Category: Economy

Nate Silver’s book “The Signal and the Noise”

 

The book by Nate Silver “The Signal and the Noise …” is an amazing read. Very well written, entertaining as well as deep, it holds lessons and learnings that are applicable in our daily personal and professional lives. Its stated purpose is to look at how predictions are made, their accuracy, in several fields : weather, stock market, earthquakes, terrorism, global warming … But beyond that simple premise, it is a real eye opener when it comes to describing some of the deeply flawed ways in which we humans analyze the data we have at hand, and take decisions.

Nate Silver has very skeptical towards the promises of Big Data, and believes that the exponential growth in available data in recent years only makes it tougher to separate the grain from the chaff, the signal from the noise. One of the way he believes we should strive to make better forecasts, is to constantly recalibrate our forecasts based on new evidence, and actively test our models to improve our predictions and therefore our decisions. The key to doing that is Bayesian statistics … This is a very compelling, if complex, use of the Bayes Theorem, and it’s detailed through a few examples in the book.

As he explains, in the field of economics, the US govt publishes some 45,000 statistics. There are billions of possible hypotheses and theories to investigate, but at the same time “there isn’t any more truth in the world than there was before the internet or the printing press”, so “most of the data is just noise, just as the universe is filled with empty space”.

The Bayes Theorem goes as follows :

P(T|E) = P(E|T)xP(T) / ( P(E|T)xP(T) + P(E|~T)xP(~T) )

Where T is the theory being tested, E the evidence available. P(E|T) means “probability of E being true if we assume that T is true”, and notation ~T stands for “NOT T”, so P(E|~T) means “probability of E being true if we assume that T is NOT true”.

A classical application of the theorem is the following problem : for a woman in her forties, what is the chance of her having a breast cancer if she had a mammogram indicating a tumor ? The basic statistics are the following, with their mathematical representation if T is the theory “has a cancer” and E the evidence “has had a mammogram that indicates a tumor” :

– if a woman in her forties has a cancer, the mammogram will detect it in 75% of cases – P(E|T) = 75%

– if a woman in her forties does NOT have a cancer, the mammogram will still erroneously detect a cancer in 10% of cases – P(E|~T) = 10%

– the probability for a woman in her forties to have a cancer is 1.4% – P(T) = 1.4%

With that data, if a woman in her forties has a mammogram that detects a cancer, the chance of her actually having a cancer is of …. less than 10% !!! That seems totally unrealistic – isn’t there an error rate of only 25% or 10% depending how you read the above data ? The twist is that there are many more women without a cancer (98,6%) than women having a cancer at that age (1.4%), so the number of erroneous cancer detections, even if they represent only 10% of the cases where women are healthy, will be very high.

That’s what the Bayes theorem computes – the probability of a women having a cancer if her mammogram has detected a tumor is :

P(T|E) = 75%x1.4% / ( 75%x1.4% + 10%x98.4% ) = 9.6 %

Nate Silver uses that same theorem in another field – we have many more scientific theories being published and tested every day around the world than ever before. How many of these as actually statistically valid ?

Let’s use the Bayes theorem : if E is the experimental demonstration of a theory, and T the fact that the theory is actually valid, and with the following statistics :

– a correct theory is demonstrated in 80% of cases – P(E|T) = 80%

– an incorrect theory will be disproved in 80% of cases – P(E|~T) = 20%

– proportion of correct to incorrect theories – P(T) = 10%

In that case, the probability of a positive experiment meaning a theory is correct is only of 30% – again a result that goes against our intuition, as it seems from the above statistics that the “accuracy” of proving or disproving theories is 80% !!! The Bayes Theorem does the calculation right, and takes into account the low probability of a new theory being valid in the first place :

P(T|E) = 80%x10% / ( 80%x10% + 20%x90% ) = 30 %

There again, events with rare occurrences (valid theories) tend to generate lots of false positives. And this results in real life in a counter-intuitive fact : at the same time as there is a huge proliferation of published scientific research, it has been found that two-thirds of “demonstrated” results cannot be reproduced !!!

So … this book should be IMO taught in school … It gives very powerful and non-intuitive mental tools to make us better citizens, professionals and individuals. I don’t have much hope of this making its way into the school curriculum any time soon, so don’t hesitate, read this book, and recommend it to your friend and family 🙂

 

Nouriel Roubini at Project Syndicate

A must read article by the economist who became famous for forecasting the crisis, Is Capitalism Doomed ?.

