Monday, September 22, 2014

Prediction failures

The flat payoff curve problem hit iPredict's vote share markets.

A contract paying $0.01 for every percentage point National got was trading at $0.44 just prior to the election: far below National's outcome of 48%. At the same time, iPredict's contract paying $1 if National were to win more than 44% of the vote was trading well over $0.80. What gives? You can tell convoluted stories trying to rationalise it around improbable underlying probability distributions, but it was just flat payoff curves.

I owned 250 contract of Vote.National. I paid an average of $0.4376 for those contracts. I will gain just under 5 cents per contract, for a gain of $10.60. To get that almost eleven bucks, I had $109.40 locked up in those contracts for a year. Sure, a 10% return seems fine, but it's a pretty heavy carrying cost where the opportunity cost is contracts elsewhere providing greater return (and more risk).

If we look across the "Pays $1 if National gets over x%" contracts, we get a fair odds line of 46.5% prior to the election. A contract paying $1 if National did better than 46.5% was trading around $0.50 in the last couple days before the election. That's still much worse than National's eventual outcome, but not nearly as far out as the 44% used in the Herald's comparison. I'd been warning folks round the office for at least the last month not to trust the continuous contracts because of the flat payoff curve problem and to rely instead on the ranged $1 contracts.

Why were the latter so far out too? That will be a fun one for the iPredict crew to look at. The fair odds line on the Greens was between 13.5 and 14%; the Conservatives were pegged between 4.5 and 5%. I don't know whether people were hedging (then why not short PM.National instead of the vote markets?), or failed to adjust thoroughly for that young Green and Internet/Mana voters might disproportionately fail to turn out.

How did I do?

  • Well over a year ago, I'd shorted ACT's winning an electoral seat. I hadn't cleared that short position after Seymour was nominated because the prices had moved to what seemed then a fair price: I don't trade to reverse past errors, only when prices currently look wrong. So I lost $26 there;
  • Up $171 on PM.2014.National, trading whenever prices seemed to have over-reacted either way;
  • Up $5.61 (so far) on Vote.2014.Nat, having bought at around the $0.42-0.44 range. I bought a pile at $0.4475 back in March when prices seemed offensively out of whack with the $1 contracts, but then gave up trying to bring some sense to that market;
  • Up $5 shorting that Act would win 2 or 3 electoral seats;
  • Up $5 shorting that Russell Norman would be the next finance minister;
  • Up $76 shorting Labour, trading whenever the market seemed to have overshot on either side;
  • Up $45 shorting that the Conservatives would cross 5%.
  • I was up on trading on Internet Party contracts, but I'd closed out all those positions well before the election and so am not entirely sure how it all netted out.
But I lost a couple of side-bets. 

Back in January, I'd reckoned that an Internet Party could cross 5% if there were an Internet Party and if there were a big Snowden release in the middle of the election campaign. I bet a round or two of beers on it with one loyal reader of this blog. I no longer believed the Internet Party likely to cross 5% when Kim DotCom sabotaged the Snowden event by releasing an email that everyone but him believed to be a forgery, but that sure wasn't a condition of the bet. I also owe BK Drinkwater and KiwiPollGuy $20 each. 

Friday, September 19, 2014

Coasean seating

Paul Walker has a series of posts* on the Coase Theorem and Josh Barro's column on property rights and reclining airline seats.

This had all seemed really very simple to me at the outset. It still seems really very simple; I don't know why everyone else has complicated it so much.

Each passenger is in a contract of carriage with the airline.

The airline has decided to put the recline button for my seat on the arm of my seat rather than on the back of my seat. The airline, which is profit maximising, has decided that the rights should lie with me, the recliner, rather than with the person behind me. I can push the button, and recline, but the person behind can offer to pay me not to. If the airline had not wished to grant me this right, the button would not be there for my use.

In the alternative, where the button were placed on the back of the seat, I would have to ask the permission of the person behind me that he might push the button. He might seek compensation for doing so, or the whole negotiation might start a fight.

