Thursday, November 02, 2006

The worst mistake ever?

Of course, I went ahead and downloaded the new book by Gregory Clark. I have NOT read it- it is 453 pages long- but the opening passages are striking.

The basic outline of world economic history is surprisingly simple. Indeed it can be summarized in one diagram: figure 1.1. Before 1800 income per person – the food, clothing, heat, light, housing, and furnishings available per head - varied across societies and epochs. But there was no upward trend. A simple but powerful mechanism explained in this book, the Malthusian Trap, kept incomes within a range narrow by modern standards.

Thus the average inhabitant in the world of 1800 was no better off than the average person of 100,000 BC. Indeed, most likely, consumption per person declined as we approached 1800. The lucky denizens of wealthy societies such as eighteenth century England or the Netherlands managed a material life style equivalent to the Neolithic. But the vast swath of humanity in East and South Asia, particularly in Japan and in China, eked out a living in conditions that seem to have been significantly poorer than those of cavemen.

The quality of life quality also failed to improve on any other observable dimension. Life expectancy was the same in 1800 as for the original foragers of the African savannah, 30-35 years at birth. Stature, a measure both of the quality of the diet, and of children’s exposure to disease, was higher in the Neolithic than in 1800. And while foragers likely satisfied their material wants with small amounts of work, the modest comforts of the English in 1800 were purchased only through a life of unrelenting drudgery. Nor did the variety of their material consumption improve. The average forager had a diet, and a work life, much more varied than the typical English worker of 1800 even though the English table by them included such exotics as tea, pepper, and sugar.

Finally hunter-gatherer societies are egalitarian. Material consumption varies little across the members. In contrast great inequality was a pervasive feature of the agrarian economies that dominated the world of 1800. The riches of a few dwarfed the pinched allocation of the masses. Considering even the broadest definition of material life, the trend, if anything, was downward from the Stone Age to 1800. And for the poor of 1800, those who lived on unskilled wages alone, the hunter-gatherer life would have been a clear improvement. Some will object that material living conditions, even including life expectancy and work efforts, give little impression of the other dimensions by which life changed between the Neolithic and 1800: dimensions such as security, stability, and personal safety. But we shall see below that however broadly we picture living conditions, things do not improve before 1800.

This reminded me of the famous article in Discover, by Jared Diamond, arguing that we should never have invented Agriculture.

Scattered throughout the world, several dozen groups of so-called primitive people, like the Kalahari bushmen, continue to support themselves that way. It turns out that these people have plenty of leisure time, sleep a good deal, and work less hard than their farming neighbors. For instance, the average time devoted each week to obtaining food is only 12 to 19 hours for one group of
Bushmen, 14 hours or less for the Hadza nomads of Tanzania. One Bushman, when asked why he hadn’t emulated neighboring tribes by adopting agriculture, replied, "Why should we, when there are so many mongongo nuts in the world?"

While farmers concentrate on high-carbohydrate crops like rice and potatoes, the mix of wild plants and animals in the diets of surviving hunter-gatherers provides more protein and a bettter balance of other nutrients. In one study, the Bushmen’s average daily food intake (during a month when food was plentiful) was 2,140 calories and 93 grams of protein, considerably greater than the recommended daily allowance for people of their size. It’s almost inconceivable that Bushmen, who eat 75 or so wild plants, could die of starvation the way hundreds of thousands of Irish farmers and their families did during the potato famine of the 1840s.

There is evidence that adopting agriculture ruined the health of most people for generations

Skeletons from Greece and Turkey show that the average height of hunger-gatherers toward the end of the ice ages was a generous 5’ 9" for men, 5’ 5" for women. With the adoption of agriculture, height crashed, and by 3000 B. C. had reached a low of only 5’ 3" for men, 5’ for women. By classical times heights were very slowly on the rise again, but modern Greeks and Turks have still not regained the average height of their distant ancestors.


At Dickson Mounds, located near the confluence of the Spoon and Illinois rivers, archaeologists have excavated some 800 skeletons that paint a picture of the health changes that occurred when a hunter-gatherer culture gave way to intensive maize farming around A. D. 1150. Studies by George Armelagos and his colleagues then at the University of Massachusetts show these early farmers paid a price for their new-found livelihood. Compared to the hunter-gatherers who preceded them, the farmers had a nearly 50 per cent increase in enamel defects indicative of malnutrition, a fourfold increase in iron-deficiency anemia (evidenced bya bone condition called porotic hyperostosis), a theefold rise in bone lesions reflecting infectious disease in general, and an increase in degenerative conditions of the spine, probably reflecting a lot of hard physical labor. "Life expectancy at birth in the pre-agricultural community was bout twenty-six years," says Armelagos, "but in the post-agricultural community it was nineteen years. So these episodes of nutritional stress and infectious disease were seriously affecting their ability to survive."

