Reading New Thoughts: Green and Bowles/Carlin Rethink Economics

Disclaimer:  I am now retired, and am therefore no longer an expert on anything.  This blog post presents only my opinions, and anything in it should not be relied on.
What I am talking about here is a history of West Africa circa 1200-1850 called “A Fistful of Shells”, by Toby Green, and a white paper by Samuel Bowles and Wendy Carlin analyzing CORE’s “The Economy”, a new multi-sourced introductory Economics textbook.  Both seem to me to provide different and troubling new ways to view economics as a whole; your mileage may vary.

Let’s start with Green.  Imho, his argument runs something like this:  a trade in gold (sub-Saharan Africa providing, North Africa/Europe/Middle East benefiting) sprang up, supplemented and then replaced by a trade in slaves.  These slaves were a natural outgrowth of previous uses of slaves (acquired in warfare, or involving criminals and excess population) both in Africa and Europe/Middle East.  

The initial result was positive economic growth.  The single source of the gold was iirc in Senegambia, and the people there carefully protected themselves and their mining from discovery and takeover, so the rest of West Africa began to be drawn in as middlemen.  Kings with control over some aspect of the trade arose, and were able to siphon off some of the profits to establish and maintain power.  Thus the Mali and Songhay “empires”.  

However, the trade relationship was fundamentally unequal.  Cowrie shells, especially those imported from the Maldives, were used locally as currency (as well as cloth and iron bars), but the fact that cowrie shells were relatively easy to produce made any currency exchange highly unequal – there are records indicating that some kings attempting a pilgrimage to Mecca had to pay in gold along the way, finally running out and then incurring debts that eventually led to the downfall of their kingdoms.  When the need for slaves for the New World surged, it effectively acted as a replacement in the economy for the decreasing demand for gold.  And when export of slaves to the New World ended, it was replaced by slavery within the kings’ domains.  

Moreover, the new slave-based economy had its own subtle traps.  Carried to an extreme, as it soon was, it meant the impoverishment of those outside the kings’ and European traders’ political control, as they moved to isolated and protected communities to escape the slave raiders.  Even within the scope of the new polities, the proportion of those in danger of slavery went up, and hence the economic benefits, such as they were, went to relatively few compared to the situation north of the Sahara. 

Analysis of Green:  Commodity/Currency-Based Economic Inequality

Green’s conclusion is, I think, worth quoting:  “an expansion of trade on the one hand [from Europe and the Middle East] provoked less access to the wealth of capital on the other [for West Africa] … growing capital differentials [were] exacerbated by the trade of currencies that were losing economic value globally – such as cowries and cloths – for those that were either gaining or producing surplus value, such as gold and human beings … When currency imports to [West] Africa were not matched by trade goods, there was inflation of currencies used in Africa … When trade goods were also imported, these competed with local production and reduced extensive exports of African manufactures … This declining export deterred investment … in manufacturing …”  In other words, a strong degree of participation in the global economy fostered from Europe from 1400 onwards did not result in comparable or even major improvements in living standards for most, or even GNP, in West Africa.  We can say of the impoverished societies in East Asia that much of the explanation might be that they were not included in this globalization; clearly, that explanation does not hold for West Africa (and, I suspect, for some sub-Saharan East Africa as well).

This also ties in with an observation I have had in much other recent reading as well:  countries that wind up in an unequal economic relationship in which they become “one-trick ponies” dependent on things such as gold or coffee or bananas typically don’t fare as well in the long run, as the value of these is much more volatile and prone to long strings of bad luck, and often is superseded as tastes or technologies change.  So Argentina with its specialization in beef, Latin and Central America with its colonial focus on gold and silver, Puerto Rico with its history of specializing in whatever the US felt was its proper commodity, West Africa for slaves, El Salvador with switching over to coffee production and then finding it could no longer provide subsistence agriculture for its population, not to mention the great difficulty in the US before about 1815 in breaking out of its unequal “enforced commoditization” relationship with Great Britain.  We view countries like Saudi Arabia with its ability to convert oil into a thriving economy as the norm, whereas they should perhaps be viewed from a global economic point of view as an exception.

I believe that we should perhaps view this kind of almost-zero-benefit unequal relationship as a fundamental feature of capitalism – because in many of the cases cited, the workings of trade and capitalism were proceeding to some extent independent of government action.  We have congratulated ourselves on the rising tide of capitalism floating the boats of all nations willing to participate in global markets on capitalistic terms – if we are talking about countries producing computer chips, perhaps this is so; if oil, pace Venezuela, the picture is very mixed; if coffee, it seems not to be true.  And the danger of capitalism is that, once a country commits to a particular narrowing of its economy, it may become harder rather than easier to recover from having the wrong product to export.  

I find this to be a sobering thought.  It suggests that rather than demanding a country or region fit into the needs of capitalism, sustainable economics will require that capitalism fit the needs of the country: e.g., diversified, sustainable agriculture to be enforced as the cheapest long-run product.  It also suggests that a world economy that is a mix of governmental technocratic command-and-control and capitalism will actually do better in some cases than a capitalism-focused economy.  Certainly Sweden suggests so.

Analysis of Bowles/Cardin:  Economics as a Branch of Sociology

Over the last 10 years, the failures of many economists in the face of the Great Recession have led to calls to fundamentally rethink economics as a discipline and as it is taught.  The recent white paper by Bowles and Cardin represents a comprehensive way that strands of economics that are presently treated as patches to economic models can instead be viewed as the essentials of a different way of looking at economics and teaching it.

Again, it is worth quoting the abstract:  “new problems now challenge the content of our introductory courses:  these include mounting economic disparities [income and wealth inequality], climate change, concerns about the future of work, and financial instability”; to which I would add that these also challenge the effectiveness of present macro- and micro-economics in guiding the analyst and decision-maker.  What I believe the introductory textbook cited does is to place existing but under-used “tools” at the center of economic analysis – specifically, “strategic interaction, [operations of markets in cases of] limited information, principal-agent models, new [real-world] behavioral foundations [that can determine what economic models best fit real-world data], and dynamic processes including instability and path-dependence.”  

By using word-frequency analysis, Bowles/Cardin establish clear differences between this and two previous generations of economics introductory textbooks as a proxy for the economic linguae franca of our world, the two previous generations being Samuelson’s post-WW II textbook and the recent textbooks of Krugman/Wells and Mankiw.  In other words, the new textbook and the new approach to economics really are in some sense fundamentally different.  

I would argue that the differences derive mostly from this:  the tone and organization of the new textbook really treat economics as a branch of sociology.  That is, they start with an analysis of economic group behavior as it shows up in current issues, not with a model of economic processes that then attempts to shoehorn in real-world data by assumptions such as rationality and self-interest.  The result is a stance that asks where government regulation, command-and-control, operation outside the economy, and more unfettered markets are appropriate, rather than a treatment of the first four as patches to assumed (but rarely if ever achieved in the real world!) perfectly competitive “free” markets.

Here’s a (to me, startling) example of the new thinking:  “it is impossible to write enforceable contracts for worker effort in an information-scarce environment,” so “firms will set wages so that there is always a cost of job loss for workers [i.e., a little higher than they might, so that workers clearly have an incentive to work because they care about their relative income when laid off or in another job] … As a result, there is involuntary unemployment at the equilibrium of the labor market.  This is not … a deviation … caused by … wage rigidities, minimum wages, monopsony, or unions … the intersection of demand and supply functions does not exist and is [replaced] by the Nash equilibrium of strategically interacting principals (employers) … and agents (employees).”  We’re not on Wall Street anymore, are we, Toto?

