Research

If I have to pick one single most important thing I have learned in college, it will be an easy choice. It is not an answer to any question. It is a question that I learnt to ask: "Who cares?"  or "So what?" I am grateful for being instilled that no-nonsense ideal.

This has since defined my attitudes toward research. As Ed Leamer nicely put, we need to think if that research has any value beyond "mere mathematical amusement".

An epidemic in China

Two pieces of news from Forbes first.
China's Zoomlion Tangles With Feisty Newspaper Over Fraud Claims

Arrested Reporter in Zoomlion Case Admits To Taking Bribes And Inaccurate Reporting
Underlying these two pieces of news is the real big challenge for Chinese Economic development---loose accounting standard and dishonest accounting practices. It is a epidemic haunting China's business community.  The tax system is partly to blame together with the loose enforcement, which makes a prisoners' dilemma---no one can afford to be honest.

I happen to know some accountants in China and what they told me is shocking beyond the kind of news you will see. I will quote anonymously what one accountant told me.

"Accounting is a stressful job. I hesitated a lot before taking another accounting job after I retired. It is just you have to make up the books when you do the job, otherwise, no one will hire you. The trouble is the accounts will be kept for ten more years, and I do not want to be haunted by the possibility of getting arrested five years down the road....audition is not the way to go either. You are too naive. Audition is super lucrative, but that does not come from its legal pay. You are certain to find problems in the books you audit, and you need to look the other way. That is where the money comes from. Also, why would anyone ask you to audit when they know you will find the problem and they can hire others to give their book a nod? That stupid certificate, is a stamp of approval, worth so much money. You can lease it out to others and earn a good profit without doing anything. Of course, that is when everything goes well."

He added, "do you understand? You are probably too young to understand".

Actually, it is not such a complicated explanation. You hear that a lot when it comes to the explanation for financial crisis. The incentive for rating agencies.

I think there are a small number of problems that account for most of our troubles. Sometimes we do not know how to solve them. Sometimes, we understand how to solve them very well, but the political system will not allow us to solve them.

Chinese Romanticism or stupidity

China has undergone gigantic changes in recent years, especially in economic areas. The market economy reform has disrupted the old system, leaving many disgruntled. Many complaints about the current outcomes are unfair for three reasons. 1) The current outcomes compared to the old unsustainable outcomes 2)The comparison ignores the gains and focuses on the losses alone 3) The comparison is made with the rest of the world, partially imagined by the Chinese to justify their complaints.


I will give some examples to illustrate how ridiculous such perceptions can get.


Education. People in China have so much complaints about their education. They think it sucks. The American education, on the other hand, rocks. American high school kids are stress-free, they do not have to work hard, they still get into good colleges and earn good money. That is how a Chinese people think. Our school teaches Maths and Science that is useless. American never need to learn that, and they are fine. So our school system is so outdated. Mea culpa. I once thought so as well. Indeed even after I came to US and realize that the US education system is far worse than the ideal I imagined it to be, I still held a bias against my hometown education (though I was never aware of it). I was shocked when I read in NYT the other day that Shanghai public secondary schools topped the world charts in the 2009 PISA (Program for International Student Assessment). When I told this to my parents, their response is "really? that is weird!"


Health care. Chinese people think they have the most expensive health care. They feel doctors earn too much. Look at Americans, their health care is much more affordable and the poor do not have to worry about not being able to go to the hospital. Nothing could be farther from the truth. I am not sure how they would react if I tell them that it cost me \$364 to get a chest X-ray, which cost a bit above 100 RMB (\$20). It is revealing to observe that when Chinese students in US go back for vacation, they rush to the dentist to get their wisdom teeth out, regardless they are impacted or not.



Housing prices. People complain about housing prices. yes, no doubt the housing prices are high. But it is unfair comparison. Americans pay property tax, but there is no property tax in China. So when you compare property prices, you have to add in the present value of all future tax payment. Also, you cannot compare Shanghai to Philadelphia. NYC is probably the only legit comparison. Many so called cities in US are nothing but small towns in China in terms of population. The demand for housing is simply no comparison. Also there is enormous difference in infrastructure. Cities in China means unparalleled public school system, convenient public transportation, better health care, and safety. The cities in US tend to have lots of problems like crime-ridden slums, inner city schools. With the only exception of NYC, the public transportation is no comparison. Even for NYC, their public transportation is outdated when compared to most cities in China.


Automobile ownership. China does tax automobile ownership a lot---this is done via expensive motor registration. The right to register is auctioned off in places like Shanghai in limited quantity, and people just bid up the prices. In Shanghai at least, that right to register could be more expensive than the car itself. I actually applaud this. I think in cities in China, the sheer number of automobiles create huge negative externalities in terms of pollution and congestion. This externatlity is best internalized via taxation, not only in car ownership and oil tax. In US, car ownership in cities is usually taxed in another form---the difficulty to find a parking place. It is so prohibitive that some people think twice before driving to cities. This tax is prevalent---even in the tiny "city" of Seattle, you will need to drive around for quite a while to get a roadside parking place. Finally it is funny to note that while a shanghainese will complain that the government do so little to alleviate the congestion problem and the pollution problem and complain that it is so expensive for him to buy another car.