The airline could be choosing the option that minimises the number of cross-row unpleasant seat discussions, since only a subset of reclinings will yield such discussions under the status quo where all of them would require it under the alternative. But if the gains from being able to recline were sufficiently low, they could choose to install seats that did not recline.

If enough anti-recliners took sufficient umbrage, there'd be returns to offering a no-reclining section. That that also hasn't happened says something about expressed versus revealed preferences.

Paul says it isn't clear where property rights lie. But recall that the interesting cases in Coase are always in the high transaction costs worlds. There the judge is called upon to assign default rights so that problems are avoided at lowest cost. The airlines are the judges. They compete with one another. They all have assigned the default rights this way when some could have chosen otherwise. If they've all set the default this way, when they could just have easily flipped it the other way, should reasonable people not infer that property rights lie with he who has the switch?

That some individuals wish to force a transfer through use of anti-reclining devices does not indicate that the existing rights are unclear unless we also believe that a bank robber indicates uncertainty about true ownership of the cash in the till.

Full disclosure: the only time I would ever recline my seat is on a long overnight flight where most people hope to sleep.

* In order: here, here, here, here, here.

Thursday, September 18, 2014

Market segmentation: candidate beauty edition

Low-information voters are more likely to vote on candidate looks alone; higher information voters add in other information.

There's a lot of randomness involved in party leader selection, or at least with regard to candidate attractiveness. But we can say that, at the margin, a party that cares about winning and that relies more heavily on low-information voters ought to lean towards more attractive candidates at the margin.

I'd written a few years ago:
In equilibrium if we've a thick market of potential candidates, I can't see how this generates any particular inefficiency. Sure, it gives an additional dimension over which parties need to optimize in candidate selection, but in sufficiently thick markets, the tradeoff in moving from the slightly less attractive to the slightly more attractive candidate won't be that large. The only problem is if you've got thin markets such that the quality gap on other margins is large as you move up the beauty scale. But that too should be a disequilibrium phenomenon. They've said that politics is show business for ugly people. Well, if the returns to beauty start ramping up in political markets relative to other markets, more beautiful people start selecting into politics rather than other endeavours. Hamermesh found that the beautiful select into professions where beauty is rewarded; why should this be any different?
Will Hayward at Auckland Uni put NZ candidate photos up for an audience of American raters, none of whom could be expected to know anything about the candidates' parties or positions.

The findings? Based only on photos, Laila Harré was seen as most competent, trustworthy, and attractive. Jamie Whyte was second from the bottom on attractiveness, with Hone stuck in last place.

We probably can't draw much from it. But it does seem to matter at the margin for low-information voters.

Note that, by photos, the competence ranking was Harré, Key, Peters, Whyte, Cunliffe, Flavell, Norman, Harawira, Turei, Craig, Turia. Expect that low information voters may well be assessing candidate competence on similar basis. At least some of these rank orderings seem out to me.

I want to eat a weka

It's been more than five years since I first posted on Roger Beattie's felicitous "Eat them to save them" campaign. And I still am not allowed to buy a weka for dinner.

Roger is one of New Zealand's great enviropreneurs: the National Farming Review called him an Eco Anarchist. He loves the environment and sees the best way of saving it as ensuring that it's profitable to save it. Weka are endangered, but they're easily farmed and tasty. Why aren't we raising them for the restaurant trade and conserving an endangered species in the process? The Department of Conservation says no. They say no incredibly incoherently. But their "No" is what matters.