Implications of Both

It seems to me that both Green and Bowles/Cardin share one suggestion about the future of economics:  It is no longer adequate to see capitalism as the answer to everything, to view it as everywhere superior to the alternatives, now and in the future.  Rather, both suggest that we are dealing with a world in which, historically and now, government, capitalism, command/control, and non-economic activity are necessary parts, all of which must be viewed as operating in more and less effective ways than the others in both the short and the long run.
In particular, I view this as a challenge from economics to that peculiar libertarian dream, of combining little or no government with “free” markets.  What Green and Bowles/Cardin are saying is that capitalism alone will lead to bad outcomes, if not to a reinstitution of (poorer) government by the capitalist in his or her own interests.  I view bitcoin/blockchain as a direct confirmation of this:  the ideal of self-regulating contracts, money, and markets simply leads to inefficiencies, greater imbalances between principal and agent, theft by hackers, and Ponzi schemes preying on the limited information of investors.  

But I also gain hope from both of these texts.  If there is a hope of sustainable economies in the future, it begins with placing the cart of capitalism behind the horse of sustainability, and accompanied by the carts of government, our own personal and societal efforts, and WW-II-like command/control of parts of the economy, at least in the short run. 

It may not be the Grand Unified Theory of Economics, to replace what was smashed in 2008.  But at least, for the first time in a long, long time, we might be beginning to say that what economics teaches us reflects fairly well what we see with our own two eyes in the real world – the altruism and its benefits, the self-centeredness and its costs, less obscured by frantic handwaving and theories.

Final note:  in rereading this, I find I have underplayed the role of innovation/technology in the “new economics”.  For those curious about this, I suggest they sample the CORE introductory economics textbook referenced above, available online.

Climate Change: The Poison of the Pseudo-Reasonable Economist

In the dog days of summer, as the average global land temperature for the first 6 months of the year is a whopping two-thirds of a degree Fahrenheit above any recorded temperature before it, and almost certainly as hot as or hotter than any time in the last million years, I find myself musing on one pernicious form of climate change obstructionism.  Not climate change deniers -- their lies have been endlessly documented and the contrary evidence of accumulating data from appropriate scientists continues to mount.  No, I am speaking rather of fundamentally flawed but seemingly rigorous arguments, especially from economists, that serve in the real world only to detract from the urgent message of climate change, and the will to face that message, by understating its likely impacts.

I gathered these two examples of the genre from the blog of Brad deLong, economics professor at Berkeley.  I hope Prof. deLong will not be offended if I describe him as the packrat of economic theory (net-net, it's a compliment); he seems to publish both the realistic alarms of Joe Romm and the examples I am about to cite with equal gusto, and to do the same with some of the more dubious efforts of Milton Friedman and Martin Feldstein in other areas.  In this case, I am going to use the screeds of Robert Pindyck and Martin Weitzman, cited over the last month, as examples of this kind of pseudo-reasonable economic analysis.

Weitzman:  The Black Swan Is a Red Herring

Weitzman's recurring argument, which he has been making for a long time now, is that a "serious" effect of climate change is unlikely -- he calls it a "black swan" event -- but that because it could have unspecified catastrophic consequences, we should try to plan for it, just as a business plans for unlikely concerns like Hurricane Sandy in its "risk management" policies.  Sounds reasonable, doesn't it?  Except that, by any reasonable analysis of climate change's fundamental model and how it has played out over at least the last five years, merely catastrophic consequences are far more likely than uncatastrophic ones, and catastrophic consequences beyond what Prof. Weitzman seem to be contemplating are the likeliest of all.

When I first began reading up on the field 6 years ago, it was still possible to argue that the very conservative IPCC 2007 model (whose most likely scenario assuming everyone started doing something about climate change projected a little less than 2 degrees Celsius global temperature increase) was at least plausible.  After all, back then, the data on Arctic sea ice, Greenland ice melt, and Antarctic ice melt was still not clearly permanently above the IPCC track -- not to mention the fact that permafrost had not clearly started melting.

However, even at that time it was clear to me from my reading that, in all likelihood, the IPCC and similar models were understating the case.  They were not considering feedback effects from Arctic sea ice melt that was well in advance of "around 2100, if that" predictions, nor the effects of permafrost melt that was very likely to come.  I would also admit that I thought the effects of climate change on weather in the US and Europe would not be visible and obvious enough for political action until around 2020.   Meanwhile, Weitzman (2008) was publishing a paper that argued that climate science simply couldn't provide enough exact predictions about temperature increase and the like to make catastrophic climate change anything but a highly unlikely event in economic modeling.

Well, here we are 7 years later.  Prof. Hansen has crystallized the most likely scenario by analyzing data on the last such event, 55 million years ago, and showing that a doubling of atmospheric carbon translates to a 4 degrees Centigrade increase in global temperature, two-thirds from the carbon itself, and 1/3 from related greenhouse-gas emissions and feedback effects.  Moreover, a great deal has been done to elaborate on the more immediate weather and "catastrophic" effects of this increase, from Dust-Bowl-like drought in most of the US and much of Europe by the end of this century to sea level rises of at least 10+ feet worldwide -- and extension of salt-water poisoning of agriculture and water supplies to an additional 10 feet due to more violent storms.

I cannot say that I am surprised by any of this.  I can also say that I see no sign in Prof. Weitzman's comments that he has even noticed it -- despite the fact that, according to Hansen's analysis, we have already blown past 2 degrees Celsius in long-run temperature increases and are beginning to talk about halting emissions growth at 700 ppm or about 5.5 degrees Celsius.   No, according to Prof. Weitzman, catastrophic climate change continues to be a "black swan" event.

So the fundamental assumption of Weitzman's statistical analysis is completely wrong -- but why should we care, if it gets people to pay attention?  Except that, as our entire history has confirmed and the last 6 years have reconfirmed, when people are told that something is pretty unlikely they typically take their time to do something about it.  As temperature increases mount, the amount of catastrophe to be coped with and the amount to do to avoid further increases mounts exponentially.  Just as with comets or asteroids striking the Earth -- but with much less justification -- appeals to "risk management" and "black swans" give us license to do just that.  No, when you deny for six years the ever-clearer message of climate science that the climate-change forces causing catastrophic effects are likely, quantifiable on average, and large, you might as well be a climate change denier.

Pindyck:  The Discount Rate of Death

I must admit, when I saw the name Pindyck but not the conclusions of his paper, I was prepared to be fascinated.  I have always regarded his book on econometric modeling, which I first read in the late 1970s, as an excellent summary of the field, still useful after all these years.  You can imagine my surprise when I found him echoing Weitzman about how "climate science simply isn't sure about the extent and impacts of climate change, and therefore we should treat those impacts as unlikely".  But my jaw almost became unhinged when I read that "we really have no idea what the discount rate [for a given climate-change-inspired policy action in a cost-benefit analysis] should be", and so we should not even attempt to model the costs and benefits of climate change action except in wide-range probabilistic terms.

