Philip Greenspun’s Weblog

Happy 2013. Time to evaluate investment ideas, particularly in light of the new tax code. The Federal Reserve Bank has announced plans to print money until unemployment rates are reduced to less upsetting levels. They say that they can do this without creating inflation, but these are the same folks who created the 1970s inflation and who missed the problems that led up to the Collapse of 2008. The potential for inflation argues in favor of equities rather than bonds. (Disclosure: I am a child of the 1970s and the Jimmy Carter “malaise” years so I probably have an irrational fear of inflation.) With tax rates on income having been increased, but capital gains rates still being reasonably low, stocks again look more attractive than bonds. The question then becomes… what stocks to buy?

As the Secretary for the MIT Class of 1982, I recently received a report on our school’s $10 billion endowment. It seems that the professional money managers have put just 6 percent of the money into bonds, 8 percent into U.S. equity, and 17 percent into international equity. So it looks as though they are favoring international but the waters are muddied by the fact that the school has 12 percent of its portfolio in real estate (e.g., office buildings in Cambridge) and 8 percent in “real assets” (gold bricks? forests?). There is another 25 percent of private equity (feeding the next Mitt Romney with fat fees) and 23 percent in scary hedge fund-type stuff. MIT seems bullish on its neighborhood (the Cambridge real estate) but bearish on the U.S. as a whole (just 8 percent faith in the S&P 500 and smaller cap stocks). The annualized return of this endowment has been 9.7 percent over the last 10 years. Vanguard says that its Total Stock Market domestic equities fund has returned 8 percent, by contrast.

MIT seems to favor international over U.S. stocks. Is this thumbs down on future U.S. growth reasonable? Naively one would think that the bigger and richer a country is the easier it would be for that country to keep getting bigger and richer. The country has a huge capital base, educated people, fantastic infrastructure, etc., that poorer countries cannot hope to match. Yet we do see Europe and the U.S. both more or less stalled out while much of the rest of the world booms (today’s New York Times: “Unemployment in the euro zone rose to a new record in November”).

Why is it that rich established countries stagnate and leave room for the upstarts? Mancur Olson claimed that it was interest groups tapping into government, e.g., companies, farmers, or unions obtaining favorable regulations that enable them to collect more money than in a market economy. I wonder if his analysis is simultaneously incomplete and overly complex.

Let’s start by considering a primitive economy. The only way to get an income is to work or to get a voluntary contribution from person who is working, e.g., a family member or close friend. As an economy advances, additional mechanisms for earning a cash or cash-equivalent income are developed. Let’s consider some of what we’ve got in the U.S. right now:

• “I am old and worked for at least a few years.” : collect Social Security
• “I drove a city bus from age 18-41.” : collect full pension from Massachusetts public transit system
• “I am disabled.” : collect Social Security Disability Insurance
• “I am able-bodied, ready to work, had a job 1.5 years ago, but don’t have a job now.” : collect unemployment insurance
• “Twenty years ago, I was married.” : collect alimony
• “Twenty two years ago, I had a child.” : collect child support (Massachusetts at least enables a parent to collect child support until a child reaches the age of 23)
• “I am poor.” : collect free or nearly free house, medical care, food, etc. (partial list)

One can argue about the merits of these various schemes, but it seems beyond doubt that in the aggregate they reduce the percentage of people in our economy who are working. Much of this effect, e.g., above-market public employee salaries and pensions, Mancur Olson budgeted for in his analysis.

Something that Olson did not consider at all, however, if memory serves, is loss aversion and the fact that wealthy societies have much more to fret about losing. Loss aversion is a massive cognitive flaw that leads to a lot of terrible decisions (see Thinking, Fast and Slow by the Nobel laureate Daniel Kahneman for a good overview). In the simplest form, an investor would be reluctant to sell a stock that they believe is likely to go down because to do so would lock in a $10/share loss already suffered. Kahneman cites research showing loss aversion will lead companies to spend millions in legal fees defending lawsuits that they expect to lose, simply because the idea of confronting the loss is too painful (so they end up losing the case, paying twice as much as they would have paid to settle it, and then paying legal fees on top).

Let’s look at where the U.S. has been beefing up spending in recent years. We spend more than any other country on health care though we know that none of it will make us healthier or feel better day to day. So really we are spending because we are afraid of losing our health or our lives. We can say that 1 percent of GDP is spent on actual health care and the other 17 percent is spent on loss aversion (total of 18 percent of GDP is spent on health care in the U.S.). How about military? We spend money because we don’t want someone invading the U.S. and taking everything that we have worked for. We spend money because we are afraid of losing our influence in the world. I think we can chalk up all military spending and all of the spending on the Iraq and Afghanistan wars to loss aversion. That’s somewhere around 5 percent of GDP (worldwide average is closer to 2.5 percent).

We spend a lot on firefighters to prevent the loss of houses and commercial buildings. We spend a lot on police, district attorneys, criminal defense lawyers, and prisons to avoid losses due to crime. A country without such expensive buildings and/or expensive property to steal would probably not invest so much in fire and police protection.

Then let’s look at private security guards (roughly 2 million in the U.S., says Wikipedia). Are you waiting in line at the guard’s desk in the lobby of a skyscraper rather than going in and engaging in a meeting? That’s a drag on potential economic growth both because you’re not working and because the security guard is being paid to make sure that you don’t do something bad to the expensive building or the expensive property inside. We’ve got a lot of fancy airplanes and airports, more so than a up-and-coming country, but then we end up having to spend billions to protect it (more than $8 billion on the Transportation Security Agency plus whatever individual airports and airlines are spending).

