How An Economy Grows, and Why it Crashes

My friend Kalyan liked the book "How an Economy Grows, and Why It Crashes" so much that he bought 4 copies, and gifted one to us. That's how I came to know about and read the book.

If someone had told me that any author could explain the differences between "Keynesian ideas" and the "Austrian school" to any lay person, I'd have been highly doubtful. But the Schiff brothers do it, in the first 3 chapters of this highly readable book.

Peter D Schiff is an investor with a great understanding of economics. Let's assume that 1 in 50 people work as teachers. But only 1 among these 50 teachers is a master teacher. Only they have grasped the subject to such an extent that they can explain it to others with lucidity and simplicity. Peter Schiff is one such teacher.

This book has much going for it. It is a book presented as one ongoing allegory. If you have read "The Richest Man in Babylon" or "The Wealthy Barber" you know the kind. This book follows that storytelling tradition.

The story starts with 3 guys (Able, Baker and Charlie) stranded in an island where they have to catch fish by hand daily to survive. Each and every concept of trade and economics is built as these three become sophisticated in their economic dealings.

The authors build seamlessly from microeconomics concepts to grander topics in macroeconomics. Using examples of two larges countries (US and China, very thinly disguised) the authors play out several dire scenarios. In its criticisms, the book is hard-hitting and opinionated, and doesn't hold back.

The authors come down very strongly against holding on to US dollars. In a way, this book serves a personal wake-up call to me, because I don't own any tangible assets at all, and all savings are in paper US dollars, which Schiff feels has to fall prey to eventual inflation.

In each chapter, boxed "Reality Checks" are sprinkled on the side margins for extra clarity. "Takeaways" are given at the end of each chapter to reinforce the economics concepts introduced.

The book is a very easy read, and can be finished in one to two sittings. Everyone who is 15 or older should read this book. I can't think of any exceptions

Quotable sentence from Tim Jackson's Ted talk

I will post about a few of my favorite Ted talks soon. Meanwhile, here's a tidbit. I was viewing Tim Jackson's "Economic Reality Check" talk, and found this sentence so good that I had to stop and jot it down.

Prof. Tim Jackson talking about people's savings ratio and ballooning debt:

This is a strange, rather perverse story, just to put it in very simple terms. It's a story about us, people being persuaded to spend money we don't have, on things we don’t need, to create impressions that won't last, on people we don't care about.

Click the play button below, for the full talk:

Higher Taxes for the rich - Simplistic

It is possible to experience a certain Robin Hood-like righteousness in contemplating about taxing the rich and sparing the poor. But in this article, Harvard professor Greg Mankiw shows me why my thinking is overly simplistic.

His point is that if the taxes were raised further, the proportion that he (and his family) can put away from each incremental dollar earned becomes so small that he might choose not to earn that extra dollar at all.

The following paragraph touches on a slightly different point and it resonated with me. I did notice a certain similarity in our thinking. My possessions, such as they are, are quite modest. Prof Mankiw writes:

Indeed, I could go so far as to say I am almost completely sated. One reason is that I don’t aspire for much more than a typical upper-middle-class lifestyle. I don’t fly around on a private jet. I have little desire to own a yacht or a Ferrari. I own only one home, in which I have lived since 1987. Paying an extra few percent in taxes wouldn’t create a lot of hardship.

Read the full article here.

Competence Trap – Addendum

Here's a quick addendum to competence trap, with one more of its implications.

Let's say that a couple decides that one of them will go to work and earn, and the other will stay back and manage the home front. Additionally, they decide that once every two years, they will alternate roles, switching who stays at home and who goes to work. They feel that this would be very fair.

However, such seemingly equitable arrangements won't make economic sense for the couple. The reason for this is the power of the competence trap. Even if the couple is able to get their respective offices to go along with their proposed arrangement, they will end up with sub-par promotion opportunities being presented to either of them. In the long run, they will end up with below average salaries.

Instead, if one of them had continued to work, that person would have become more and more competent at what they do, and would likely have enjoyed better financial compensation.

Related post: Competence Trap

Inferior vs Normal Goods

In my assorted reading, I come across several new (to me) concepts and ideas. Quite often, these concepts seem to apply to my situation at the time I encounter them.

Recently, in an economics book, I read about what economists refer to as inferior goods as contrasted against normal goods. This seemed to have implications for those interested in early retirement.

First the definitions: An inferior good is something that people want less of as they get richer.

Examples of inferior goods include eating street food (as opposed to eating in white-tablecloth restaurants); buying new items (versus settling for used ones or getting old items repaired); and taking bus rides (compared to driving one's own car).

A normal good is something that people buy more of as their incomes rise (better clothing, getting a bigger house, fancier entertainment etc.)

In my own case, the goal was to get time off. Now, I am very aware of how important luck is in our lives and I won't deny that my wife and I are extremely fortunate. But we also planned for and made numerous adjustments in working towards this goal of getting time off (which in our case means no steady income). In retrospect, I see that starting from years earlier, we consciously opted for the so-called inferior goods.

To me, this choice seems to be another necessary condition. It strikes me that those who are serious about taking time off (by giving up their regular salary) have to opt for at least some "inferior goods."

You make all the adjustments you can, and then you hope for luck.

Nobel Economics committee can't go wrong

Economist Alex Tabarrok has identified an interesting situation and points it out. Even as opinions are divided on the Nobel Peace Prize committee’s decision this year, Prof. Tabarrok says that the Nobel Economics Prize committee can't go wrong this year.

We need to know a couple of things before we can appreciate why he is saying that.

In the betting market for the Economics Nobel prize this year, Eugene Fama is the leading candidate. He has the best odds.

Fama is best known for his Efficient Market Theory (EMT) which might be Nobel-worthy. To oversimplify, EMT states that markets are always "informationally efficient" and all known facts are instantly factored into the price of an equity/entity.

So here’s why this year’s Nobel committee’s decision will be self-fulfilling. Let’s say that they do give it to Fama. Then he deserved it because even the betting markets demonstrate an instance of EMT at work. All is well.

Let’s say they give it to someone else. Then the betting markets were wrong, and the EMT didn’t hold true at least in this one instance. (The odds for the eventual winner should have been better in a very efficient market.) The prize shouldn’t be given to the theory since the EMT doesn't always hold. (Aside: Many are now arguing that EMT doesn’t always hold true.)

Therefore, either way the Nobel committee can’t go wrong this year.

Leisure Class on both ends

There is a seductive quote in Jon Krakauer's book 'Eiger Dreams.' (That book is, in my opinion, just as readable as his very well-known Into Thin Air.)

A guy, who just lives to ski and rock-climb claims that
"At either end of the economic spectrum lies a leisure class"

The idea of people enjoying leisure (rich in time) even while being on the financially-poor end of the spectrum fascinated me. I remember mentioning this sentiment to SR, a close friend and a colleague of mine at the time.
"Ram, this sounds very cool but is not true, man" he insisted. He was probably right in his pragmatism.

But even now, after all these years, I wonder if there isn't something to that quote after all.