Iirc, the discount rate in a business-investment analysis is the rate of return that will justify investing in a project.  Now, there are workarounds to estimate probabilities and therefore at least approximate return on investment for a particular investment -- but that isn't the source of my bemusement.  Rather, it's the notion that one cannot come up with a discount rate for a climate-change-mitigation investment compared with an alternative, and therefore, one cannot do model-based cost-benefit analysis.

Here's my counter-example.  Suppose a company must choose between two investments.  One returns 5% per year over the next 5 years.  The second contains exposed asbestos; it returns 10% over 5 years, and 20 years from now, everyone in the company during that period will die and the company will fold.  What is the discount rate under which the company should choose investment 2?  It's a trick question, obviously; the discount rate for investment 2 must be infinite to match its infinite costs, and therefore there is no such discount rate.

But that's my point.  The costs of climate change are likely and catastrophic, and so you need a really high discount rate to justify the alternative of "business as usual".  The only way you can get a low enough discount rate to justify "business as usual" is to assume that climate change catastrophe is very unlikely. And so, as far as I'm concerned, the "we don't know the discount rate" argument takes us right back to Weitzman's and Pindyck’s "climate change catastrophe is unlikely."  

Thus, Pindyck's discount-rate argument is also a red herring, and a particularly dangerous one:  It seems to move the playing field from climate science, which climate scientists can easily refute, to the arcana of econometrics.  Not only does Pindyck fail on the climate science; he uses that failure to cloak inaction in pseudo-economic jargon.   And so, when Pindyck's "analysis" winds up making it even harder than Weitzman's to argue for climate-change action, I regard it as particularly poisonous in effect.

The So-Called deLong Smackdown

Prof. deLong occasionally publishes an article called a “smackdown” in his blog that seems to correct him on something he clearly views himself as having erred on.  Frankly, I don't view the above as a smackdown; although I wish he and Prof. Krugman would admit that they underestimated gold's disadvantages by comparing it to the S&P 500 index rather than the S&P 500 total return index.  Rather, I view this as a wake-up call to both of them, if they truly want economics to deal with the real world.  As Joe Romm points out, underestimation of effects for the sake of absolute sureness of a minimum effect by the IPCC is not new, nor is an extensive body of literature giving a picture both far more somber and far better reflected in current real-world weather and climate.

But what are we to make of Weitzman and Pindyck, who apparently have been denying that literature, and then using that denial to peddle a far weaker reason for action, for the last six years or so?  3 years, maybe, as the Arctic sea ice shrank to a new dramatic low only in 2012; but six?  No; unless we succumb entirely to the old NPR comedy routine “It’s Dr. Science! He’s smarter than you are!”, this behavior is disingenuous and has poisonous effects.  And, because any sort of modeling of the medium-term future should take account of economic effects, it hinders real-world planning just as much as real-world action.  Heckuva job, economists – not.

Why the Rich Get Richer – and Why Even Most Economists Don’t Seem to Get It

I was recently pleased to note that a Frontline program from last year (“The Retirement Gamble”) had finally begun to note the virtues of low-expense-ratio large-market-index index funds.  This year, we have Piketty and Saez, who have finally noticed the importance of wealth rather than merely income in creating and maintaining the ranks of the rich.  They echo what I wrote in an (unpublished) book on money management for the rest of us 15 years ago:  that while over the long term (20 years or more) stocks are the best bet, there are two sets of people who will guarantee that your stock investments will under-perform:  other people (most advisers and fund managers) and yourself.  Index funds are on auto-pilot; they avoid both sins.

However, what I really had not thought deeply about 15 years ago was that simply putting half of your money available to invest in a reasonably diversified stock portfolio (the rest, say, in bonds), above a certain level of investment “wealth”, will effectively guarantee that you will get richer and richer relative to everyone else.  In other words, unless you manage to spend so outrageously that you go below that minimum amount (despite what you think, it’s not easy), your net worth will over any 20-year period grow at such a rate, on average, that it will double every 8-15 years.  $5 million today?  If you go for an S&P 500 index fund from Vanguard with a 0.1% expense ratio, it will be $10 million in 2022, $20 million in 2030, and $40 million in 2038, or about when you’re ready to pack it in if you’re 60 now – and that’s after inflation. 

And those who don’t invest in stocks (reasonably diversified) and are lucky enough to avoid a shark like Bernie Madoff (as the late Robin Williams remarked, “Was the name not a clue?”) – i.e., those who aren’t rich – will find it much harder to get rich, at the least.  Bonds?  1-2% above inflation, often less than enough to cover living expenses. Houses?  2% above inflation at best, because all those fancy sales figures don’t show the large amount you must spend on upkeep to keep them usable.  Anything else?  Historically, either worse, or the equivalent of hoping to “win the lottery”. 

Rich Person’s Game

So here’s how it works, for a particular rich person – one, say, starting with $3 million in the Vanguard index fund referenced above, and with a net wage income of, say, $57,000.  That index fund, on average (actually, something called the geometric mean), generates about 10.85% per year before inflation, about 8.6% after.  About 2.25% of this comes from dividends, or $67,500, on which you pay 15% tax, or about $10,000, leaving you with $57,000 (net return about 8.3%).  Now let’s assume that you live on your income for the first year.  The next year, you have about $3.25 million.  What about capital gains?  The S& P fund is superb for avoiding most of those – the smallest stocks in the index are the ones that get bought and sold (enter or leave the S&P 500). And you’re still paying only 15-20% in taxes on those.

8 years from when you start (when you’ve doubled your money), your take from your dividends has reached $114,000.  However, you’re still getting a net of about 8.3% from your investment, year after year.  Over time, the amount of capital gains gets slightly larger, but – here’s the shocking kicker – after you die, the “cost basis” from which capital gains get computed goes to the stocks’ current value, which means that capital gains of anything that gets sold after that goes back to about $0 again.  How could Mitt Romney pay 10% of his income in taxes?  1/3 of the income was dividends, and 2/3 was sale of stocks with effectively 0% capital gains tax. I don’t know if that’s what happened, but that’s how it could be done.

The most amazing thing about this is that you can up the taxes, assume that the rich person is sub-optimally investing by a large amount, and still, the net worth will keep marching on up – by less, but still by enough to handle a lot of wasted spending.  At $6 million, you can spend money on four $100,000 cars per year and your net worth will still march on upwards.  At $12 million, you can afford an $800,000 second house, cash up front, and you will still be gaining.  You can give away 3% to an active manager of a fund in a 401(k), and still be doing well.  You could be taxed on your wage income at 90%, or your dividends and capital gains at 50%, and you’re still doing excellently, increasing your net worth more and more. 

In fact, many rich people do invest poorly.  They go for active funds, investment advisors, hedge funds (performs less well than index funds over time, latest figures show, and the fund is taking perhaps 80% of the profit), far too much in the way of bonds (by some figures, about 50%), and plenty of fads.  Piketty’s figures seem to suggest that they’re no better than the few non-rich who have to use 401(k)s with their rigid menu of non-index funds and high fees up and down the line (estimates are it costs us 2-4 %).  The difference is, the not rich are trying to reach that magic $3 million, and using some of the investments for living expenses, because they have to.  Even at $500,000 in investment wealth, you’re still in real danger of getting poorer.  But the rich get richer.

And the higher you go, the less job income matters.  Don’t like the CEO’s $10-million-per-year package, 400 times the corporate median wage?  If that CEO is a billionaire, he or she is earning $80 million a year just from investments (if it’s our index fund example), or $40 million if he or she is the typical lousy investor.

