I hear much support for the monarchy/I hear the Union Jack’s to remain

Another SMH-based story – and after I just criticised it. I can’t remember where I read/heard the needless advice that Team Howard/Costello would start the scare tactics soon (what with Rudd thoroughly caning Howard in the polls). It was not necessary because it is exactly how Team Howard wins its elections – just ask Arne Rinnan – so none of us truly expect emotional growth from the Prime Minister.

Thus into the fray enters former Midnight Oil frontman and Honourable Member of Parliament for Kingsford Smith (NSW) and the Labor party’s Shadow Minister for Climate Change, Environment, Heritage and the Arts. Specifically, the Prime Minister warns us of the “Garrett Recession”, the consequences of a Labor victory, and a Peter Garrett actual Ministership of Climate Change and the Environment. He warned audiences during a weekend of speeches that “Peter Garrett’s approach to climate change “would be a recipe for a Garrett recession – not a recession Australia has to have”".

Note that nice touch at the end (Australians will generally remember then-Treasurer Paul Keating’s “Recession We Had to Have” – also the beginning of his end).

This is of course the same PM who warned us last time about interest rates (which we told would go off the chart if Labor won the last election). Needless to say this is silly, even generally, but standard Howard scaremongering (the Central Bank – independent, like all good ones – in fact ended up complaining to the Federal Electoral Commission about the Liberal* party’s tactics). How is that working out, I wonder?

This sort of thing will come as no surprise to American readers, of course, who should by now be well-used to their execrable Vice-President, among others. It is hard to get anywhere thinking about who manages an economy better in the US, a country where Republicans can accuse Democrats of tax-and-spend profligacy while amassing the greatest debt imaginable, post-Clinton. England has not really seen scare tactics of either kind. Labour entered after utterly shambolic economic ‘management’ by the Tories, and since then Tony Blair has steadily out-Thatcher’d Thatcher – so what in hell else is there?

It will be interesting to see what else comes down the Liberal line. I figure interest rates some more – they are steady at the moment, and if they stay that way the government will have the opportunity to pull them out. Labor being in thrall of the Unions is always good (‘thrall’ of course is the conservative’s adjective for providing living wages – the long-forgetten other thing upon which Adam Smith insisted). It would appear climate change (and Labor’s insistence upon addressing it subsequently reducing Australia to penury) will be a theme. Labor control of Federal as well as State legislatures (along the lines of the GOP tax-and-spend whipping boy) will come up as often as the Liberals think it will work. Democrats are ascendant in Washington, and even the conservatives don’t seem much to mind Prime Minister Rudd, in their own weird way. Anything else? The politics of cynicism has more than that to offer, surely…

*Almost forgot: In Australia, the Liberal party is conservative, not liberal. Hence our government students must learn to use ‘big L’ and ‘little l’ liberal in sentences. Serves them right (full disclosure: at my alma mater – one of them, anyway – the Government department is in the Economics faculty, when it bloody-well belongs in the Arts faculty).

UPDATE: Peter Garrett responds. Note (i) why is that the picture of choice? Because the SMH is stupid, and (ii) sadly ’slams’ has entered Australian media as the instant synonym for ‘criticises’ or ‘disagrees’. Thanks a goddamn lot, Huffington Post and CNN. Thanks a lot.

HowTo: Hyperbolic Discounting

Why are you always late? Why do you double-book yourself? Why do you think you will get that report/paper finished by next week, yet never manage to do so?

Suppose I offered you the choice between $100 today and $100 in one year exactly. You would (I hope) take the money today. Leaving aside ordinary impatience, if you deposited that money in, say, an ING Direct savings account, you would make 5% AER, giving you $105 in one year. In order to make you indifferent between my two offers, I should have to offer you $100 today or $105 in one year.

This is discounting – future costs and benefits are not valued as highly as current costs and benefits. In order to make a decision today (say, should we buy that car? Should we build that hospital? Should I invest in that gold mine?), we need a Present Value of all costs and benefits – i.e. the current value, today, of all of the relevant future costs and benefits.

