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.
Friday, October 25, 2013
Tuesday, October 1, 2013
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.
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".
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.
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.
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.
Monday, September 30, 2013
I simply need to share this----College Admission
Writing (or ridiculing, depending on your persepective) about american college admission system was on my agenda. Now, I probably won't because there is a better article.
http://www.newrepublic.com/article/114848/college-admissions-criteria-american-vs-british
http://www.newrepublic.com/article/114848/college-admissions-criteria-american-vs-british
Sunday, September 29, 2013
About Models
I did not intend to write this, but I felt I need to after reading a comment to my post.
There are two kinds of models. One kind of model is to make a point, or formalize an insight. The other kind of model is used to model the reality closely, and they are intended to be brought to empirical tests.
The first kind of model are designed to be as simple as possible, but not simpler. The second kind is designed to be as realistic as possible. We calibrate the parameters, and estimate the distributions if there is stochastic elements. Each parameter or variable has a direct implications---none of which is true for the first model.
I probably will only discuss and present the first kind of model in my blogs (I tend to prefer them in research as well). So what to make of my model? There are some basic take-aways, and that is why I wrote the model down. There are also many conclusions specific to the model assumptions, do not pay attention to them. They are not likely to be robust. The general rule is that do not be religious of the numbers I generate, and they depend on model assumptions heavily. Nevertheless, I try to present robust qualitative results.
There are tons of criticisms that I could leash out against normal distribution. But I will use them anyway. It is unlikely it gonna change the basic idea, and it is convenient.
I will end with a semi-relevant anecdote. In class one day, professor Helpman decided to present a general model of multiple goods. There is one "theoretic" guy in class and he asked:" Why don't we make the model more realistic and generalize to a continuum of goods?" Not a super impressive question. With finite numbers of molecules in the universe (yes, a large number), "continuum" is is not more realistic than "general N".
There are two kinds of models. One kind of model is to make a point, or formalize an insight. The other kind of model is used to model the reality closely, and they are intended to be brought to empirical tests.
The first kind of model are designed to be as simple as possible, but not simpler. The second kind is designed to be as realistic as possible. We calibrate the parameters, and estimate the distributions if there is stochastic elements. Each parameter or variable has a direct implications---none of which is true for the first model.
I probably will only discuss and present the first kind of model in my blogs (I tend to prefer them in research as well). So what to make of my model? There are some basic take-aways, and that is why I wrote the model down. There are also many conclusions specific to the model assumptions, do not pay attention to them. They are not likely to be robust. The general rule is that do not be religious of the numbers I generate, and they depend on model assumptions heavily. Nevertheless, I try to present robust qualitative results.
There are tons of criticisms that I could leash out against normal distribution. But I will use them anyway. It is unlikely it gonna change the basic idea, and it is convenient.
I will end with a semi-relevant anecdote. In class one day, professor Helpman decided to present a general model of multiple goods. There is one "theoretic" guy in class and he asked:" Why don't we make the model more realistic and generalize to a continuum of goods?" Not a super impressive question. With finite numbers of molecules in the universe (yes, a large number), "continuum" is is not more realistic than "general N".
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