And so, what the CEO earns (most of the rich are CEOs, including CEOs of financial firms) is not a case of the rich getting richer; it’s a case of the head of the firm finding a way to enter the charmed circle of the rich, quickly.  Controlling inequality is not a matter of controlling income from work; it’s primarily a matter of controlling the amount the invested rich reap from their stock investments compared to the non-rich.

Why Even the Best Don’t Seem to Fully Get It

Most commentary about today’s increasing imbalances in income and wealth seems to fall into three categories.  The first category is those who justify these imbalances as somehow reflecting the value of the individual who is becoming richer and richer.  Of what added value to society is an individual who simply sits on an investment and watches it grow (remember, that’s how today’s rich are increasing their wealth)?  Anyone can do that.  No, to me those who justify the imbalances are the equivalents of the prostitute in one of Douglas Adams’ Hitchhiker books, whose sole source of income is assuring the rich that they really do deserve all that money, and those who criticize them are just meanies.

The second class of commentators are aware that there’s a problem, but seem to think that income taxes are the solution.  Rather, high income taxes slow the flow of new rich into the charmed circle, but have very little effect on those who have already joined – they get most of their money through dividends and stock appreciation. 

The third set of commentators – I would include Paul Krugman and Piketty and Saez in this class – realize that there’s a problem, and that it’s connected to wealth.  However, the same sophistication in economics and understanding of data collected about the aggregate within a nation that allows them to see the results of the rich getting richer right now, seems to fail them when they actually consider the connection between national trends and the individual case.

In the case of Piketty and his better critics, the question focused on is whether “r-g” will continue – at a guess, whether the rich can continue to gain a larger piece of the pie indefinitely.  But that’s a question with an easy answer:  as long as stock markets continue to deliver outsized returns over the long term, as they have done for at least the last 95 years, and taxes and very severe depressions do not shrink wealth to the point where many fall out of the charmed circle (as seems to have happened in the forty years during and after the Great Depression), then the rich will indeed get richer.  And yet, looking at things from the perspective of national economies, the idea that the rich can have a bigger slice of the pie for a very long time seems counterintuitive.  And so, the idea of higher income taxes and estate taxes is the focus, while a wealth tax such as the one in France is barely mentioned and assumed not to be an effective path to reversing wealth and hence income inequality.

To my mind, one of the main reasons for this “difficulty in getting it” is the fact that we don’t see most of the appreciation of stock in the data – it shows up only as capital gains when the stock is sold, and even those are far less than the real income appreciation.  Remember, you first pay out of dividends, and then take a little capital gains when the index fund has to rebalance, and when you die the cost basis is reset and when your inheritor sells it seems as if there has been little increase in the stock.  So, over 30 years your wealth may multiply by 8 times and yet, going by dividend and capital gains figures, it has not yet doubled.

There is, by the way, one really strange way that we also underestimate the wealth underlying capital gains reporting.  Let us suppose that we arbitrarily decide to sell 0.8% of our stocks every year.  Remember, each year the value of the stocks goes up by 8+ %, so for the first ten years, we are paying capital gains on our first year’s gain in stocks, and by the end of the 20^th year, we are still paying capital gains on the second year’s gain.  However, during the 20 years, we have seen inflation that has effectively reduced the value of the money we are paying.  So, at about 3.5% inflation, that payment in the 20^th year, in real terms, is about ½ of what it would have been if we had paid at the end of the first year.  This, by the way, is another way that the rich reduce their taxes in real terms.

Now, if at the time of your death you had to sell all your stocks, all those capital gains savings on delayed capital gains tax payment would be reversed.  But you don’t – you will probably have to sell relatively little of the stock.  And so, the real cost of the capital gains to your heir keeps getting smaller, and smaller, and the amount of actual wealth relative to the amount of capital gains reported keeps getting larger and larger …   

The Personal and Global Bottom Line

I see two take-aways from this analysis of the investment rich getting richer.  The first is personal:  whoever you are, if you aren’t rich by my definition, get somehow to a net worth of at least $1.5-$3 million that includes at least $1.5-$3 million in diversified stocks.  Then, by the method I’ve outlined, you should be set for life.  Note that this doesn’t include expenses from your support for other people, such as a spouse and children – ideally, they too at some point in their lives should reach equivalent wealth, so they are set no matter what happens to you.  Yes, I realize that for most this is very hard to do, and that the kind of fees we see out there when you do a 401(k) or an actively-managed fund or get investment advice or try to do stock investing yourself make it much, much harder.  All of this discussion of how to optimize your investments is in my unpublished book of 15 years ago.

My second take-away applies in the area of global economic policy.  Piketty and Saez have masterfully shown how, with the exception of the period after the Great Depression, income and wealth inequality have grown steadily over at least the last 150 years.  Unless policy deals with the underlying reason, as I’ve laid it out, that the rich can indeed get richer in relation to the rest of the world, then policy is very likely to be ineffective.  That means serious consideration of a wealth tax such as the 2% one in France, as long as it applies to stock investments.  Personally, I’d make it a 3% tax targeted at the rich – those who are smart enough to weight their investments heavily in index funds will continue to grow in wealth, but the majority, whose yield is much less, should see an almost flat net worth trend.

Of course, you still have to deal with the problem of making such a tax global, else the rich will just domicile elsewhere.  Still, as with other taxes, there are ways of dealing with this to some extent.  If we wish to get a handle on a problem that makes the global and US economy underperform and also has very bad effects on the non-rich, we need to target just exactly why the rich are getting richer, and target our solutions to that understanding.  Here’s hoping we won’t take decades to do this.

The Insights of the New Inequality Reports Relevant to Personal Finance

Those of you who have skimmed my bio will have noted that a good while ago I wrote a (unpublished) book on personal finance.  In the book, I came to certain counterintuitive conclusions about the best way to manage your money; in the last few years, I have conjectured that my take on personal finance can be used to analyze wealth management and investment patterns at the macro level, i.e., at the country or global level.  However, up to now, the only evidence I had for the correctness of my views was anecdotal.

In recent publications, the acknowledged experts on income inequality – Piketty and Saez – turn their attention (and that of their co-authors) – to wealth.  In the process, they derive some insights which place on a solid statistical foundation most of my conjectures.  In this post, I summarize some of the insights of the reports that may seem counter-intuitive to many readers, but together form a picture that places wealth – not income – squarely at the forefront of personal finance and many aspects of today’s economics.

In no particular order, here are the insights, in grossly generalized form:

1.        Over the last 200 years, except for a period around the Great Depression, “capital” (really, stocks and bonds) has consistently performed better in terms of growth of wealth than income from “labor” (ranging from salaries to CEO “incentive pay”).

2.       As a result, again consistently, there is a line somewhere around $2-$4 million in invested (stocks and bonds, not real estate or venture capital-type investments) wealth below which the wealth of the individual does not grow significantly over time, and above which his or her wealth grows at about a 7% (in real terms) rate per year.

3.       Again consistently, 50% of the population has zero or negative wealth, 40% has minimal investment wealth, and for 8-9% much of the investment wealth comes from a pension or 401(k) whose yield income is typically less than that person’s labor income.  Only the top 1-2 percent have investment income greater than labor income.

