Saturday, March 17, 2007

Casino Royale

Tonight, for the first time, I made myself the drink James Bond creates in Casino Royale:

"Just a moment. Three measures of Gordon’s, one of vodka, half a measure of Kina Lillet. Shake it very well until it’s ice-cold, then add a large slice of lemon-peel. Got it?’”

It is actually very good.

Mortgages and Houses

A few years ago, Alan Greenspan suggested that many households would have been better off financing their houses with adjustable rate mortgages. This is because for many years payments on adjustable rate mortgages were lower than on fixed rate mortgages--so after the fact, Greenspan was correct.

The problem with advising people to use adjustable rate mortgages, however, is that ARMs give households liabilities that have short duration--that is, liabilities whose market value remains close to face value at all times. This is because the rates on ARMs by definition change to meet market rates on a regular basis. Houses, on the other hand, are assets with lots of duration. The services they give to homeowners (shelter and a set of amenities) is pretty much invariant to market conditions. Consequently, house values change with market conditions, such as changing interest rates.

Good financial management practice suggests that to minimize risk, the duration of of assets and liabilities for any institution, including households, should be matched. In the case of houses, this means that households looking to minimize risk should use a fixed rate mortgage to finance their house. There are exceptions--if one buys a house and expects to sell it in five years, a five year ARM makes lots of sense, because the duration of the asset (housing services over five years) and the liability would match.

This is not to say there is anything wrong per se with people getting ARMS, so long as they explicitly understand the risk embedded in them. But a principle I have been pushing for years is that if people can't afford a house with a fixed-rate mortgage, they probably shouldn't buy a house. It is one thing to have the option of the FRM, and then decide to take the risk of the ARM anyway. One of the nice things about the United States is that FRMs are easy to come by--this is not true in most countries around the world. It is something else to be forced into taking a risk in order to buy. Under these circumstances, buying probably isn't worth it.

That said, there is probably too much ink being spilled on the downside of home-owning. The Times this morning had a piece that would make one wonder why anyone should own a house. But it is important to remember that renting is risky too--leases are usually only a year long, which means renters are subject to increases in rent or may even be forced to move every year.

Notice that I have not even mentioned the subprime market in this post. That will be for another day (probably tomorrow).

Friday, March 16, 2007

A few words about urbanization and growth

From a paper I am writing for the World Bank:

Every affluent country in the world is urbanized. Among OECD countries, 77 percent of people live in urban areas, and among World Bank-designated high-income countries, 78 percent of people live in urban areas. The poorest two countries in the OECD, Turkey and Mexico, are 67 percent and 76 percent urbanized, respectively. The least urbanized affluent country, Portugal, is 55 or 59 percent urbanized, depending on source. At the same time, the world’s lowest income countries are generally not urbanized: in 2004, the urbanization rate among the World Bank’s designated low income countries was 31 percent. All of the countries with urbanization rates of less than 20 percent, Burkina Faso, Burundi, Cambodia, Ethiopia, Malawi, Nepal, Papua New Guinea, and Uganda, are low-income countries, all with Gross National Incomes Per Capita of less than $660, and most with GNIs that are substantially lower than that.[1] The correlation between urbanization and PPP Per Capita GDP in 2000 was .70. In short, urbanization accompanies affluence.

That urbanization accompanies affluence does not, however, mean that urbanization causes affluence. First, it is worth noting that Latin America and the Caribbean are 77 percent urbanized, and the countries in that region are certainly not among the World’s richest (nor are they in general, among the poorest). There are also very poor countries in Africa--Cameroon, Mauritania, and Senegal--that are at least 50 percent urbanized. All of these countries have per capita GNIs of less than $1010.[2] Hence affluence does not necessarily follow urbanization.

One of the most interesting questions in development economics, then, is whether urbanization causes affluence, or whether affluence causes urbanization. Knowing the direction of causation is important, because it will dictate whether policy should encourage urbanization or be neutral with respect to urbanization. Discussion below will outline arguments for both directions.