Roger features in Vice's "Munchies" column this week. Here's an excerpt.
How do you think we should be protecting endangered species?We need to change the legislation. We wonder why we’re losing 6 percent of our kiwi population per year. The Department is right in identifying the problem, but have the wrong solutions. A market solution is necessary. If private individuals want to do conservationist things, there should be no impediment. We farm native paua, plenty of people are propagating native trees—but certain native species can’t be farmed. No species that have ever been farmed have ever died out. Since man has been in New Zealand, we’ve lost 44 bird species because they were protected. If you’ve got the choice between something being protected and dying, and something being farmed and thriving, that’s not much of a choice.
What species do you want to farm first?In terms of sustainable farming, you have to have a species that is friendly and tasty. What I do know about is weka. Weka grow fast, they can be farmed with only a relatively small amount of capital, they eat a variety of food, and are cheap to grow and keep. We’ve bred hundreds of them and given them away. You’re not allowed to sell them without a permit. You’d end up in jail.
I'd love to see work on the economics of allowing the breeding and sale of jewelled geckos, or tuatara, for the pet trade.

Wednesday, September 17, 2014

Capital Gains Tax Bleg

When I first started writing posts on capital gains taxes three years ago, starting with this post and this one, they were sort of a bleg. I have never understood the rationale for CGT, as the arguments that are usually put seem to involve shifting definitions, or incomplete partial-equilibrium analysis. So I wrote those two posts to explain why I thought the arguments in favour don't add up, hoping that someone could counter with a coherent argument. With a CGT defended within the context of a coherent model, it should be possible to phrase the debate in terms of differences in either values or empirical beliefs about the economy. Three years on, I have seen a lot of public discussion of capital gains taxes, but still don't understand what is the model from which proponents draw their conclusions.

But now I have a different bleg. I would like to know how actual CGTs that have been implemented elsewhere (or the ones proposed by opposition parties in New Zealand) would deal with a particular issue. This issue is easiest explained with a series of examples:

  1. Imagine that you are a householder with a portfolio of $2,000 of shares in a single company that is earning a 5% rate of return on its capital. At the start of a new year, you decide that you want to save some more, so you buy $100 in a different company using money you have earned in the previous year but not spent. You now have a portfolio of $2,100. This increase in the value of your portfolio would not be classified as a capital gain. It simply represents increased savings.
  2. Now imagine that instead of putting the $100 into a different company, you bought $100 of freshly issued shares in the same company that you already have a shareholding of $2,000.  That still doesn't count as a capital gain, right? The company uses the money from its new share issue to buy some capital equipment, which will also earn a 5% rate of return, but what they do with the money is irrelevant.
  3. Now, imagine that in the previous year, you were paid a dividend of $100 by the company in which you own $2,000 of shares, and you bought $100 of freshly issued shared by the same company. Again, this makes no difference. The fact that your purchase of new shares was in exactly the same amount as your dividend payment, is irrelevant; the additional $100 was paid for out of your total income and was available for buying shares because of a choice not to use it on consumption. 
  4. Now make one more change. Instead of paying out $100 in dividends and then issuing $100 of new shares, the company simply retains the profit, pays a dividend of $0, and uses the money to pay for the new capital, as above. The company has increased its ownership of capital equipment by 5%, and so the value of the existing shares will increase by 5%. So now our shareholder sees that his shareholding portfolio has increased from $2,000 to $2,100, just as in all the previous cases, except in this case he hasn't bought any new shares; he has seen what looks like a capital gain of 5%. Except, it is not really a capital gain; the reinvestment of profits by the company instead of paying out a dividend is a form of saving that is imposed on its shareholders.  

In the absence of taxes, the only difference between example 3 and 4 is in the default position. In 3, the shareholder receives the dividend and needs to make a decision to buy new shares to turn that dividend into saving. In 4, the default is that the dividend is saved, and the shareholder would need to sell $100 of shares to convert that saving into consumption.

But what if we add capital gains taxation. Wouldn't a CGT induce a difference between example 3 and example 4, adding additional taxation in the latter but not the former. And wouldn't this induce a distortion in which the tax system created an incentive for firms to pay out all their profits as dividends and then raise new capital rather than retaining profits for investment? What I would like to know is how to other countries deal with this distortion in their CGTs (if at all), and how would the opposition parties in New Zealand plan to deal with it.

