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Theory has, at length, become so "scientific" and abstract as to intrigue the mathematicians who have taken delight in developing the concept of a kaleidoscopic and frictionless play of atomistic units in a complex and eternally unfolding equilibrium. The notion of equilibrium suggested equations; equations are prolific parents of their kind; and the game has gone on until the pages of the more esoteric economic journals have become a mass of hieroglyphics intelligible only to those who know the code. All the inconvenient freight of fact has been discarded by the more recondite practitioners until the "science" has come to move in a realm of pure abstraction useful for purposes of cerebration but of steadily declining practical importance.

Much first-rate analytical skill and much scholarly industry has miscarried because the road to academic recognition lay in the refinement of traditional technique, or in assiduous dust-gathering, with little consideration of ultimate purpose. The means have been exalted over the end, and the neophyte, compelled to show his mastery of technique, has quickly learned to love and practice it for its own sake.
This is not to deny the virtue, even the necessity, of abstract speculation or the desirability of the most catholic comprehension of the facts. It is merely to assert that these should be tools rather than ornaments and that we should never cease to ask ourselves what we want and how we propose to get it.

Frank D. Graham, 1942
Social Goals and Economic Institutions, Frank D. Graham, Princeton University Press, 1942, pp. xv-xx
What do Economists Contribute?, Cato Institute, NY University Press, 1999, pp. 27

schwund"In a surprisingly growing number of regions in Germany private "regional currencies" are issued as a cash substitute for the euro. Currently, these regional currencies are conceived almost exclusively as Schwundgeld (depreciative currency), which loses value on a predetermined timescale. This loss of value is intended to encourage the money owners to spend their money quickly in order to boost local demand. This paper shows that the issuance of unofficial parallel currencies is not a fundamentally new phenomenon neither in Germany nor in other European countries. The theoretical assumptions of the Schwundgeld concept (Silvio Gesell (1862 – 1930)) are highly flawed and suboptimal from a welfare-theoretical perspective. However, the current economic welfare losses resulting from the issuance of Schwundgeld are negligibly small."

Determinants of the demand for regional money: "[T]he reasons underlying the demand for regional currency are likely to consist more in its curiosity value in an age when the monetary system is becoming increasingly internationalised and in the regional currency holders’ belief ((listen to Russell Roberts (Cafe Hayek) talking on Minnesota Public Radio about whether it is a good idea to "buy local.") that they are promoting the regional economy by using local money. Furthermore, these currencies provide those that hold them with the opportunity to demonstrate their loyalty to the region and thereby take a stand against globalisation ("Geld der Anti-Globalisierer" [Currency of the globalisation opponents]). According to research undertaken by Süddeutsche Zeitung, it is, at least, always the same people ("immer die gleichen") who pay in regional currencies."

Harvard Business Review, Mar2007: Ideally, businesses improve lives by creating things people want. At the very least, companies produce wealth (which, at the individual level, is an imperfect but passable proxy for happiness). So businesses should be interested in this map, developed by Adrian G. White, a social psychologist at the University of Leicester, which shows the global distribution of happiness. White combined data from more than 100 studies involving 80,000 people worldwide to gauge countries' "subjective well-being" - which, he found, correlates most strongly with health, wealth, and access to basic education, in that order. White's map suggests regions that need more of what companies do best (for further details, see here).
happiness_mapFor current discussion, see here and here.

"It is sometimes claimed in the economic literature that discussions of the notions of utility and preferences are altogether unnecessary, since these are purely verbal definitions with no empirically observable consequences, i.e., entirely tautological. It does not seem to us that these are qualitatively inferior to certain well established and indispensable notions in physics, like force, mass, charge, etc. That is, while they are in their immediate form merely definitions, they become subject to empirical control through the theories which are built on them--and in no other way. Thus the notion of utility is raised above the status of a tautology by such economic theories as make use of it and the results of which can be compared with experience or at least with common sense."

-- John von Neumann and Oskar Morgenstern

"The notion of saving as "postponed consumption" is common in economic literature, yet it seems to embody a profound misconception of the nature both of saving and consumption. The difficulty seems to arise because of a confusion between the idea of consumption as we have used it in this work, and as it is also used by the classical economists, as the "using up" or the destruction of stocks of goods, and the idea of consumption as the source of satisfactions or enjoyments. In fact these are two quite distinct ideas. Enjoyment or satisfaction is normally derived not from the using up but from the use of a good. This is obvious in the case of durable goods. When I go for a ride in my car the fact that the car is being consumed--i.e., is wearing out--in no way contributes to my satisfaction; indeed, quite the reverse. What I get satisfaction from is the use of the stock of goods, not from their consumption. It is the size of the house we live in, the elegance of the clothes we wear, that give us satisfactions, not the incidental and regrettable fact that in the course of yielding these satisfactions, or even when they are not yielding satisfactions, they happen to be afflicted by decay and consumption.