Why was agriculture so bad for human health?

There are at least three sets of reasons to explain the findings that agriculture was bad for health.

First, hunter-gatherers enjoyed a varied diet, while early farmers obtained most of their food from one or a few starchy crops. The farmers gained cheap calories at the cost of poor nutrition. (today just three high-carbohydrate plants–wheat, rice, and corn–provide the bulk of the calories consumed by the human species, yet each one is deficient in certain vitamins or amino acids essential to life.) Second, because of dependence on a limited number of crops, farmers ran the risk of starvation if one crop failed. Finally, the mere fact that agriculture encouraged people to clump together in crowded societies, many of which then carried on trade with other crowded societies, led to the spread of parasites and infectious disease. (Some archaeologists think it was the crowding, rather than agriculture, that promoted disease, but this is a chicken-and-egg argument, because crowding encourages agriculture and vice versa.)

Epidemics couldn’t take hold when populations were scattered in small bands that constantly shifted camp. Tuberculosis and diarrheal disease had to await the rise of farming, measles and bubonic plague the appearnce of large cities.

and things get worse

Besides malnutrition, starvation, and epidemic diseases, farming helped bring another curse upon humanity: deep class divisions. Hunter-gatherers have little or no stored food, and no concentrated food sources, like an orchard or a herd of cows: they live off the wild plants and animals they obtain each day. Therefore, there can be no kings, no class of social parasites who grow fat on food seized from others. Only in a farming population could a healthy, non-producing élite set itself above the disease-ridden masses. Skeletons from Greek tombs at Mycenae c. 1500 B. C. suggest that royals enjoyed a better diet than commoners, since the royal skeletons were two or three inches taller and had better teeth (on the average, one instead of six cavities or missing teeth). Among Chilean mummies from c. A. D. 1000, the élite were distinguished not only by ornaments and gold hair clips but also by a fourfold lower rate of bone lesions caused by disease.

Farming may have been even worse for women

Farming may have encouraged inequality between the sexes, as well. Freed from the need to transport their babies during a nomadic existence, and under pressure to produce more hands to till the fields, farming women tended to have more frequent pregnancies than their hunter-gatherer counterparts–with consequent drains on their health. Among the Chilean mummies for example, more women than men had bone lesions from infectious disease.

Women in agricultural societies were sometimes made beasts of burden. In New Guinea farming communities today I often see women staggering under loads of vegetables and firewood while the men walk empty-handed. Once while on a field trip there studying birds, I offered to pay some villagers to carry supplies from an airstrip to my mountain camp. The heaviest item was a 110-pound bag of rice, which I lashed to a pole and assigned to a team of four men to shoulder together. When I eventually caught up with the villagers, the men were carrying light loads, while one small woman weighing less than the bag of rice was bent under it, supporting its weight by a cord across her temples.

So why did our silly ancestors take up agriculture at all? The proposed explanation seems to be based on a kind of group selection.

One answer boils down to the adage "Might makes right." Farming could support many more people than hunting, albeit with a poorer quality of life. (Population densities of hunter-gatherers are rarely over on eperson per ten square miles, while farmers average 100 times that.) Partly, this is because a field planted entirely in edible crops lets one feed far more mouths than a forest with scattered edible plants. Partly, too, it’s because nomadic hunter-gatherers have to keep their children spaced at four-year intervals by infanticide and other means, since a mother must carry her toddler until it’s old enough to keep up with the adults. Because farm women don’t have that burden, they can and often do bear a child every two years.

As population densities of hunter-gatherers slowly rose at the end of the ice ages, bands had to choose between feeding more mouths by taking the first steps toward agriculture, or else finding ways to limit growth. Some bands chose the former solution, unable to anticipate the evils of farming, and seduced by the transient abundance they enjoyed until population growth caught up with increased food production. Such bands outbred and then drove off or killed the bands that chose to remain hunter-gatherers, because a hundred malnourished farmers can still outfight one healthy hunter. It’s not that hunter-gatherers abandonded their life style, but that those sensible enough not to abandon it were forced out of all areas except the ones farmers didn’t want.

I am much more optimistic about the future than Diamond is in this article. He seems to expect the return of what Gregory Clark calls the Malthusian Trap. I suspect that no wwe know the trick of getting out of that trap, we are unlikely to go back there.

The Very Origins

Tyler Cowen's latest "Economics Scene" article in the New York Times is about the oldest question in Economics: the Nature and Causes of the Wealth of Nations. He describes the work of Gregory Clark at the University of Davis.

In “A Farewell to Alms: A Brief Economic History of the World” (forthcoming, Princeton University Press), Gregory Clark, an economics professor at the University of California, Davis, identifies the quality of labor as the fundamental factor behind economic growth. Poor labor quality discourages capital from flowing into a country, which means that poverty persists. Good institutions never have a chance to develop.