You Shall Not Crucify Mankind on [the] cross of Ignorance and Arrogance

There is no typo in the title, it is when ignorance and arrogance cross that I am referring to. That crossing is not "a cross of gold", by all means.

When I came to US, it was a humbling experience. Everyone seemed to know so much and display so much confidence when they discuss various things. I on the other hand, never felt confident enough to discuss anything. Then I realized that they do not know more than I do. The question becomes:Why don't you shut the f*** up and listen? the answer is, because we think we know it all.

As a student of economics, I think I still fail to understand so many issues---the meaning of an empirical test, the consequences of monetary policy,  the function of exchange rate, or the effect of health insurance. But I understand these issues more than the lay people. However, it is troubling to observe that the lay people have much more confidence in their interpretation/opinions of these issues.

The sad truth is that we human beings are not "noble in reason" or "infinite in faculty". We are far from being "like a god" "in apprehension". Our brain however, tend to think we are as perfect as Hamlet sees. Because we are like a god in apprehension, then we should have a consistent story. As a result, our brain constructs a consistent story based on limited information we have, by downplaying contradicting information. When we obtain new information, our brain confirms our original story if the new information is consistent, but tend to rationalize/distort/ignore the new information if it is not. After all, how can a god's judgement be false. It must be that the new information is wrong! This phenomenon is extensively documented in the "confirmation bias" in psychology. Things get worse from here. Our brains take in irrelevant information. For example when we evaluate a person's competence, we take into factor such as if he looks good. In an embarrassing study, researchers found that asking people rate people by looking at their picture, and these meaningless ratings predict election result very well (from local elections). Indeed, that is why newspapers like to include irrelevant information to stir up our emotion. Look at those shocking pictures! Are those pictures powerful because they convey much information or because they stir up strong feelings, that is sure to get entangled with your reasoning?

Indeed, what a crappy piece of work is a man!

So some anecdotes. I have some American guy tells me how I am wrong about what it is like living in China. But I have lived in China for more than 18 years! And he barely spent one year in China. wow!

I know you all have strong opinions, on lots of things. But you seriously do not know them all. How much do you seriously understand what health insurance is about when economics as a profession think they only scratched the surface? How could you think you are a competent judge of the territorial disputes between  China and the Philippines, by just reading a NYT article?

Fellow human beings, be humble. Admit you do not know it all. do not have so much faith in your story. Listen to those who might know more.

Real Explanations for Chinese Trade Surplus---Finale

So I have discussed three explanations I have for Chinese Trade Surplus. There are more of them. I do not wish to write about them all, as it gets tedious for the readers. Nevertheless, I think there are some lessons to be learnt.

The first lesson is do not trust economists religiously. First look at the following diagram. It is the IMF forecasts of Chinese Current Account Surplus vs the actual data. What is striking but not surprising from this diagram is how they systematically got it wrong. Impressive record.

When economists manage to keep such a lousy record, you know they are missing something important. They simply do not understand.

The inability or reluctance to contextualize data is a fatal trend among researchers in general. We ask RA to collect data and we never bother to waste another minute on the data other than running some damn regression to find some spurious relations to publish. We sometimes do not even know what is a canonical data point is like. In this case, it never occurred to us that given such an anomaly, we probably need to understand the country a little bit better. No.

This is a sure recipe for disaster. We never recognize or admit our mistakes (even with a lousy record as shown in the graph) until a disaster takes place and force us to rethink. This is true of Asian financial crisis, the 2007 financial crisis. We can only ex post rationalize, and head towards the next mistake.

The industry of publication no longer cares about truth. We are no longer interested in a simple story linked to the context of a country. Country idiosyncrasies do not matter. They are error term. However, once in a while, we are sure to get a real big error term. We want fancy statistical methods carried out on a huge data set. Thus many of us spend hours to construct dataset without ever thinking or looking at the data. We use all kinds of fancy names, pooled data, panel techniques, cluster analysis, instrumental variables and GMM. This is a complete farce.

Real Explanations for Chinese Trade Surplus 3

In the previous two posts, I discussed two explanations for Chinese trade surplus. I now continue to offer another one.

I will once again start with a story. Imagine you are the firm of one multi-national. You have one branch in country A and one branch in country B. You discovered that you have to pay lots of taxes on profits in country B, but you can evade taxes in country A due to its loose taxation enforcement, poor auditing system, and favorable tax conditions. You also know that there is gigantic intra-firm trade---some things are made in country A and sold to country B and vice versa. What can you do to maximize profit.