The reader may object that this argument does not apply to non-durables, or "one-use goods," such as food, which are destroyed in the very act of enjoying them. It is only because consumption and satisfaction are close together in time, however, that we tend to identify them; analytically they must be kept separate. Even in the case of none-use goods economy in consumption is always desirable, and if we examine the use of these goods closely we will always find that they are consumed in the maintenance of some desired but depreciating state. Thus we burn fuel because the warmth of our houses "depreciates" in cold climate. The less fuel we can burn to maintain a given temperature, the better off we are. We need food similarly to maintain certain bodily states which likewise depreciate. The less food we need to keep us from being hungry and to maintain our bodily temperature and energy, the better off we are. Similarly we need entertainment to maintain certain mental or emotional states. It should be observed that the depreciation of goods (i.e., of desirable states) frequently involves their physical growth. Thus a shaved chin, a clipped head, or a mowed lawn depreciates by the process of growth of a "discommodity" (whiskers, hair, grass) and needs to be restored by periodic shaving, haircutting, or mowing. In this case it is the growth of the discommodity which constitutes "consumption" in the economic sense, and its removal which constitutes production.

In the light of these considerations, then, what is the significance of "saving"? Saving is the process by which goods are accumulated--i.e., by which the total stock of goods is increased. This can only be done by producing more than is consumed. If society is producing at capacity, saving does imply a certain "sacrifice" of consumption, in the sense that consumption would be greater if there were no saving. The sacrifice of consumption is also likely to lead to a sacrifice of satisfactions, unless there is at the same time an economizing of consumption--i.e., a decline in the amount of consumption which is necessary to maintain given states of satisfaction. Because of these sacrifices, however, the total stock of goods (desirable states) is increased, and the total future flow of satisfactions is presumably increased also. In this sense saving does involve the sacrifice of present satisfaction in order to increase satisfaction in the future. It does not, however, necessarily involve the sacrifice of present consumption in order to increase future consumption. It is true that future consumption may be increased as a result of saving, both because a larger stock of goods in itself implies a higher rate of consumption and because the accumulation of the larger stock may permit higher rates of production. We do not generally, however, accumulate now in order that we may decumulate in the future; we do not build up a stock of goods in order to tear it down in the future, but in order to be able to maintain and increase this stock in the future. We have not built up all this apparatus of houses, farms, roads, machines harbors, and factories in order that some day we may allow them to fall down and so return to living in holes in the ground and to grubbing our food from berry bushes!

An illustration may clarify these principles. Suppose that we have a society which is living just above the edge of subsistence, with its productive activities just sufficient to maintain the bodily strength of its people, to reproduce the generations as they die off, and to maintain the miserable huts in which the people live and the scanty clothes which they wear. How does such a society progress to a better state? If it is to improve, it is clear that it must build up its stock of capital: it must have more implements, more machines, more live-stock, better houses, and so on. In order to do this (without aid from outside) it must withdraw resources from maintaining the existing fabric of the society in order to devote them to making the increased stock of implements, etc. This means that some of its existing states cannot be maintained as well as before; people may have to go a little hungry in order that the implement makers can be spared from food-production, leisure time and ceremonial activities may have to be skimped in order to release time for building, and so on. All this involves curtailment of satisfactions as well as of consumption. If, now, the result of this process is simply a larger stock of things--bigger houses, better clothes, and so on--without any improvement in the productivity of the society, as measured in some sense by output per man-hour, the society may be no better off than before. In order to maintain its bigger houses and finer clothes the society may still have to withdraw resources from previously enjoyed occupations, though not so much as in the period of building up the stock. If, however, the increase stock is at least partly in the form of instruments and implements which incerease output per man-hour, the society is permanently richer as a result of the accumulation; and if the improvement is sufficient it will not only be able to maintain its increased stock with no more effort than it previously took to maintain its smaller stock, but may even be able to maintain the larger stock with less effort than it took to maintain the smaller one. In that happy event the society will not only be richer, but will find it easier to get still richer, as it will be able to devote further accumulation in the resources released from maintenance by its increased productivity."[1]

[1] Boulding, K. E. (1955), Economic Analysis, 3 edn, Harper & Row, New York, pp. 363-366

