Monthly Archives: October 2008

The Nobel memorial prize in economics has been awarded to Paul Krugman, a professor at Princeton University and a prominent columnist for the New York Times. Mr Krugman is one of the great popularisers of economic ideas and a trenchant critic of the Bush administration, but his prize was awarded for work done almost three decades ago in developing what is known as “new trade theory” and “new economic geography”.
Earlier trade theories suggested that a country would trade with trading partners that were very different – rich would trade with poor, and capital-intensive would trade with labour-intensive. In practice, rich countries tend to trade with other rich countries. Mr Krugman’s analysis showed why this was to be expected: many products were most efficiently produced by very large companies, but consumers wanted variety and would thus buy products from foreign giants as well as the dominant domestic corporations. Mr Krugman’s ideas on the importance of economies of scale could be traced all the way back to Adam Smith, but the new ingredient was a usable mathematical description of what was going on.
Economic geography uses much the same mathematics to explain the location of jobs and businesses. Mr Krugman showed that the forces of globalisation, far from creating a “flat world”, could enhance the power of global cities such as New York and London, because those cities could increasingly do business with a global market.
Mr Krugman has long been seen as a future Nobel laureate. He won the John Bates Clark medal for young economists in 1991, an award which is often a precursor to a Nobel. Yet if the choice is not surprising, the timing – just before the US Presidential election – might be. Mr Krugman is an influential and partisan political commentator. His columns, first in Slate and then the New York Times, were at first clever refutations of popular misconceptions about trade protection or the “new economy”, but they have become far more notable for their stinging attacks on the Bush administration. He has recently criticised Hank Paulson, the US treasury secretary, for mishandling the credit crisis, while praising the British government for being “willing to think clearly about the financial crisis, and act quickly on its conclusions.” He also warned of the US housing bubble in the summer of 2005.
This is, however, not the first time that the Nobel prize committee has recognised an economist with a public profile and an appetite for political debate. Joseph Stiglitz shared the prize in 2001, after a combative stint as chief economist of the World Bank; Milton Friedman was an early laureate in 1976.
Among professional economists, Mr Krugman is admired for his work on currency crises as well as the work on trade that won the prize. A Princeton colleague, Avinash Dixit, once described Krugman’s methods: “He spots an important economic issues coming down the pike months or years before anyone else. Then he constructs a little model of it, which offers some new and unexpected insight. Soon the issue reaches general attention, and Krugman’s model is waiting for other economists to catch up.”
Mr Krugman’s trade model showed that there were circumstances in which trade protection could be in a nation’s economic interest. This idea was joyfully embraced by protectionists, and Mr Krugman spent much of the 1990s vigorously defending free trade and arguing that trade protection in practice was almost always harmful. The experience may have fuelled his enthusiasm for economic popularisation, although even his early writing betrayed a wit and clarity not common amongst economists: he wrote, in 1978, “A theory of interstellar trade”, commenting that it was “a serious analysis of a ridiculous subject, which is of course the opposite of what is usual in economics.”
The economics prize was not one of the original Nobel prizes. It was established in 1968 by the Swedish central bank and is officially called the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel. The prize money is 10 million Swedish Kronor (£810,000; $1.4m; euro1m).

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Marginal Revolution will also have much more. Here is Krugman’s blog. Congratulations to Paul!

I can attest that he’s an excellent speaker and always provocative.

‘Decisions, Probability and Beliefs: Beware Mickey Mouse probability’ is on Monday 13 October at 7-8.30pm in the Sheikh Zayed Theatre, New Academic Building, LSE, 54 Lincoln’s Inn Fields, London, WC2A 3LJ.

Someone recently grumbled to me that, given the appalling state of the world’s financial system, nobody should be awarded today’s Nobel memorial prize for economics. That’s a little harsh: some economists did warn us of trouble on the horizon.
Still, Nobel-watchers think that this will not be the year that the prize is given to a man called Eugene Fama. Fama, a Professor at the University of Chicago and a long-time contender for the prize, is best known as the man who believes that financial markets are efficient. The timing would seem awkward.
I think that’s a shame. The belief that financial markets are efficient sounds like some Thatcherite creed, but it means something quite different: that the price of shares today reflects everything we currently know about their value. There are no obvious bargains, no easy forecasts, no get-rich-quick schemes.
More of us ought to know about Eugene Fama’s ideas. We’d learn that trying to spot a good value share or to make a killing with a buy-to-let property is a bit like trying to pick the fastest queue in the supermarket. If it was so obvious which was the fastest queue, people would get into it and it wouldn’t be the fastest queue for long. If Eugene Fama is right and financial markets really are efficient – and the evidence still suggests that they might be – then you and I can’t pick a brilliant investment except by blind luck.
Neither can anyone predict what the market will do tomorrow, because efficient markets already reflect everything we know. Prices change daily only because of news, not because of anything that could have been forecast yesterday. Imagine all the time we could save by ignoring the prognostications of city economists.
Investors who believe in efficient markets make more money – or perhaps I should say lose less money. They don’t pay fund managers huge fees to pick good stocks, because they don’t think fund managers can pick good stocks. They ignore advertisements touting past performance, because in an efficient market past performance tells you literally nothing about the future. They don’t try to time the market, which in practice has always meant rushing in during booms and panic selling during busts – buying high and selling low. In fact, they don’t even look at what the stock market is doing from day to day. Why bother? It won’t give you an investment edge, and it might well give you an ulcer.
So here’s hoping for a Nobel prize for Eugene Fama. The stock market may not be efficient, but it’s smarter than you and me.