This is posted on the “Project Syndicate” blog, where all the best minds in politics, economics, science, and culture post articles with deep independent analysis of the world trends. All the people I have been impressed by in the field of economy are there : Nouriel Roubini, Stephen Roach, Joseph Stiglitz …

http://www.project-syndicate.org/

“The great stagnation : how America ate all the low hanging fruits” by Tyler Cowen


Just finished a book by Tyler Cowen, “The great stagnation : how America ate all the low hanging fruits”. It is a short book with depth, which lays out facts and ideas in a very crisp and engaging manner.

The author’s theory is that the US have reaped the low hanging fruits of productivity, and that its future material and financial growth is at risk. He details three key areas that fueled past productivity, but will not drive progress going forward :
– access to free land, from the 17th century to the end of the 19th century
– improvements in education. The percentage of the population graduating from High School grew from 6% in 1900 to 60% in 1960, and 74% today. Only 0.25% of people went to college in 1900, a number which has grown to 40% today. But we seem to have reached the limit of these improvements, as college drop-out rates have grown from 20% in the 60s to 30% now …
– a host of technological breakthroughs from 1880 to 1940. These have slowed down since then, and as the author puts there is not much difference between a kitchen or a house) today and one in the 50s in terms of the basic functionalities that had then become available (fridge, TV …). 80% of the economic growth from 1950 to 1993 actually came from innovations that happened before that time.

The author links that last point with the drastic reduction in the rate of growth of the median income, starting in 1970. His view is that discoveries since then have been geared towards private goods rather than goods for the larger public. The impact of the Internet is much more complex though and there is a whole chapter on that, which I will comment on later.

There is a whole section then looking at how we have tended to overestimate productivity through the GDP calculations :
– government spending is always factored in the GDP at cost, regardless of the utility or value created. This does not take into account the fact that as government grows there will be a diminishing return on that value. Since the 19th century the cost of government (excluding redistributions) has grown from 5% of GDP to 15-20%, which means we have overestimated the GDP growth, and the productivity, derived from that growth in spending.
– there is a similar issue with Healthcare, which is 15% of GDP in the US. Its efficacy is impossible to determine, and there is an established disconnect across modern countries between the spend, and metrics such as average life span.
– same thing with Education, which represents 6% of US GDP. Reading and mathematics scores at the age of 17 have not changed since the early 70s, while the expenditure corrected for inflation has doubled per pupil.

The looming question that the author then tackles is of the impact of the Internet. To summarise, he says that the Web provides huge innovation for the mind, not for the economy. It makes us happier and enables personal growth, but does not impact the economy very much, as so much of the content is free or very low cost.
So the Internet is also not properly reflected in GDP and productivity metrics, and that is one area where GDP underestimates the positive impact of technological change.

The issue though with the Internet revolution are the following :
– we have been counting on real productivity and material economic impact to generate future revenues and pay off our debts …
– the benefits from that revolution are unequally shared. Using the Internet positively is a function of one’s cognitive powers, while past inventions were usable equally by everyone.
– it creates few jobs. Google 20 000 employees, Facebook 1700…

The author then goes into an analysis of the current Economic crisis, which he sees as a result of overconfidence across our society in productivity. I am not convinced that should be the only explanation, but this is at least a refreshing view and a new angle.

Looking forward, despite the gloomy title of his book, Mr Cowen sees some positive future trends :
– india and china growth will create larger markets that will reward innovations again. They have so far grown by imitating the west, they will probably fuel innovation in the future.
– Internet might start generating growth. It creates a “cognitive surplus” (Clay Shirky) as billions of people are getting smarter and better connected, which would have positive effects on innovation.
– the Obama administration has taken steps to reform education

He conclude with an appeal to raising the status of scientists in our society, to make science and technology aspirational and rewarding careers for our children … Could not agree more !

http://www.amazon.com/Great-Stagnation-America-Low-Hanging-Eventually/dp/0525952713/ref=sr_1_1?s=books&ie=UTF8&qid=1309751050&sr=1-1

Oil price and its impact on economy

We saw this morning a good thought-provoking video about the importance of oil prices to our economy, and the ineluctability of drastic changes as the price of a barrel goes over 100 dollars for good.

The orator is Jeff Rubin, former chief economist at ICBC. His wikipedia bio is here.

The first part explaining why the rising oil prices have triggered the recession is not the best, but keep listening to the part where he first predicts a sustained (and rapid) increase in oil price to triple digits, and then explains the impact on our economic model.

The issue of peak oil has been shadowed in the past two years by the recession, and by global warming. It is a healthy reminder that for a while we are dependant on oil as a source of energy, and if indeed the demand-supply equation drives prices up, we have fundamental adjustments to make to our societies.