Tyler believes that

Professor Clark’s analysis counters Jared M. Diamond, who in his “Guns, Germs and Steel” (W. W. Norton & Company, 1999) located the ultimate sources of European advantage in geography, like safety from tropical diseases, and a greater number of available animals that could be domesticated.

I cannot agree- Diamond's book was about the very long-term development of various continents: about why Eurasia developed so differently from Africa, Australia and the Americas over the past 10,000 years. Diamond's thesis is that Eurasia was caught in a race between technology and population, and standards of living consequently stagnated, while other continents did not manage even this. Their technology and populations were stagnant, and in Australasia, technology actually regressed. He tries to explain this difference ("dynamic" stagnation in Eurasia, and "static" stagnation in the other continents).

However, he quotes some very interesting examples from Gregory Clark's book (emphasis added)

As early as the 19th century, textile factories in the West and in India had essentially the same machinery, and it was not hard to transport the final product. Yet the difference in cultures could be seen on the factory floor. Although Indian labor costs were many times lower, Indian labor was far less efficient at many basic tasks.

For instance, when it came to “doffing” (periodically removing spindles of yarn from machines), American workers were often six or more times as productive as their Indian counterparts, according to measures from the early to mid-20th century. Importing Western managers did not in general narrow these gaps. As a result, India failed to attract comparable capital investment.


An independent estimate by two economics professors at the University of Wisconsin, Madison, Rodolfo E. Manuelli and Ananth Seshadri, (“Human Capital and the Wealth of Nations") suggests that if variations in the quality of labor across nations are taken into account, other productivity factors need differ by only 27 percent to explain differences in per capita income.

Professor Clark questions whether the poorest parts of the world will ever develop. Japan has climbed out of poverty, and now China is improving rapidly, but Dr. Clark views these successes as built upon hundreds of years of earlier cultural foundations. Formal education is no panacea, since well-functioning institutions are needed for it to be effective.

I am sure that this is not as simple as Tyler and Clark say it is, and I was reminded of this post from Stumbling and Mumbling, on the problems which confronted early European Industrialists.

Evidence from pre-capitalist society suggests that people stop working once they have achieved subsistence. Andre Gorz describes how this blighted early factories:

The worker did not ask: ‘how much can I earn in a day if I do as much work as possible?’ but: ‘how much must I work in order to earn the wage which I earned before and which takes care of my traditional needs?’

The unwillingness of the workers to do a full day’s labour, day after day, was the principal reason why the first factories went bankrupt. (Critique of Economic Reason, p21.)

It was also, he says, the reason why factory owners wanted child labour; only children were sufficiently pliable.

I suspect we are as far as ever from answering the old question.

Investing II

The New York Times article which I cited in my previous post mentioned index funds that employ non-conventional weighting methodologies, for fear of over-investing in bubbles. Over at Stumbling and Mumbling, Chris Dillow adds much wisdom.

An equal-weighted basket of FTSE 350 stocks has hugely out-performed the capitalization-weighted index - 36% against 21%. This is because the cap-weighted index has been dragged down by poor performance by mega-cap stocks, Glaxo and Vodafone, and because mid-cap stocks have out-performed larger ones. Our letter baskets benefit from this equal-weighting. But fund managers, being closet trackers, have lost by being roughly cap-weighted.

But beware

As Isaac Tabner says, over the long-run, cap-weighted indices beat equal-weighted ones.

And he signs off with a very smart point indeed.

There's a big difference between being rational and being right.
As my new chum Daniel Finkelstein says, you cannot judge the quality of a decision by its outcome.

Read the whole thing- its the kind of writing you won't often encounter in the mainstream press.

Wednesday, November 01, 2006


This morning, I spoke to an "Investment advisor" at a large mutual fund which already has some of my money invested in Index Funds. He strongly urged me to buy one of their actively-managed funds: claiming that they offer wonderful returns. I demurred, and said I was looking at adding to my stake in the Index Fund. He immediately turned around and said that I should diversify my investments- have I considered looking at other Mutual Funds?
He was actually asking me to go to another company! I suspect they are making no money from my investment, even though my assets have more than doubled in the past 18 months.
This article in the New York Times may be relevant.

This year through September, only 28.5 percent of actively managed large-capitalization funds — which try to beat the market through stock selection — were able to outpace the S.& P. 500 index of large-cap stocks, according to a new study by S.& P. In the third quarter alone, it was even worse, with only one in five actively managed large-capitalization funds beating the index.

That isn’t terribly surprising, said Rosanne Pane, mutual fund strategist at S.& P., because active managers tend to have difficulty beating indexes when market leadership changes. And in the third quarter, many stocks that had paced the market for much of this decade began to fall behind. Small-company stocks were finally beaten by shares of big, blue-chip companies; sectors like energy also started to lose ground.