Jensen's inequality is probably the most well-known inequality in economics. Students stumble at least over the following two straightforward applications during their studies:
  • Microeconomics: E[U(w)] < U(E[w]) if U''(w) < 0: For a risk averse agent, the expected utility of wealth is less than the utility of expected wealth. The reason this is so: If wealth has diminishing marginal utility, losses cost more utility than equivalent monetary gains provide. Consequently, a risk averse agent is better of to receive a given amount of wealth with certainty than the same amount of wealth on average but with variance around this quantity. <>


  • International Macroeconomics/Finance: E[1/S] > 1/E[S]: The expectation of the reciprocal of an exchange rate is greater than the reciprocal of the expectation of the exchange rate. Jeremy Siegel showed that as a result of Jensen's inequality, the currency forward rate cannot be an unbiased estimate of the future spot rate because an expected increase in one exchange rate implies an expected decrease of smaller magnitude in its reciprocal. Therefore, even if expected changes in the spot rate are distributed symmetrically around the forward rate from the perspective of one investor, "Siegel's paradox" guarantees that the forward rate will be biased from the perspective of the investor on the other side of the exchange rate. <>
Today, I came across another interesting application (Honestly, did you ever think about that?):
The sample variance is an unbiased estimate of the true variance, but due to Jensen's Inequality, the sample standard deviation is biased low as an estimate of the true volatility, because the square root is a concave function:

Alfred Hofflander writes: A great many philosophers and economists have contributed to the development of the human capital concept. Some semblance of the idea existed in the old Anglo-Saxon Law where it was used to determine the compensation to be allowed to the relatives of an individual who was killed by a third party.

peopleSir William Petty (1623-1687) is credited with being the first economist to recognize the economic value of man. The purpose of his discourse was to show that factors other than area and population were important in determining the wealth and strength of a nation. He attempted to demonstrate through statistics that England, while small in area, had natural advantages (e.g. excellent and inexpensive shipping facilities) which could make it the greates of all nations and "that the impediments of Englands Greatnefs [sic] are but contingent and removable." In order to measure the national wealth of England, Petty felt that he had first to determine the value of the population. He started by assuming that England had six million people and their annual expense was £7 “per head,” producing a total annual expense for the population of £42 million. Rent of land was computed to be £8 million and the yearly profit of all personal estates was £8 million more. He therefore concluded that the labor of the people must have supplied the remaining £ 26 million per year (total expense minus rent and profit). When multiplied by twenty ("the mass of mankind as well as land being worth twenty years purchase") this £28 million yielded a value of the whole people equal to £520 million. This, divided by the population of six million, gave the value of each head of man, woman, and child at something more than £80 sterling. In such a manner, he concluded, the loss sustained due to plague, war, and by sending men "abroad into the service of foreign princes" could be estimated. Since land continues in perpetuity, multiplying its yield by twenty is equivalent to capitalizing it at five per cent. Man, however, does not live forever and so multiplying this yield by twenty is equivalent to capitalizing him by some figure less than five per cent. (The actual percentage can be determined only if a given set of mortality statistics is assumed.) Petty’s method and logic appealed greatly to his followers and were used in most calculations of national wealth for about one hundred years after his death.

About fifty years passed before another economist made a contribution to the concept of human capital. Philip Cantillon’s (1680-1734) evaluation was based on the cost of maintaining the slave and his offspring rather than on the earnings that the slave created. <>

Unlike his predecessors, Adam Smith (1723-1790) was not interested in determining the value of human capital. He was interested in the difference in wages in different fields of endeavor, and tried to explain these differences in terms of the concept of human capital. Smith actually dealt with this topic only twice in his Wealth of Nations. The first reference was to the inequalities of wage and profits where he explained that a man educated at the expense of much labor and time may be compared to an expensive machine (fixed capital). Further, his income should cover the usual wages of common labor plus the cost of education:
... with at least the ordinary profits of an equally valuable capital. It must do this too in a reasonable time, regard being had to the very uncertain duration of human life.
It would appear from this that Smith considered man as human capital, but in a later chapter, where he listed the components of fixed capital, he listed not man, bur rather "the acquired and useful abilities of all the inhabitants or members of the society."