Discounting falls broadly into two types: Exponential Discounting:

and Hyperbolic Discounting:

Note the important distinctions: (i) Exponential discounting is much more commonly-used, and (ii) Exponential discounting uses a constant discount rate <em>r</em>, rather than <em>rt</em> (it is therefore also called Linear Discounting). This means that the decision we make is dependent only upon the distance between two outcomes, and not on the time vantage point of the decision-maker. Ergo, you are indifferent between $100 today and $105 in one year. Under linear discounting you are equally indifferent between $100 today and $100.0133 tomorrow, or $265.33 in 20 years. In fact people usually are Hyperbolic, not linear, discounters (this is why you are always late and not finishing your work when you expected to).

Hyperbolic discounting is where the discount rate is not constant. The discount factor falls more quickly in the short run than the long run, specifically:

In fact, at a 5% AER and Hyperbolic discounting, you are indifferent between $100 today and $105 in one year (because at one year the formulae do not differ – try it and see), $100.0137 tomorrow and $200 in 20 years.

Scarcity

Where does the environment come into the equation? Suppose instead of me offering you $100, I’m telling you that something will cost a certain amount in 20 years. Like, say, the environmental consequences of drilling in Alaska? Now you will notice the real difference from a policy perspective. Future costs are worth less under Exponential Discounting than under Hyperbolic Discounting. Thus, although people are more likely to be Hyperbolic Disounters, when government and/or industrial projects with environmental consequences are discounted linearly, they over-estimates immediate economic benefits and under-estimate long-term environmental costs. This is exacerbated for the environment, where as less and less of it remains over time, the costs of saving what does remain increases (i.e. the discount rate should not be linear over time anyway). There is an unexplored intersection here as well with the Coase theorem.

Thus, Hyperbolic Discounting, rendered simply. The lesson? When you are late or over-committed, tell your friends it is because you’re a Hyperbolic Discounter, and over-estimated the time you would have available in the future. When ‘they’ tell you that the benefit of something is worth the cost, stop a minute and consider whether the costs and benefits occur at the same time. If they don’t, which comes first, and how equal do you think they really are? Some other time I will discuss the actual selection of the discount rate (I used the rate of return on a bank account, which is fine for money, but for the monetised value of health, or the diversity of species, or keeping bees? Perhaps not).

Finally, some references:

Discounting in a World of Limited Growth

Abstract: This paper explores the consequences for discounting of assuming limits to growth. One of the main determinants of the discount rate is the rate of economic growth. If growth rates decline in the future then the discount rate should not be constant but also decline over time. In fact, we would then need not a single discount rate but rather a variable discount schedule. This would imply higher present values for the distant future. The paper analyses how discount rates would vary with different assumptions about the patterns of growth and the pure rate of time preference. http://www.springerlink.com/content/r68137168n1p0528/

Time Discounting and Time Consistency

Abstract: In the economic literature the most widely used type of additive time discounting is Exponential Discounting. Recent work however casts doubts on its ability in explaining how individuals effectively choose. In particular a more general form of discounting that gained importance, in both applied and theoretical work, is Hyperbolic Discounting which captures well phenomena such as procrastination and addiction. An important issue related to the additive form assumed for discounting is that time consistent preferences are the case only with Exponential Discounting. This paper shows that forms of Hyperbolic Discounting, in particular close to the so called Quasi-Hyperbolic model, could also be characterized in terms of dynamically consistent choices when individuals discount the welfare of future selves as well as their payoffs. http://ideas.repec.org/p/usi/wpaper/456.html

Global Warming and Hyperbolic Discounting

Abstract: The use of a constant discount rate to study long-lived environmental problems such as global warming has two disadvantages: the prescribed policy is sensitive to the discount rate, and with moderate discount rates, large future damages have almost no effect on current decisions. Time- consistent quasi-hyperbolic discounting alleviates both of these modeling problems, and is a plausible description of how people think about the future. We analyze the time-consistent Markov Perfect equilibrium in a general model with a stock pollutant. The solution to the linear-quadratic specialization illustrates the role of hyperbolic discounting in a model of global warming. http://are.berkeley.edu/~karp/JpubEcon05.pdf