A couple examples of these adjustments mentionned in the video :
– the US government should have invested money into public transportation instead of bailing out GM.
– industries will have to be localized again, as transportation costs will no longer be incidentals.

Here is the link – enjoy !

Video of Jeff Rubin on the triple digit oil prices and the impact on economy

The movie that cost 2 Trillion dollars

We went to watch “Inside Job”, a fabulous movie about the crisis, mixing interviews of the highest profile international experts and leaders, with an outstanding narration by Matt Damon !

It pretty much explains what is already laid out in several books, but hearing the confused explanations of top players, their shameless lies, just give the crisis an additional dimension of amorality. It leads one to question what kind of system brings such shallow characters to positions of power or influence – not only in business, but also in politics and academics. The interviews of Eliot Spitzer, former New-york Attorney General, are very revealing, and it’s a shame no prosecutor of that caliber is going after those who should be held accountable for having created the system and profited from what ended-up in ruin for others.

An absolute must-see, you can get all details on IMDB at http://www.imdb.com/title/tt1645089/

Demography, Economy and Society

A theme is emerging in lots of recent readings – the impact of demographics on society and economy. We’ve probably ridden a wave of demographic explosion in the West over the past 50 years with the Baby Boom. And it’s interesting to look at the excesses of the bubble years, and the current bust, as the result of the savings of retiring Baby Boomers looking for high yields.

An example I recently read explained the interest rates as the demand-supply balance between the older and younger generations. The older people have savings, and in order to secure their retirement want to lend it to secure regular yield, as high as possible, ie high interest rates. The younger generation has no savings, but wants to borrow money to buy a home, start a business, and are looking for low interest rates. The proportion of both population hence drives the interest rate level – it is high if there is a large proportion of young people, low if there’s an excess of old people.

Aouda and I were born when the Baby Boomers entered the workforce, and when I read this all of a sudden the high interest rates my parents paid on their mortages started to make a lot of sense – as did the current low interest rates !

Of course, our world itself is highly bipolar in this regard – one of the biggest difference between the West and the high-growth countries is the demographic structure. Just look at an interactive map of the world as they now exist, and just browse various countries for the average age of their citizens, you will be amazed at the differences – US and Europe at 40 years (and sorry Mr Rumsfeld, there’s really no “Old Europe” and “New Europe” – it’s all pretty old all the way to Russia), versus India at 25 and Africa at 20 years of average age ! (Never forget Africa and its 1 Billion of people, even if they don’t make the news as they’ve not taken off economically yet). Very interestingly, China is already at an average age of 35 years, quite close to the US average age actually – not clear what the implications are, except it might mean China might be the Japan of yesteryears, which after explosive growth attracting everybody’s attention will rapidly stabilize and have to cope with its own issues.

This is such a fascinating topic, especially when you think beyond economics and look at the societal implications. A large young population giving us Woodstock, the Hippies and May ’68, what will these same folks drive in our culture and politics as they retire and become unsurprisingly conservative ?

Aouda is reading a book called “The 4th Turning” about supposed patterns in generations behaviors – interesting to see how that can shed some light into this issue !

The end of the Party

I have recently finished a good book : “Whoops!” by John Lanchester. It is another of a long series of readings i have done over the past two years since the crisis hit. Like most of them it explains the root causes of the financial and economic crisis, and the lack of cure so far. It does so probably less accurately but in a more lively and entertaining manner.

One of the most interesting contentions of the author is that with the end of the cold war and the obvious failure of communism, capitalism found itself unchallenged as a paradigm. The most extreme supporters of free unbridled markets found themselves in a position of ideological monopoly, and were able to dismantle the apparatus of controls that had been put together by governments after the crisis of ’29 and the social safety nets built during the cold war at a time when communist countries were claiming to bring security and happiness to their citizens.

It is an interesting theory, but I am not entirely convinced by the logic of the arguments. It certainly fails to recognise the historical events that were the opening up of India and China and their return to the forefront of the international economic scene after two centuries of absence. It also does not mention the impact of an ageing western population, and especially of the baby-boom generation, creating a glut of retirement money chasing yields that a smaller number of younger people could not satisfy -unless that is one could find a way to hand out large numbers of real estate loans to folks who could never pay them back …

Still a very interesting read !

P.S. One particular paragraph in the book made me think hard … And not very successfully so far ! I searched the Internet a bit and found the following link which will show you how confusing some statistics can be.
Click here for link

Happy thinking !