I agree with the basic point in this New York Times story – which is that it’s pointless to try to time the market – but this argument hardly makes the case:

H. Nejat Seyhun, a professor of finance at the Ross School of Business at the University of Michigan, put together a study in 2005 for Towneley Capital Management, where he tested the long-term damage that investors could do to their portfolios if they missed out on the small percentage of days when the stock market experienced big gains.

From 1963 to 2004, the index of American stocks he tested gained 10.84 percent annually in a geometric average, which avoided overstating the true performance. For people who missed the 90 biggest-gaining days in that period, however, the annual return fell to just 3.2 percent. Less than 1 percent of the trading days accounted for 96 percent of the market gains.

This fall, Javier Estrada, a professor of finance at IESE Business School in Barcelona, published a similar study in The Journal of Investing that looked at equity markets in 15 nations, including the United States. A portfolio belonging to an investor who missed the 10 best days over several decades across all of those markets would end up, on average, with about half the balance of someone who sat tight throughout.

It’s not that Seyhun and Estrada are wrong. I’m sure they’re not. On a wonderful day the stock market can gain 4-5 per cent, sometimes even more. Of COURSE it will cost you money to miss ten such days.

But I could equally make the opposite case by observing how much money you would save by being out of the market on the worst days. I mean, there was the 1987 crash – about 25 per cent. There have been several days of losses in excess of 5 per cent in the past few weeks. Just imagine how much better off you’d been if you had missed the ten worst days of the market…

By the way, I’m all in favour of buy and hold, but this is a silly argument even though the conclusion is correct.

Either this is 1930 all over again or it’s a wonderful buying opportunity. Needless to say, I don’t know which is the case. But for those of you who have a big tax bill coming due in January, I have the perfect diversified strategy for you. Pre-pay your taxes while investing in stocks.

If armageddon arrives, you’ll be delighted with the risk-free zero nominal rate of return you’ve achieved on your tax payment. If not, your stock investment will pay off instead.

No? Well, I’m not expecting the call from FT Money any time soon.

On Monday, the winner of the 2008 Nobel prize in economics will be announced. That statement is not quite true: there is no Nobel prize in economics, merely a more recent prize established in memory of Alfred Nobel.

The existence of a quasi-Nobel in economics infuriates some. One objection is that Nobel himself would not have approved. I do not much care. A more serious objection is that economics is not incontrovertibly a science, but then neither is peace or literature.

Nor am I convinced that the economics Nobel is, as some claim, an instrument for the enforcement of orthodoxy. The prize committee has been broad-minded, occasionally even daring. The prize has gone to Keynesians such as James Tobin and to Friedmanites such as, um, Milton Friedman, to a psychologist (Daniel Kahneman), a mathematician (John Nash) and to the unclassifiable Herbert Simon. 

The rest of this column can be read here. Please post comments below.

I have a question which, I hope, you will be able to answer with particular insight. Should I subscribe to the Financial Times?

I buy the FT Weekend every Saturday, for $2.17 including California sales tax. I recently received an e-mail offer to receive the FT for $8.25 for four weeks, which would be a saving of 43 cents, and yet provide me with the newspaper every day.

However, I am conflicted because I primarily enjoy the FT Weekend for the cultural and political coverage. I am somewhat interested in the financial news, but my concern is that I will spend too much of my time following the soap opera that is Wall Street these days. But if there was a time when it would be advisable to read the FT, this would be it.
John Halbert, Los Angeles

Dear John,

I am not sure what puzzles me more, the fact that the FT subscription department is trying to get you to pay less in order to receive more, or the fact that you hesitate to accept.

The most likely explanation is that both you and the subscription department suspect the Financial Times of being an addictive product. They hope that once you are hooked, you won’t stop. Admittedly, this assigns the subscription department the role of crack-pushers, but we should call a spade a spade here.

The story is further complicated by the fact that not all addictions are harmful. You may find yourself addicted to the Pink’un for the happiest of reasons: an infatuation with Lucy Kellaway – or Gideon Rachman, if you prefer.

I suggest that you put this offer to one side, because the sums involved are trifling. Instead, buy and read the FT every day for a week. If you’re hooked by Friday, it will be because you’ve found the daily newspaper to your taste. You can then take advantage of the next subscription offer to feed your habit cheaply.

Questions to economist@ft.com

Well, I don’t know, but the clever fellows at VoxEU do. Their collected wisdom is posted here. I haven’t read it at the time of writing but I am assured the link will be live by the time this post is live. The booklet is a snappy 35 pages and contains the collected wisdom of Alberto Alesina, Michael Burda, Charles Calomiris, Roger Craine, Stijn Claessens, J Bradford DeLong, Douglas Diamond, Barry Eichengreen, Daniel Gros, Luigi Guiso, Anil K Kashyap, Marco Pagano, Avinash Persaud, Richard Portes, Raghuram G Rajan, Guido Tabellini, Charles Wyplosz and Klaus Zimmermann.

It’s here. Subjects are what you would expect: market design and repugnant markets. There is of course, no better guide.

It’s here, courtesy of Moody’s Dismal Scientist. Seems to focus on macroeconomics, although that may just be a function of the current crisis…

The Undercover Economist: a guide

Publishing schedule: Excerpts from "The Undercover Economist" and "Dear Economist", Tim's weekly columns for the FT Magazine, are published on this blog on Saturday mornings.
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