Still, such transitional periods aren’t the only good times for indexing. S.& P. research shows that while active management fared poorly in the third quarter, it has actually been lagging behind the indexes for a considerable period.

Over the five years through the end of the third quarter — a span that included both bull and bear markets — only 29.1 percent of large-cap funds managed to beat the S.& P. 500. What’s more, only 16.4 percent of mid-cap funds beat the S.& P. 400 index of mid-cap stocks, and 19.5 percent of small-cap funds outpaced the S.& P. 600 index of small-company shares. “The long term does seem to favor the indexes,” Ms. Pane said.

However, thats not the only reason Index Funds shine (emphasis added)

For John C. Bogle, founder of the Vanguard Group, which started the first retail stock index fund 30 years ago, the recent success of indexing is self-evident.

“The reality is, fads come and go and styles of investing come and go,” he said. “The only things that go on forever are costs and taxes.” And by simply buying all the stocks in an equity benchmark and holding them for the long run, traditional index funds minimize the transaction costs and capital gains taxes associated with investing, he said.

Mr. Bogle argued that while indexing grew in popularity in the late 1990s — when the Vanguard 500 Index fund, which tracks the S.& P. 500, was consistently returning more than 20 percent a year — the strategy is even more valuable in a period of modest returns. If equities gain only 6 or 7 percent annually in the coming years, the higher investment management fees, transaction costs and taxes associated with actively managed portfolios will take a disproportionate bite out of a fund’s gross returns, he said.

Yet it’s precisely during these stretches of modest returns when individual investors tend to take indexing for granted. After all, there’s nothing sexy about earning mid-single-digit returns through an index fund.

There are alternatives to traditional Index Funds, which invest in shares in proportion to their market capitalization.

Research Affiliates, an asset management firm in Pasadena, Calif., has built its own set of indexes that get around the problem of market-cap weightings.

The Research Affiliates Fundamental Indexes, or RAFI, instead weigh stocks on other factors such as sales, book value, free cash flow and dividends.

Jason Hsu, director of research and investment management at Research Affiliates, says that this prevents an index from becoming too oriented toward the fastest-growing and largest-capitalization stocks, for example, just because of market momentum.

Essentially, this could save the portfolio from over-investing in inflated stocks. Should be a good diversification tool. Would also like to get hold of some REITs. Where are they?

Growing World

Robert Shiller has a nice article in Project Syndicate, describing what he has learnt from the new Penn World Table, version 6.2.

Among the 82 countries for which 2004 data are now available, there has been really good news: real per capita GDP has risen by an average of 18.9% between 2000 and 2004, or 4.4% per year. People generally are a lot better off than they were just a few years ago. At this rate, real per capita GDP will double every 16 years.

However, there has been little change in the relative ranking of countries.

Despite all the talk about the Chinese economic miracle, China’s ranking has risen only slightly, from 61st out of 82 countries in 2000 to 60th in 2004 – even though per capita real GDP grew by 44% between 2000 and 2004, or 9.6% a year, the highest of the major countries.

The reason China has not risen higher is that other countries have been growing too, and because the gaps between countries are enormous. The range between the poorest and the richest countries in the world is a factor of more than 100. The average real per capita GDP of the top 25% of countries is 15 times that of the bottom 25%.


If such growth rates continue, we will see relatively poor countries like India, Indonesia, the Philippines, or Nicaragua reach the average levels currently enjoyed by advanced countries in 50 years. But, of course, they will not have caught up with these countries, for those countries will have moved ahead too.

I myself cannot be too concerned by this. I think its more important to keep the poor countries
growing, and get their citizens to feel optimistic about the future. This would not only save lives which would otherwise be lost to cholera, dysentry, and malaria but would help temper ethnic conflict as people adopt escape the straightjacket of "zero-sum" thinking. This is the same reason I am relatively sanguine about inequality in wealthy countries.

Schiller then hearkens back to the work of Galbraith, and asks goods account for all this growth.

But real per capita GDP in the US is now three times higher than it was in 1958. What have people been spending all that extra money on? Is it all dictated by advertisers and salesmen who are inventing needs?

According to my calculations comparing 1958 and 2005 data from the US Department of Commerce, Americans spent 27% of the huge increase in income between 1958 and 2005 on medical care, 23% on their homes, 12% on transportation, 10% on recreation, and 9% on personal business activities. The kinds of things that advertisers and salesmen typically promote were relatively unimportant. Food got only 8% of the extra money, clothing only 3%, and personal care 1%. Unfortunately, idealistic activities also received little of the extra money: 3% for welfare and religious activities, and a similar share for education.

Thus, most of the extra money was spent on staying healthy, having a nice home, traveling and relaxing, and doing a little business.

Sounds they have the right priorities.