Principles set forth by Richard Freeman, however, suggests that the evidence is already sufficient to know that policy should not discourage urbanization. Freeman’s three rules of econometrics are: (1) it had better be there in the ordinary-least-squares regression; (2) it had better still be there in the econometrically-sophisticated high-tech instrument procedures; (3) it had better still be there for small technical tweaks to the econometrically-sophisticated procedures. That urbanization has a deleterious effect on affluence is not there in scatter-plots and correlations, and, as we shall see below, is not there in the OLS regressions in the literature.

The fact that there is no evidence that urbanization inhibits development is in itself important. On my visit to Bangladesh in 2004, some officials were convinced that urbanization was shown scientifically to be “immoral,” and wanted to know where to find the work that would prove it to be so. I disappointed them when I was not able to point them to any such work.

[1] Afghanistan is likely within this group as well, but there is no good current data on urbanization in the country.

[2] Gabon, a sub-Saharan that is 84 percent urbanized, has a per capita GNI of more than $5000, a very high number for the region. But the primary reason for the high number is the presence of oil.

Sunday, March 04, 2007

Taking the log out of our own eye

I admire Brad Delong very much: he is a wonderful blogger and scholar. He also is very tough on the Washington Post. I, on the other hand, consider the Post a treasure, and am grateful to have it on my doorstep every morning. To be sure, the paper has stories that I am not crazy about; it also regularly has stories that are breathtakingly good (such as the recent series by Dana Priest and Anne Hull on Walter Reed).

So let us stipulate that that even the best newspapers have reporters who are not particularly good at their jobs. Unfortunately, universities, even the best of them, have professors who are not particularly good at their jobs. Here at George Washington, we have many wonderful, inspiring teachers. We also have people who should be embarrassed to step into a classroom--people who are unprepared, are indifferent, or worse, haven't kept themselves up to date on their supposed area of expertise. Moreover, unlike reporters, who must meet short deadlines, professors have time to reflect on what they are going to say and do in their classrooms.

Some might argue that comparing George Washington with the Post is not really appropriate: the Post is supposed to be one of the greatest newspapers in the country, while GW is rarely listed as one of the greatest universities. OK. When I was an undergraduate at Harvard, I encountered some really horrible teaching (and of course, truly extraordinary teaching, from Gwynn Evans, James Q. Wilson, Stanley Hoffman, Benjamin Friedman, and my Ec. 10 TA. Jeff Wolcowitz, among others). That was between 1976-1980, so perhaps all the bad teachers are gone now, but based on what Derek Bok and Harry Lewis have been writing lately, I doubt it. I am guessing that even Berkeley has bad teachers.

This is not a plea for reducing the emphasis that universities place on research: many unproductive researchers are bad teachers, and the greatest teachers are often the greatest researchers. Gwynn Evans, my Shakespeare professor, was likely the greatest Shakespeare scholar of his time. During my time teaching at Wisconsin, I discerned a strong positive correlation between research productivity and teacher quality. And no wonder: active researchers know their subjects well, and that rubs off on their ability to explain and enlighten.

Nevertheless, we need to do a better job of quality control for teaching. How exactly we do this without compromising academic freedom is not entirely clear to me. Culture probably matters a lot. When I was a visiting Professor at Wharton, it was striking to me that even those who didn't particularly like teaching considered it important to avoid embarrassing themselves; people generally had too much pride to do anything less than well. More generally, I see too much complacency is our business; many professors are content in the knowledge that American universities are the best in the world, and so don't feel any urgency to change. One of my colleagues here at GW gets upset with me for being too self-flagilating.

I actually feel a great deal of pride in being a professor at a reasonably well-known university--I think that it is among the most rewarding things one can do in life. I think in generally our universities are wonderful. But before we go around removing other institutions' specks, we have some of our own timber to clear.