This is strategy 101. When you sell things made in country A to the branch in country B, you simply price them a lot higher, so that when branch in country B resell it, it does not seem to make any profit. You will do the opposite for things made in country B. In this way, you have transferred your profits to country A.

I hypothesized this in my sophomore year, and after sending out an email describing hypothesis, I learnt this strategy is not new at all, it is called "Transfer Pricing". Yesterday while working in HBS, I learnt that it is a hot topic in strategy.

Let me make this more lucrative. You happen to think that the currency in country A gonna appreciate against the currency of country B. wow, such a good deal. Thus transfer pricing takes place and it looks as if country A is having a gigantic trade surplus.

Back to China. It is quite self-explanatory how to apply this theory to China. Nike shoes are produced at cost of about $1, and is sold around $60 say. There is plenty of room to transfer profits.

Another aspect of this is the mere expectation that Yuan will appreciate make this transfer pricing more attractive. However, what many people did not realize is that some of the trade surplus might be exactly due to such practices---in other words, such practice is self-reinforcing due to opacity. What you see in trade surplus is not real (due to the reasons I explained in previous two posts), and you expect Yuan to appreciate, so you engage in transfer pricing, enlarging the trade surplus, amplifiying the "false trade surplus".

Real Explanations for Chinese Trade Surplus 2

In the previous blog, Real Explanations for Chinese Trade Surplus 1, I discussed "Suppressed Import Hypothesis". In this entry, I will discuss "Fickle Citizen Hypothesis".

Imagine there is one very rich person in country A. He is capable of making tons of things through his own labor. Each year he exports so much to another country B. He makes a handsome profit out of it. There is no doubt that you suspect this young man is causing a potential trade surplus of country A. Absolutely, you are right. That is what we see in data. However, data are damned by fickle accounting standards. What if I suddenly tell you that young fellow has been revealed to be a citizen of country B instead? Then what he sells to country B is no longer exports (As Rachel correctly points out, from a GDP perspective it is still exports, but not from a GNP perspective. See the technical addendum for a discussion and justification)! If that is the only trade taking place, there is no trade surplus at all! This story shows how sensitive our Current Account (CA) deficits (you can think of this as trade deficit, properly defined) number are to citizenship definition.

Back to China. Many of the super wealthy are thinking of migrating out (for lots of reasons, sometimes for better education opportunities for their kids, which is linked to the story I told in the previous blog, but many times because what they earned is semi-legal via corruption).  If this takes place, and there is indeed evidence it is beginning to take place, we could witness a big capital flow that will wipe out all the trade surplus accumulated in previous years. By that time, not only will appreciation pressure on
RMB disappear, but also there might be depreciation pressure.




Technical Addendum:
I have been sloppy about trade surplus and CA surplus. For one thing I wish not to introduce too much technicalities, and for another, I think CA account is the proper definition of trade account. Trade account, too narrowly defines what is trade. In some sense, CA surplus is the trade surplus with respect to GNP, but trade account is trade surplus with respect to GDP. GNP, in my opinion is a more appropriate measure, but in most cases, there is little difference between GDP and GNP.
In general it is the large CA surplus that is disturbing. If country A earn huge trade surplus, but that is balanced out in its equally gigantic payments on foreign investment, it is no big deal, it is just a very different trade structure in that country B exports its capital service.

In China's case, most people ascribe the CA surplus to trade surplus. What this blog aims to illustrate is that such a large trade surplus is not incompatible with a balanced CA account, if proper adjustment is made. The important piece here is not net factor payment, however, it is rather capital account, namely cash transfers, which will take place when citizenship changes. Capital account has been completely out of discussion since it is generally unimportant, but what I argue here is it is illuminating to consider this channel in China's case.

Real Explanations for Chinese Trade Surplus 1

By real, I mean the real side, not the monetary/currency side. Of course, I am playing the pun that what politicians and economists in DC says aren't real.

Suppose there is a country A. Its people want to import a good from country B. However that has not been possible due to all kinds of reasons. Nevertheless, it expects that it will soon be able to import that good. If the expected import of that good is large enough, we will not be surprised to witness a gigantic trade surplus for country A now. This is my "Suppressed Import Hypothesis".

Back to China. What is the suppressed import I have in mind? Education. The number of students coming from China to US (or abroad more generally) for high school and undergraduates have been growing exponentially. I have not yet looked up official data, but anecdotal evidence is striking enough. For UC Berkeley, it started with single digit, and within 2 years, it reached 3 digits. NowI think the number is about 400. I heard similar stories in other state universities. I am talking about undergraduates here, who for the most part, pay every single cent. That is a gigantic number. This trend is a new phenomenon, and it should partly explain the current account surplus of China in previous year. There are lots of other reasons I will discuss in later blogs, but I think this is one story that is missing from the scene.