4.       The very rich (top 1-0.1%, $20 million to $100 million in wealth, plus the top 0.1%, $100 million and above in wealth) are no better investors than the other 99% (actually, the other 49%, since 50% have zero or negative wealth) – despite sometimes having certain advantages in the treatment of capital income, and in connections to investment “opportunities”.  

5.       It appears that high estate taxes, fairly high income-tax rates, fairly high capital-gains rates, and fairly high dividend-taxation rates have had little effect on this “shift to capital income”, while the main reversal of trend (the Great Depression) may have occurred because the loss of stock value was so severe (perhaps 70% from peak to trough) that many of the 1% found themselves below $2-4 million in invested wealth, with habits of high spending that were difficult to break.  Also, the Great Depression effect may have lasted for 40-odd years because high marginal income tax rates and smaller markets and pay norms did not prevent those with more than $4 million from growing at 7% per year, but did prevent most would-be entrants (typically CEOs) from reaching the magic level over the course of a career.  Reductions in tax rates, globalization of markets that allowed more scope for high CEO salaries, and new norms of compensation that piled direct-to-investment stock options on top of large increases in salaries in the 1979-1990 time period probably broke the Great Depression mold.

Here are the initial conclusions I draw – or, more properly, move from “anecdotal evidence” to “firmly based in statistics”:

1.        The aim of personal finance should be to achieve $2-3 million in low-expense-ratio S&P 500 (or Russell 2000) index funds.   Note that Vanguard typically has a 0.1-0.2% expense ratio over time.  The tendency of the rich to invest instead in high-expense-ratio actively-managed funds, in bonds, in derivatives, in hedge funds, in real estate, in venture capital firms (assuming that the aim isn’t philanthropic), in listening to con men, in conspicuous consumption, and in political maneuvering to protect labor income from miniscule threats, explains why the average rich person is no better at investing than the less-well-off 401(k) owner who is forced to deal with lack of available index funds and 2% fees in the 401(k), as well as less opportunity to use capital-gains, dividend, and interest tax advantages.

2.       Overall, these wrong investing decisions cost the top 50% about 1.5% per year (based on a study that showed that in real terms, a Vanguard S&P 500 index fund or the like grows about 8.5% per year).  They also suggest that unless there is less than 15 years to go until retirement or one’s employer is also contributing significantly, investing directly in such an index fund may be better than putting that money in a high-expense-ratio 401(k) or IRA.

3.       It also follows that once one reaches the “safe rich” category as defined above, there is far less urgency about piling up more and more than is assumed.  What the rich buy in terms of power to protect their money with the extra cash is unneeded in the first place.  Economics, as many have said, is not a morality play; but if one reaches the “safe rich” category, it is perfectly reasonable to do the moral thing and not stretch desperately after more and more and more, and the person who does so will typically not suffer any real penalty.

4.       The first macro implication of these insights is that income tax and estate tax tweaking is strictly limited in its effect on this “investment rich get richer” trend.  It now appears unlikely that we can reverse the trend by limiting entry into the “$4 million and up” investment club – although we can prevent its spread to many of today’s CEO wannabes.  No, by far the most powerful tactic for preventing rapid wealth/income rich-share expansion (and, by the way, the top 1% now have 40% of the wealth and the top 0.1% 20-22% of it) is an investment-wealth tax.  France, I note, has a general-wealth tax of 2%, which has helped somewhat – one might consider putting it at 3.5%, to counter the effects of 2.5% inflation.  Note that this will simply take the rich’s yield down to 3.5%, still enough to ensure some wealth increase, but one-half the increase of the 49%.  I limit it to investment wealth, because the data suggest that if the super-rich shift to other forms of investment, not only will their own income suffer (stock options), but their own investment yields as well.  However, other distortionary economic effects may mean that one should echo France.

5.       The second macro implication, I believe, is that inequality and its follow-on economic effects is not primarily a problem of income inequality, or as Krugman conjectures in recent blog posts, a matter of inherited wealth – the Rockefellers and Vanderbilts are still doing quite well through stringent estate taxes and loosened ones.  It is, rather, a matter of regulating both entry into the “safe wealthy” category and the amount of wealth growth once one has reached that stage.  To have a hope of long-term success, in other words, inequality policy must deal with investment wealth above a certain level.

A Lousy Job Of Embalming Microsoft

So now that Steve Ballmer has announced he’s leaving, the usual suspects – and some on-high commentators who also seem to be missing the mark – have gathered to criticize Microsoft via Ballmer.  I am no unthinking fan of Microsoft, and I have had my share of strong disagreements with their strategies and solutions over the years.  However, I have found myself in the last decade defending them frequently, simply because their critics seemed to fundamentally misunderstand them.  And now, here we go again.

Let me start by a quick thumb-nail sketch of Microsoft’s history and nature as I see it – not at all the typical view presented these days.  First of all, Microsoft started by finding itself (by virtue of a lucky contract with IBM, then dominant in PC hardware) with an incipient monopoly in operating system software.  The key word here is software – that uniquely flexible foundation for building “meta-solutions” that adapt more rapidly than anything else as technology and customer needs evolve.  Microsoft, even then, had two valuable characteristics:  it could create foundational software like Microsoft Word that was “orthogonal” – it was relatively user-friendly because the commands it offered were relatively compact and powerful – and it could keep at a solution until it got it right.  As a result, Microsoft was able to use its favored position in operating systems to create an effective monopoly in office-system suites, especially when the Windows version of its operating system led to the success of the mouse-using “graphical user interface.”  All of this pretty much happened in the 1980s.

Also in the 1980s, Microsoft took the tack of “rough and ready” versions of the operating system open to developers, and it took great pains to nurture those developers.  Here, I am talking about the ecosystem of developers in their time either outside of their employer, or in small companies dedicated to producing Windows versions of applications.  Apple, by contrast, wanted to control the “quality” of the operating system and sell hardware, so Apple’s share rapidly shrank to the entertainment and education markets, while Microsoft took a larger and larger software share of PCs that were now becoming ubiquitous and the machine of choice as cheap scale-out servers.  And so, by the end of the 1990s, Microsoft had adapted enough to the Internet via Internet Explorer to ensure a strong presence in scale-out server farms (the ancestors of the cloud), in businesses, and in the PCs usually used to access the Internet.

What followed in the decade of the 2000s was not so much the encroachment of competition from the likes of Google and Apple as saturation of existing markets.  Under Ballmer, Microsoft adapted to federal regulation by making a sort of peace with its enemies, from Sun to Apple to IBM, so that Microsoft joined the pervading “coopetition” approach to the market.  Far more importantly, Microsoft got business customers in its “DNA” by hires and investment, so that Microsoft was able to balance its customer markets with a secondary but still very important business market relatively impervious to saturation of the customer market. 

Over the last five years or so, however, Microsoft has finally begun to stop seemingly defying gravity in its rapid revenue growth.  Microsoft could see the handwriting on the wall, and has been trying to establish a strong position – necessarily, via innovation – in new markets.  It has had some success in innovating, and therefore reaping a strong market position, with video-game Kinect, and Windows 8 does represent some needed innovation in its present markets.  However, this is too little to move the revenues dramatically in what is a very-large-revenue company.  And it’s not clear what will change that.