It is also interesting to note that currently in New Zealand, there is a slight tax distortion that favours retained income over dividend payout (as the corporate income tax rate is lower than the top rate of income tax). At the time the rate was lowered from .33 to .30 in 2008, the then Labour government said this was a deliberate distortion as a kind of nudge to encourage retained earnings and hence make saving the default. Does Labour now think that we should be changing the nudge to consumption by moving the tax advantage the other way?

Oh Christchurch, revisited

My chapter on the failures in the Christchurch rebuild is up at Public Address.

I'll be speaking on it at a lunchtime panel tomorrow in Wellington. Perhaps I'll see you there.

From my chapter:
If we learn anything from the intersection of the work of Jane Jacobs and of Ed Glaeser, it’s that cities are organic. The best parts of cities emerge from the distributed decisions of thousands of property owners, building near each other to take advantage of complementarities in location that they could foresee and that the planners couldn’t envision. SimCity takes no account of the wishes and dreams of the Sims. All of the small actions of distributed individuals can add up to something wonderful, if only Council and the bureaucrats would get out of the way and let it happen. Instead, we had the worst of all possible worlds: the insistence that a perfect central plan supercede these decentralised decisions, but absolutely no bureaucratic capacity to set or follow through with a plan.

Monday, September 15, 2014

Parker versus NZIER on Capital Gains Taxes

Labour finance spokesperson, David Parker, sent this letter to the New Zealand Institute of Economic Research, regarding a report they wrote for Federated Farmers on Labour's proposed captial gains tax policy. 

I don't have time to read the original report or the earlier one by BERL referred to in the letter. What struck me, however, is that the points of disagreement are really quite tangential to the issues that should be at the heart of a debate on the merits of a capital gains tax (CGT). Let's take these in turn.
  1. Parker believes the tax will raise more revenue than NZIER do. A CGT that is designed to ensure savings is directed to the most productive investments rather than be motivated by differential tax treatments is one that would raise zero revenue. Any CGT that increases revenue is one that increases the existing tax distortion penalising saving relative to consumption. Of course, one might have the objective of increasing the tax on saving for the equity objective of increasing the tax paid by the rich, but that is a different objective. Either claim the tax will raise revenue, or claim it is about encouraging productive investment, not both.
  2. Parker believes the proposed CGT will be more progressive than NZIER do. This may be true, but if the objective is to increase the progressivity of the tax system, the policy question is whether it would be better to achieve this through increasing the income tax rates that would target high levels of wage and salary income as well, rather than just one component of capital income. 
  3. Parker believes the current income-tax paid on trading is not important enough to make the claim that we currently have a CGT. That is possibly true, but it misses the point: We do have a perfect, all-of-the-advantages, none-of-the-disadvantages 13% CGT. It is called GST
  4. Parker believes that a CGT will have more impact on housing speculation than NZIER. Again, this is possibly true, but why is that a good thing? Let's reiterate some points made previously, here and here
    • Housing speculation is only profitable if house prices are expected to rise in the future. That is, speculation can't permanently increase house prices; it can only bring the increases forward in time. A policy designed to make speculation less profitable is a policy that admits that nothing will be done to curb the underlying drivers of house-price inflation. 
    • To the extent that bringing forward future house price increases creates an incentive to build more houses, speculation will actually lower future prices. One can claim that the tax distortion that means home owners pay no income tax on the imputed rental they earn from themselves leads to a country having too large a housing stock, but not if your rhetoric is about making home ownership more affordable. 
    • And curbing speculation in home ownership, to the extent that it has an impact on home affordability must operate through making renting more expensive. Again, this might be an objective, but not one that is easily squared with rhetoric concerned with poverty levels. 
One final point. Parker claims that the Australian experience is illustrative, because they had a CGT excluding the family home, their "home ownership rate was lower than New Zealand's. Now it is higher and ours is at a 60-year low". Is the claim that Australia's CGT had an impact on New Zealand's home-ownership rate? Or is this a difference-in-difference estimation that assumes as a control that Australia's rate would have fallen like New Zealand's but for the CGT?