inflation rate) behaved overtime. Overall, there has been a large decline in real interest rates over the past 40 years.
Thursday class…we used all our tools and talked about the economic affects of immigration…its affects on GDP, wages, and real interest rates.

Week in Review (2/15)

Great job! What have we accomplished this past week:

Talked about the production function: Three key properties: (i) more inputs, more outputs, (i) diminishing marginal products, (iii) constant returns to scale. The big lesson here is about how the factors of production along with TFP determine real GDP.
From our accounting, we know that the fruits of production are distributed as income. So we learned about how wages are determined: MPL = real wage. The production function makes clear how the MPL and, in turn, the wage depend on the stuff. For example, diminishing marginal products implies that more L, lowers the marginal product of labor (MPL), lowers the real wage.
We then tested some implications of this theory by looking at PS1. One prediction was that growth in nominal GDP (PY) should grow at the same rate as total labor compensation (wL). We saw that this was mostly true. A second (related) prediction was that the ratio of labor compensation to output was nearly constant. And was is this value 1- $\alpha$.
Final point about the “labors share” or 1-$\alpha$. The way to think about this is again GDP is a pie of stuff, how is it shared amongst the people that help make the stuff. Well in our world, it’s a constant fraction.

Remember to complete the quiz tonight. A new quiz will be posted soon, due for next week.

Next week: Q2 on PS1 and talk about the capital market.

More Problem Set help

Q: I still don’t get it, how do I compute growth rates?

Yah, so my preference is to use the continuously compounded growth rate. I think it is simpler. So to compute the growth rate of GDP between 1980 and 1970, do the following

(ln(GDP_1980) - ln(GDP_1970)) / (1980 - 1970)

Where the stuff in the first brackets simply takes the natural log difference of GDP between the two years. Then we want to make it interpretable, so we convert the growth rate to a per year basis. This is done by dividing by the number of years. So we divide by the difference between 1980 and 1970, or 10.

Q: In the second question, do we take the growth rate the 1-year treasury rate? Or what?

DO NOT TAKE THE GROWTH RATE. That will not make much sense.

Take the average value of the rate over that time period. So, e.g., the average rate between 1970 and 1980 was X, report that.

TIP: When taking the difference between the rate and inflation, make sure they are in the same units. So either are both in percent units or both not. If they are in different units, the answers will not make much sense.

Problem Set Help and Update

First, one of the codes for labor compensation was discontinued in 2016. Be sure to use the updated code here:

“A033RC1A027NBEA” called “National income: Compensation of employees”

This ends in 2017, so do it up to that point.

Wait…but I don’t know how to use FRED. In the back of the slides here there are notes on how to use FRED.

Ok, how do I compute growth rates? In this class, I prefer to use continuously compounded growth rates for many reasons. They are explained in this handout here:

Notes on Computing Growth Rates

How do I learn more about the questions in this problem set?

Here is a break down of National Income (GDP) by where it comes from:

https://fred.stlouisfed.org/release/tables?rid=53&eid=42133&snid=42136

First week…

Great job guys. So we started off by asking some big questions—specifically “what is economic growth?” Through our discussion we got around to four ideas:

It’s something about our capacity to more produce stuff.
It’s something about earning more income, be it from working or investments.
It’s something about being able to buy more goods and services.
And it tells us something about quality of life, but not everything.

This work was awesome. And then the first three bullet points lead us to talk about GDP—which literally is a measure of how much we can produce (first bullet), but those making the production happen to receive income for their effort (second bullet), and we are able to spend that income on goods and services (third bullet). And enjoying goods and services in not what life is about, but does provide us with satisfaction (last bullet). So GDP is an all encompassing measure that picks up these ideas we started out with.

Next week: Seeing how it works in a semi-complicated economy, measures of employment. The production function.

The 2018/2019 Global Economy in a nutshell

This course is about global macroeconomics and the goal is that you can systematically think about macroeconomic events, evaluate them, and make informed decisions for your business, operating unit, life, etc.

Ok, so what is the current situation? This is probably the most complex situation that I have experienced in my lifetime. The good news: economic growth in the US has been booming in a way we have not seen for nearly 15 years. The bad news: there is tremendous uncertainty about many issues that complicate our understating about the path forward. Let me put these uncertain/outstanding issues in the context of things we will discuss:

Why is the US booming? Is it sustainable? Economic growth in China is slowing, why? The first third of this course focuses on sources of economic growth gives us tools to understand these issues and think about where we have been and where the economy is going.
Trade wars. What’s the issue? What’s stake? Globalization has been under sustained attack over the past several years (and not just in the US, see Brexit). This has complicated the economic outlook. The second third of the course focuses on understating the motivation for international trade and why there are valid concerns about trade. FYI: this is something I’m an active researcher in see this summary of some of it.
What will the FED do in 2019? Will the FED continue to raise interest rates? Will we go into a recession? Amongst market commentators (and our President) what the FED will do in 2019 is of great interest. The final third of the course focuses on understanding how the nominal side of the economy interacts with the real side, what role the FED plays, and how it might be able to prevent (cause?) a recession. By the last day of the course, you should be able to lecture your parents on FED policy.

Awesome right? One final thought. Economics is not a boring subject, far from it. You can not open a newspaper (web-browser) without seeing economics on the front page. So it helps all of us if we keep up with the news and current economic events.

Where can I start? Here are some places that I will focus on over the semester.

As a STERN student, you should have free access to the FT. This is an amazing resource to take advantage of. On the FT, there is an economic commentator Gavyn Davies who provides nice, market oriented economic commentary (backed up by his hedge funds macro forecasts). See his round up of 2018 here.
This is a FAV of Stern Economics. It’s the econsnapshot a website ran by the former Dean of Stern Tom Cooley and friends. It provides nice graphics of the current state of the US economy and Europe.
I also like the real time economics blog in the WSJ. You have to pay. When something great comes up, I’ll circulate it.
Finally The Economist is great. Ask your parents to get you a subscription for your birthday.

Welcome to The Economics of Global Business!

Soon we will have our first meeting and get the semester started. I want to reach out to you about some features of this course to help you prepare for the semester ahead.

Read the Syllabus. I’ve posted a preliminary version of the syllabus for the upcoming semester. This has information about important dates, texts, grading, etc. Please take some time to go over this prior to our first class meeting.

Take the online survey. This link has the survey for you to complete. As the syllabus details, there will be a bunch of online quizzes throughout the semester. This is the first one. It just asks questions about your background and as long as you complete it, you’ll receive full credit. And you have until Jan 31st to complete it—so no rush if your still on vacation!

Explore the website. I’ve the designed website to provide a bunch of information about the course in a simple way. In particular, the main week by week guide of the course.

I’m looking forward to meeting you all and a great Spring semester!

mike