What’s blocking Microsoft is fundamentally the hold of Apple and Google on developers of smartphone apps.  It’s not that Microsoft has lost its own developers, but if it wants a good revenue jump it needs an equal or greater mass of developers in some other market where it is a credible competitor.  And recent moves to establish its own app-development encouragement suggest that it’s not doing enough to create a relatively friendly app-dev environment in mobile smartphones/tablets.

The Usual Misunderstandings

You see very little of this in today’s commentary on Steve Ballmer.  There’s notes about how he didn’t understand Microsoft’s friction with US and EU governments about its monopolies – actually, that has died down, precisely because he did enough to defang much of it.  There’s the “dominance of iOS on mobile” – granted, Apple’s laptops have also made major inroads in the PC/laptop market, but that still leaves Windows with the overwhelming majority of sales and existing boxes, and, as noted, the non-smartphone/tablet market is saturated but not in a major decline, especially if you look at IBM Windows-PC sales compared to Unix/Linux.   There’s “it’s all about Apple design”, while a cursory inspection reveals that Samsung Galaxy based on Google Android is more than competitive with Apple design these days, and Samsung is seeing the results in its sales.  I’ve already noted the exceptions to the “Microsoft can’t innovate” mantra.

Then there are the more global economic commentators – now that they’ve finally realized that computing software matters, although they’re still underestimating the importance of software compared to hardware.  Prof. Krugman posited that Microsoft might do OK despite Apple’s seemingly obvious and eternal dominance, because it is now focused on business.  Um, no, Microsoft’s revenues and employees are still not primarily focused on business.  Microsoft will do OK because its present markets are saturated, not defunct, because Apple’s relative “innovative” status is going away where it counts, in the actual products, and because Apple is not doing enough for its own developer ecosystem.  Hence, as the need for larger-form-factor products for the enduring popularity of longer blog posts (like this!) persists, Microsoft will get its share via not-dead-yet laptops and their hybrid variants.

Or, we can cite Alex Tabarrok as simply noting that Microsoft’s stock jumped when Ballmer announced his resignation.  Sorry, the stock market is notorious for predicting 9 out of the last 3 recessions, as the old saying goes.

Above all, commentators continue to misunderstand the ongoing global economic contribution of software to such factors as productivity and “technological” advances.  Microsoft’s commitment to a developer ecosystem and its “orthogonal” designs (in the best cases) are simply examples of how the software industry enables a welter of new applications that actually do, once the dust finally settles, produce fundamental innovation that leads to productivity improvement as measured by our economic statistics. 

Resignation?  Who cares?  I don’t.  Microsoft?  Who cares any more?  I do; and you should.  For all the reasons no one seems to be talking about.

Data Snow Blindness

I am taking a break from everything else that’s going on today to tell the story of an error in data analysis and presentation, seriously affecting the strength of the argument being made, that to me is jaw-dropping – not the error itself, but people’s reaction to its being pointed out.  And that reaction is:

Nothing.

Seriously.  Nothing.  Nothing by commenters on either blog where the original analysis and reactions is prominently mentioned (Weisenthal and Krugman).  Nothing by the bloggers themselves. No change in the analysis as presented on the blog.  Dead silence. Debate continues to be waged based on the uncorrected blog data.

I have racked my brain as to why this might be.  The best reason I can think of is that most people are so focused on the “bright” parts of the data as presented, the fact that the two measures over time involved show a clear relationship, that they ignore the fact that one of the two measures is not quite the correct one to use.  It is, if you will, an example of blindness like the blindness caused by trying to look ahead into a landscape of snow reflecting the sun fiercely – the well-known phenomenon of “snow blindness.”  Data snow blindness.  And, as in the case the other snow blindness, you become truly blind – you simply don’t notice the information indicating that the analysis is off.

The Story

The story begins when Weisenthal reacts to an ongoing debate on the merits of investment in gold by doing a couple of graphs comparing the value of the S&P 500 index over time (1979 and 2007 to now) to the value of gold in the markets ($/troy ounce). His point – a valid one – is that even with recent fluctuations in gold’s price, investment in stocks outperforms investment in gold over time.

Now, as I found out in doing my post-MIT-Sloan-School-of-Management research on investment theory for my own use, it turns out that the S&P 500 is a price-only measure.  That is, the typical value of the S&P 500 that everyone quotes does not include the value of dividends that the companies issue over time, and it doesn’t include the reinvestment of those dividends.  As far as I can tell from observations over the past 15 years as well as from previous data, the dividends themselves average about 2.3% per year, and the reinvestment adds another 0.1% per year (the “geometric mean” of returns, the correct way to measure, suggests that at least until about 2007 (a period of maybe 90 years), the growth in the S&P 500 was about 10.8% per year, which meant that reinvestment of dividends over the course of a year would yield about 2.3% times 10.8% times ½ [to reflect the fact that dividends don’t all occur at the start of the year], or about 0.12%).

If you don’t believe my assessment, go look at the S&P web page where they report S&P 500 values and returns over time.  Above the regular report is a measure of “total return.”  If you look at the description of that return, you find that “total return” does indeed compute return with dividends included (it appears that dividend reinvestment is also included, but I’m not sure about that).  They do it over a much longer period than a year, so at this point the TR index is almost twice the regular S&P 500 index.

If you add in this adjustment, the result of the analysis changes significantly.  In Weisenthal’s original graph (made so that 2013 represents 1), the ratio of S&P 500 to gold price goes from about 0.1 in 1979 to 1 in 2013. Accepting the same starting point, my computed ratio goes from about 0.1 in 1979 to 2.12 in 2013.  A sharp drop in the ratio (reflecting dubious “flight to safety”) from 2007 to 2009 becomes a drop from about 6 to 2, not a drop from 5 to 0.7. It hasn’t been flat or dropping since then; it’s been climbing by about 6%.  Stocks don’t just beat gold over long periods of time – they beat gold over the short and medium term pretty consistently, and over the long term by a huge amount – try 21.2 times as much.

So I posted this in a comment in Weisenthal’s blog and, getting no response, in Krugman’s blog.  As noted, no one took notice (I would have posted my comments in caps, but it’s not netiquette to scream).  In fact, the debate in the comments proceeded as if the original Weisenthal graphs were the issue – is the government understating inflation data (from “gold bugs”) and therefore there is another gold price surge to come once that becomes clear?  Is the advantage of stocks over gold clear enough, or would an even further surge erase it?

Data snow blindness.

Implications For Y’All

At this point, I have to distinguish this from other sources of problematic analyses that have happened recently – e.g., the Reinhart-Rogoff controversy in economics (which apparently revolved partly around a coding error) and the London-trader miscomputation of risk (partially a human Excel miscalculation).  Those are not really a problem of not noticing that one of your sets of data points is not capturing well what you want it to capture – and they have been exhaustively investigated and debated.

For another example of data snow blindness, I’d like to go back to investments again – the idea of 401(k)s (also applicable to IRAs).  What no one seems to be pointing out is that the expense ratios in those 401(k)s are quite high – I believe they’re still above 2%.  If your employer isn’t paying into your 401(k), this means that you must balance the gain 20 years from now in lower taxes when you cash them out with the loss you get from not sticking an equivalent amount in a Vanguard S&P 500 index fund with an expense ratio of 0.1%.  Even if you pay zero taxes when you cash out, somewhere over a 10-20-year dividing line, you may well lose money on your IRA/401(k) compared to the alternative.  And that’s true of 401(k) bond investments as well (vs. bond index funds). Or so the data suggests – but no one seems to notice this enough to discuss it.