Hyperbolic Discount Functions, Undersaving, and Savings Policy

Abstract: Studies of animal and human behavior suggest that discount functions are approximately hyperbolic (Ainslie, 1992). I analyze an economy with complete markets which is populated by hyperbolic consumers. I identify two ways in which this economy can be distinguished from an exponential economy. First, hyperbolic discounting predicts the empirical regularity that the elasticity of intertemporal substitution is less than the inverse of the coefficient of relative risk aversion. Second, hyperbolic discounting explains many features of the policy debate about undersaving. The calibrated hyperbolic economy matches Bernheim’s (1994) survey data on self-reported undersaving, and predicts pro-savings government interventions like capital-income subsidies and penalties for early withdrawal from retirement accounts. Hyperbolic consumers are willing to sacrifice 9/10 of a year’s worth of income to induce the government to implement optimal revenue-neutral saving incentives. http://www.nber.org/papers/w5635.pdf

Discounting for Health Effects in Cost Benefit and Cost Effectiveness Analysis

Abstract: When health effects can be valued in monetary terms, as in CBA, they should be
discounted at the same rate as costs. If health effects are measured in quantities (eg
QALYs), as in CEA, and the value of health effects is increasing over time, then discounting
the volume of health effects at a lower rate than costs is a valid method of taking account of
the increase in the future value of health effects. We present individualistic and welfare
models to argue that the rate of growth of the value of health effects g is positive. The
welfare model suggests that g is a weighted average of the rate of growth of the value of the
direct effect of health on utility, the growth rate of income, and the growth rate of income
times the elasticity of the marginal utility of income. We also show that the Keeler-Cretin
paradox, often used as an argument against discounting health effects at a lower rate than
costs, has no relevance for the choice of discount rate in CEA. http://www.york.ac.uk/inst/che/pdf/tp20.pdf

John Howard hates working women. Still.

While I wait for my maths converter to set itself up. I caught the latest article by Gittins in the (otherwise not-especially-useful-but-pickings-are-slim) SMH.

Discussion of concepts such as Full Capacity, Full Employment, Natural Rates of Unemployment and Potential Real GDP don’t often find their way out of first-year Economics classes, so it is nice to see one in a newspaper. Essentially the point is this: when you are at capacity (i.e. actual GDP = potential GDP), you will not get new jobs from increasing Aggregate Demand, which increases GDP.
What is needed are policies that increase potential GDP (also known as policies for Long-Run Economic Growth).

As it happens, Australia is – once Gittins removes from consideration the farming sector, which tends not to do much for job creation – pretty much expected to grow at what is pretty much considered potential real GDP. In comes the interesting part. The government/Treasure need to work on supply (of labour), not demand. Thus:

“…

Treasury says that any employment creation occurring in our present circumstances will have to involve adding to the potential supply of labour – to labour utilisation – not just to the demand for labour.

“This may come about, for example, through raising the labour force attachment of older workers, providing assistance for people with disabilities to enter employment, or employment of indigenous Australians who would otherwise face a life of passive welfare dependency,” Treasury notes.

“Another avenue is to increase the size of the labour market through immigration of suitably skilled workers.”

…“

What catches the eye is this discussion of properly-managed immigration (the idea of which, under this government, is frankly laughable), but notice also the people that Treasury is talking about getting in the workforce: the elderly, the disabled, indigenous people. All people otherwise draining Treasury of welfare payments of one type or another. What better than policy to get them paying into the Treasury rather than taking out of it?

I’m not compaining – if this or any other government can come at all close to doing something about the state of Indigenous Australia they’d have my vote. I don’t see John Howard getting far down that road. Ever.

What I noticed first in the Treasury statement (and that upon which Gittins comments and closes), is the absence of the large, qualified pool of non-participating workers in Australia: mothers. It strikes me that just about every tax and workplace relations law in our country actively or passively contributes to the marginal cost of women (re)entering the workplace. Ever since his first Family Tax Initiative.

So here we are with more women going in and out of higher education, no real policy for imbuing our indigenous people with skills, let alone qualifications, more alacrity for locking asylum seekers up in the middle of the desert than for integrating them, and crying poor for skilled labour. And here we shall probably remain (although there is an election looming…more on that soon).