Johann H. von Thünen (1783-1850) in the second part of Volume Two of The Isolated State reflected upon the view of man as capital. He derived an equation to measure the value of a human life, but he died before completing this work and the equation was published after his death. The origin of the formula used is not given and substitution of reasonable values in the equation does not produce meaningful results. Von Thünen states that should man be considered capital, it would be necessary for the state:
  1. to compensate the family of every soldier killed for the cost of his upbringing,
  2. to pay the disabled soldier the amount of his upbringing plus maintenance, and
  3. to pay the soldier who returns healthy for the depletion of his strength.
Unfortunately, he did little to estimate the losses involved so that the real worth of his work appears to be in the stimulation it provided to those who followed (e.g., Marshall). The fact that a man had value as property when he was a slave, but not when he was free, perplexed von Thünen and he viewed it as a paradox without solution.

raboteurs_parquetSir William Farr (1807-1883) completes the cycle by essentially returning to the method used by Petty. Farr, however, was much more sophisticated in his approach in that he realized that the populace cannot be considered as a whole, but must be taken in small homogeneous groups. He attempted to find an equitable system of taxing the populace and felt that each member of the community should contribute every year to the public expenditure in a fixed proportion to the amount of property in his possession during that year. Farr believed that no more exact measure of a man’s ability and duty to contribute to the public revenue exists than the value of his property. He defined property as:
Anything which yields produce that will sell for money although it may itself be inalienable; consequently, all the free labourers, artizans (sic), professional men of the United Kingdom, having within them this power of production, are essentially property as the things usually designated by that name, and characterized as personal or real, movable or immovable. Exclusive of all his external property every man is worth something.
Farr then sets down his method of determining the value of a person’s property (i.e. his human life value). His method is based upon the concept of surplus. He states that "the present value of the person’s probably future earnings, minus the necessary outgo in realizing those earnings is the present value of that person’s services." {Mathematically}

Here (JSTOR) is the whole paper.

related items:
Specifying Human Capital, Ludger Wößmann (2003), Journal of Economic Surveys
Proxying Human Capital, Me, Marginal Revolution

Back in 2002, i.e. shortly after I changed from what is now called international business administration to economics and statistics, I was told in an econometrics seminar that I had to present a paper written by Baltagi and Li entitled "Double Length Artificial Regression for Testing Spatial Dependence". By just reading the title you can probably imagine that I swore like a sailor. From the 50 people who showed up in the first two lectures of the preceding econometrics course only 2 people survived (at that time econometrics wasn't a mandatory course for economics students). But if that wouldn't have been enough, we started with a completely new topic, namely spatial econometrics. To cut a long story short, I unexpectedly--thanks to the help of my advisors Thomas Url and Werner Müller--passed with flying colors. But what really caused a mass release of 5-HT was what my former seminar-colleague (the other guy who survived) Markus Pock told me today:
Hey, I've just returned from a conference in Thessaloniki about the use of panel data in health economics held by Badi Baltagi and Pravin Trivedi. Guess how I felt after Baltagi started to go through YOUR old presentation. He sayed he found it on the web the other day and that he doesn't know these guys... but it is well done!
How cool is that??

Don't believe me? Here is a picture of me and my presentation in 2002:
And here is Baltagi (picture taken by Trivedi) and my presentation in 2006:

Maybe you find at least parts of my old presentations for your presentations useful too. Most topics are evergreens.

Greg Mankiw reports that Jacob Mincer, the great empirical labor economist, died yesterday.

Here (pdf) are some reflections on Jacob Mincer. This short esssay (5 pages) will be online for three days.
related items (JSTOR):
Essays in Honor of Jacob Mincer, Journal of Labor Economics, Jan., 1993

In case you missed it:
  • Barro on Growth : Russell Roberts interviews Robert Barro on the economics of growth, what the developed world can do to help poor people around the world, and the role of US assets and the dollar in world finance.
  • Making Schools Better: A Conversation with Eric Hanushek : Russell Roberts and Eric Hanushek talk about why the standard reforms such as more spending or better educated teachers have failed and what needs to be done in the future.
related items:
Modern Growth Theory -- Part I, Mahalanobis
A Schumpeterian Approach to Endogenous Growth Theory, Mahalanobis
Distance to Frontier - Big Deal!, Mahalanobis
Growth Regressions: Bayesian Averaging, Mahalanobis
Economic Growth & Parameter Heterogeneity, Mahalanobis
Video Lecture :: Measuring Sector TFPs, Mahalanobis
Video Lecture :: The Embodiment Question, Robert Solow
Ideas and Growth, Mahalanobis
Why are poor countries poor?, Stumbling and Mumbling
Education and economic development, Marginal Revolution
Is education good for growth?, Marginal Revolution
Proxying Human Capital, Marginal Revolution
The Weak Case for Public Schooling, David Friedman
Publicly Provided Education, Mahalanobis
School Accountability Leads to Improved Student Performance, Mahalanobis
Education Vouchers Around the World, Foreign Dispatches
Teacher Can't Teach, Mahalanobis
Improving Educational Performance, Mahalanobis