Here’s a few more:  stock risk vs. bonds and everything else. If you have your money in a US S&P 500 index fund, what is your risk?  Over any 20-year period, the stock market as a whole has outperformed any other investment – including inflation.  But what if the stock market collapses drastically and stays collapsed?  If you think about it, that would mean that the US government has collapsed, since it’s the government that insures the banks underpinning economic investment by various mechanisms. So the risk of collapse of the stock market’s 500 largest members is pretty much the same as the risk of the US collapsing – in which case, without that government backing, your money is likely to be worthless (and your gold coins). So why are you “diversifying” beyond the stock market, again?  If you’re planning to start drawing it down or keeping it level within the next 20 years, then some amount of, say, a bond index fund or inflation-protected securities (TIPS) that will keep up with inflation is fine; but the reason for doing anything beyond that is not as clear as it might seem.  Data snow blindness.

How about stock investment returns? Today mutual fund companies compare their results to the S&P 500 – is that the regular S&P 500 or the total return one?  Do they include their expense ratios – above 2% until recently, now (afaik) around 1.5% -- and do you compare them to the Vanguard 0.1% and the Fidelity Spartan 0.2% (plus withholding a bit in cash, which right now earns effectively zero)?  There’s a reason why those index funds outperform around 70% of all other stock investments over a 10-year period, and probably close to 90% over a 30-year-period.

In other words, the real implication of data snow blindness is that it is probably hitting you right in the wallet right now – not necessarily yours, since everyone else seems to be doing it too. Or almost everyone else … Gee, I wonder why the Vanguard S&P 500 index fund is one of the two most popular stock investments today?

Anyway, please think about it.  Me, I’m going to go off and check myself for further signs of data snow blindness. 

Thoughts on Dangerous Misunderstandings of Statistics

I was listening to an IBM presentation of their latest Business Intelligence offering today, including new capabilities based on their SPSS statistical package, and my mind wandered, as it often does, all the way to a way I have seen such statistics capabilities used wrongly, in our daily lives, to the point where it even becomes a danger to us. And no, I am not talking about “confirmation bias” (look it up?).

Here’s the way, in my naïve understanding, statistics presently works for us. We have a worldview. Scientists using statistics beaver away and discover possible changes in that worldview (A new drug helps cancer? Tobacco may be harmful to you?), and then test them against a null hypothesis, until it is extremely likely that your worldview should be modified; and at that point they announce, they get beaten up while others check their work (if necessary), and then as rational people we change our worldview accordingly.

No, again, my problem is not with how rational we are. Rather, I am concerned with what happens between the time when a new hypothesis shows promise and the time when it is pronounced “extremely likely” -- statistics-speak for “time to change.” [For those who care, think of “extremely likely” as a one-tailed or two-tailed distribution in which likelihood of rejecting the null hypothesis is greater than 95% to 99% and power and data mining bias are just fine]

So what’s wrong with that? We’re risk-averse, aren’t we? Isn’t it the height of rationality to wait for certainty before going off in the wrong direction, and doing worse instead of better?
Not really. Let me reprise a real-world example that I recently saw.

Polar Bears and Statistics

A scientist in Alaska (Dr. Monett) had been observing polar bears, sampling one-tenth of his area each year, for 20-odd years (I have stripped this down to its statistical core). One year, for the first time, he observed 4 polar bears in their migration swimming rather than walking across the ice. The next week, again for the first time, he observed 3 polar bears in that area, dead. Let me also add, to streamline this argument, that this was the first time he had observed open water next to the shore during migration season.

Here was what that scientist did, as a good statistician: wrote a paper noting the new hypothesis (open water is beginning to occur, and it’s killing polar bears), and indicating that based on his sample size, an initial alternate hypothesis was 40 polar bears per year swimming instead of ice-walking in that region, causing 30 additional polar bear deaths per year. He then requested help from other scientists in carrying out similar surveys in other regions, while he would continue his yearly sample in his region. Duly, they did so, and the evidence grew stronger over the last five years. Afaik, it has not yet been officially recognized as an extremely likely hypothesis, but it seems reasonable to guess that if it has not already been done, this hypothesis will be recognized as an “extremely likely scientific fact” in the next five years.

Now, let’s look more closely at the likely statistical distribution of the data. The first thing to realize is, there can’t be less than zero polar bear deaths. In other words, sorry, this is not a normal distribution. It’s not a matter of a cluster of data points around zero and a cluster greater than zero; if you get 20 years of zeros and then a year of 3 or 4, especially given the circumstances, the alternate hypothesis is in fact immediately more likely than your conservative statistician is telling you, even before more data arrive.

Now look at the statistical distribution of polar bears swimming in the new situation. Because you only have a year’s worth of data, that distribution is pretty flat. If you add that, on average, there are 10 polar bears migrating in the area surveyed, then the distribution runs from zero to 94 polar bears swimming in that year, and zero to 100 in any year, in a pretty flat fashion. But statistics also tells us that 40 is the most likely number – even if it has 2% likelihood – and that it is also the median of likely outcomes as of now: you are just as likely to see more polar bears swimming in the region as less. In other words, it’s pretty darn likely that some polar bears are going to be swimming from now on (you can take as given that there’s going to continue to be open water), and, if so, the new null hypothesis is 40 per year.

So the only question is, when in the last five years should we have changed our worldview? And the answer is, not after five years, when conservative statistics says the new null hypothesis is “extremely likely.” Rather, depending on the importance of the statistics to us, we should change after the first year’s additional data, at the latest, which is the point at which the new null hypothesis becomes much more likely than the old. [again, for those who care, the point at which the likely zero-swims lambda probability distribution is twice as unlikely as a semi-normal distribution somewhere around 40 polar bears].

Because now we have to ask, what are we using this data for? If it’s a nice-to-have cancer cure, sure, by all means, let’s wait. If it’s a matter of just how fast climate change is happening …

Of Course Disastrous Climate Change is Still Unlikely. Isn’t It?

I picked that last example above on purpose, as a kind of shock therapy. You see, it appears to me that there is a directly comparable “super-case”: how we – or at least, almost all of the people I see quoted – view the likelihood of various scenarios for upcoming climate change.

Let’s start with the 2007 IPCC report upon which most analysis is based. Those sane, rational folks recognized that this IPCC report lays out all the scientific facts – those aspects of climate change that scientists have confirmed are “extremely likely” – and fits them all together into a model of how climate change is happening and will happen. In that model, we can by reasonable efforts limit global climate change to 2 degrees C total, reached by the end of the century, which is a disastrous amount, but, given the time frame over which this occurs, not civilization-threatening.

That, it turns out, as in the polar bear case, is just about the absolute minimum. And, as in the polar bear case, what the scientists knew in the years before 2007, and which to a fair extent they have confirmed since then, is that it is not the most likely case nor the median-likelihood case under all scenarios except those involving a really drastic reduction in fossil-fuel use over the next 8-18 years. It is just that, still, all the real-world data has not quite reached the point where scientists can stamp it as an “extremely likely” new hypothesis. But even in 2007, it was quite a bit more likely than the 2007 “scientific fact” model; it is now far, far more likely.

So, as in the polar bear case, here we have the most likely, median-likelihood case, and it is much worse than the minimum case, and what does everyone talk about? The minimum case – which means that it is all too easy to assume that we will make a reasonable effort (or the “free market” has begun taking care of everything) that will hold climate change to 2 degrees C or below.

Just to cite a few examples of this: all the political leaders are talking about conferences to set as targets (bad ones, but valid targets if we assume the global economy doesn’t grow from now on) carbon emissions reductions aimed at reducing emissions by 20% by 2020-30, the number that should hold climate change to 2 degrees C; and Prof. Krugman, whom nobody regards as an optimist, is pointing approvingly to the work of an economist expert in the relationship of climate change to economics, who argues that although climate change of 2 degrees C is really unlikely, we should do something about it because of the horrible consequences if it did occur.

These are not irrational people (or, at least, their thinking here seems to be pretty rational). It is just that scientists, concerned about the scientific process, have told them that the IPCC report is scientific fact and the stuff beyond it is not, and we, who should be operating based on “most likely” and “median likelihood”, are instead, operating on the basis of a stale “null hypothesis” and “alternative hypothesis.”

Moreover, we should not expect scientists to change their tune. It is their job to move from scientific fact to scientific fact. It should be our job to listen to their “opinions” as well, and weave them together into an understanding of just what the most likely, median-likelihood model is right now. And, because in this case the most likely, median-likelihood case is pretty darn frightening, we must prioritize; we must see that this is not like the polar bear or the cancer cure: The answer to this matters a lot, right now.

A Quick, Boring Aside on Climate Change Statistics, Right?

Not that anyone cares, what is that most likely, median-likelihood climate change model and what are the resulting scenarios over the next 90 years or so? Well, first let’s look at where real-world data is diverging from the “minimum” model. Arctic ice decrease is supposed to be linear, and the alternative hypothesis has been it’s exponential. In the first case, less than 5 % ice at minimum somewhere around 2100; in the second, somewhere around 2030. Real-world volume data? Somewhere between 2016 and 2020. Oh, and the same data shows the Arctic all but free of ice year-round by somewhere between 2035 and 2045.

Similar thing with Greenland ice. Looks like it’s doubling its rate of ice loss every decade, but null hypothesis is, it will be linear from now on. Antarctic ice? Null hypothesis is still zero ice loss; initial surveys suggest linear ice loss; you think maybe we’ll start to figure out exponential ice loss in the next ten years? Natural-source methane release: can’t rule out zero natural-source increase, the likelihood is that a fairly big increase in the last 10 years is due mainly to natural causes, too early to tell about exponential, never mind the Russian surveys. At least, with atmospheric carbon measurements, somebody has noted a semi-linear increase in the annual increase over the last thirty years, and another scientist has come up with a reason that the rate of temp change caused by that rising increase will top out at 1 degree C per decade in 2050 – and he’s not operating on the basis of the minimum model, thank heavens.

So what does that mean? Well, the closest any scientist has come to a most likely, median likelihood model is the MIT 2011 study. “Business as usual” – a reasonable effort – yields 6 degrees C (11 degrees F) temp rise by end of century and 10-15 feet of sea rise. Of course, the results of that are probably not much more than the results of 2 degrees C temp rise, right?

And, remember, this model is still more scientifically “conservative” than the most likely one. Now we’re talking more than 6 degrees C by 2100, perhaps 25 feet of sea rise (mostly between 2050 and 2100) by 2100. And still, there’s that methane kicker to possibly add – which is “unlikely” now because we still aren’t sure how it will play out; it’s happening faster than we thought, but the absolute upper limit on its effects is coming down as we learn more.

Back to Statistics, Wrapping Up

I would dearly like for scientists to make a reasonable effort, as part of communicating a result, to tell us the implications of most-likely, median-likelihood models based on that result. I can understand why they won’t, given how the legal system and the press beats them up for imagined “sins” in that direction. Which is why I would simply ask the reader to make the effort, in cases that just might be very important to the reader or to us all.

Because, you see, in the long run, scientists are all dead, and so are we. If we wait for scientific fact to be established, which can sometimes take a lifetime, no one can criticize us for it. But, in cases where we should have acted long before we did, because, in fact, our old worldview was dangerously wrong and the evidence told us well before the final scientist’s official extremely-likely stamp, we ought at least to feel some pangs of guilt. Rationality isn’t enough. Understanding and compensating for the limitations of our null-hypothesis statistics hopefully is.

A Few Books That "Rocked My World"

I recently saw a list of “100 books that rocked my world” from a blogger. It turned out to be a list of “books that are really cool” and not “books that made me think differently in fundamental ways.” So I thought I’d look back and ask myself, years later, what books changed me fundamentally?

1. Godel’s Proof, Nagel and Freeman. As Shaw says in “Man and Superman”, it made me want to “think more, so that I would be more.” The idea of there being some things that I will never know or prove, is something that I am still wrestling with.

2. Spark, Ratey. The idea that we fluctuate chemically between addiction to pessimism and addiction to optimism based on whether we are channeling our hunter ancestors seeking prey by exercising in company, between learning by moderate physical stress and forgetting based on sedentary habits, between inoculating against disorders by moderately poisoning ourselves with food and moderately stressing ourselves with exercise and opening ourselves to disease and death by eating unchallenging foods and avoiding challenging exercise, seems to apply to and alter every aspect of my life.

3. The Age of Diminished Expectations, Krugman. It began to give me an ability not only to understand my sense of disconnect between conventional economics and what was happening to me in the real world, but to apply new tools to understand and improve the broad scope of my life in terms of money and generational cycles – something I’d been looking for over 20 years of college and work. Of course, I needed several additional books and articles to understand the full scope of Krugman’s approach.

4. The Fellowship of the Ring, Tolkien. I wasn’t expecting what I got when I scrounged my Dad’s library for yet more books at age 12. Suddenly, I was able to see the non-human world around me as a separate, interconnected, wonderful, alive thing. And the idea that you could frame a book or part of a life as the necessary preface leading to the beginning of a journey – like Frodo’s, stripped of his teachers, into Mordor – made me see that my life could be seen that way – and that has always given me hope.

5. Falconer, Cheever. This one is painful. I had to ask myself, after it was over, am I, like the protagonist, seeing my relationships with women too much in terms of my own needs, or can I finally grow up? I don’t know how much I’ve changed in my behavior after reading it; but I know I can never think the way I used to about relationships without far greater discomfort and dissatisfaction with myself.

6. How to Win Friends and Influence People, Dale Carnegie. There are many, many things wrong with this book, as I have come to realize. But it gave me the humility of understanding that my artsy and intellectual achievements were of very little value to others, and showed me that I really liked people, if I just listened to them. It also gave me a basis for understanding people’s social viewpoint that has allowed me to connect, slowly, over 30 years.

7. A Connecticut Yankee at King Arthur’s Court, Twain. I don’t think I recognized this at the time, but it was my introduction to what I might call the “science fiction viewpoint”: the idea that by facing scientific facts and leveraging technology, you could make a fundamental change for good in the world – the true meaning of “progress”. I can never quite shake that idea, and it has led me in quite a different direction from the rest of my family, into math and computers, and away from Great Literature that had few solutions to offer. Of course, I never quite accepted Twain’s other idea: that this progress could vanish like the mist from history, resisted by willfully ignorant humans frightened of change, unless you were lucky.