Planning, zoning, and environmental delays are all part of loss aversion as well. We don’t want to lose open space, members of an endangered species, or some good feature of our neighborhood. So it took us about 10 years after the 9/11 attacks to begin rebuilding the World Trade Center. By contrast, one construction firm in China “put up a 15-story hotel in just 48 hours back in 2010 and a 30-story tower in 15 days in 2011” (now they are planning to build the world’s largest skyscraper, 220 stories high, in 90 days).

As a society we spend a huge amount of money on insurance (and then billions more to bail out AIG!), but I couldn’t find a good source for property and casualty insurance total revenues.

[It is actually kind of hard to come up with government spending that does not fall into either the “paying someone for doing something other than work” or the “loss aversion” categories. Education is the only sizable government program that comes most easily to mind (parks and recreation are obvious as well, but they are tiny in terms of dollars). Since government is over 40 percent of GDP that means a huge chunk of national income spent on loss aversion even before private expenditures kick in.]

The more that you have, the more than you worry about losing it. It seems to be true for individuals. Not too many college students have renter’s insurance, for example. It also seems to be true of societies and loss aversion may ultimately impose a drag on the economy comparable to the interest groups that Mancur Olson cited.

How as investors can we put this theory into practice? We could invest in countries that are really poor. Congo and Zimbabwe, for example, are at the bottom of the CIA’s list of countries ranked by purchasing power parity. They probably aren’t spending too much on insurance to protect whatever is left of their societies, but on the other hand they aren’t easy places to do business. What about the middle income nations? They should have enough money to support a decent physical and legal infrastructure but not so much money that they spend most of their time and effort protecting what they’ve already got. If we were to say that we wanted to invest in countries that had purchasing-power adjusted incomes of between $5000 and $25,000 per year, what would we have? Nauru and Syria are first on the list. That doesn’t seem very practical. We could further refine our criteria and say that the country has to be big enough to have a stock market, needs to have a government that the inhabitants accept, and cannot have its income based purely on a natural resource of some sort. Now we’re looking at countries such as Jordan, Armenia, Georgia, Belize, China, Ecuador towards the bottom. Brazil, Costa Rica, Panama, and Uruguay are in the middle. Botswana, Russia, Latvia, Chile, Argentina, Croatia, Hungary, Poland, Estonia, Portugal are near the top. Maybe we need some more refinement that the country has to be on its way up rather than on its way down or stagnating. So we get rid of Argentina and Portugal, for example, because workers there will be depressed thinking about the good old days.

Finally we have the challenge as individual investors of finding a way to buy stocks in companies that are headquartered in and/or mostly do business in these countries.

So… questions for the readers:

1. does this theory of why rich countries stagnate make sense/add anything to Mancur Olson’s time-honored analysis?
2. are middle-income countries likely to grow faster than the U.S. and Europe?
3. if so, what’s a reasonable way to invest in that growth?

[This posting is also available in a Czech translation.]

I sent an email recently to a couple of my favorite 17-year-olds (two of three triplets). They’re applying to colleges and anxious about where they’ll be accepted. I thought my email might be of interest to others, so I’m posting it below.

There are a few interesting new reviews on DxOMark:

• Canon EOS M “mirrorless” camera
• Nikon 28/1.8 lens
• Canon 28/2.8 lens

The Canon M turns in a dismal sensor quality score, with a dynamic range of 11.2 Evs. That is two f-stops worse than the Sony NEX-6. The Sony (which I own and like, especially for photographing toddlers due to the flip-up waist-level viewfinder (something else the Canon lacks; its screen is fixed)) does everything better than the Canon: color depth, dynamic range, low-light performance.

If that were not bad enough, the latest Nikon 28mm prime lens turns in a fantastic performance, 19 perceptual megapixels compared to just 15 megapixels for Canon’s 28/2.8 (more than one f-stop slower). The Nikon also handily outperforms a manual focus Zeiss 28/2 lens that costs twice as much.

[Separately, I just discovered an amazingly bad user interface feature of my Canon EOS 5D Mark III. When recording simultaneously to two cards, e.g., RAW to the CF card and JPEG to the SD card, if one deletes a goofed-up out-of-focus or eyes-closed image it is deleted only from one card. So you come home with 500 RAWs and 600 JPEGs, for example.]

A friend invited me on a minibus tour of Israel and Jordan with her three children, an 11-year-old friend of the oldest daughter, and about 20 members of her extended family. I hadn’t been to Israel since teaching a class there in 2003.

The first difference observed was changing planes on Christmas morning in the Rome airport. To judge by the decaying terminal, Italy is well on its way to Third World status. I had expected to be interrogated by security personnel prior to getting on the Rome-Tel Aviv leg, but no special security procedures were applied. The only thing unusual was a group of portly Orthodox Jews davening, which prompted a slender American woman to ask “Is there something about Orthodox Judaism that prohibits them from working out?” For my part, watching these folks boarding the plane from stairways at both ends and trying to get settled in their seats, I observed that “Southwest Airlines would go bankrupt if most of their customers were Orthodox.” As with flights into DCA, we were told that we couldn’t get out of our seats once we entered Israeli airspace. Given that Israel is about the size of New Jersey this didn’t amount to much. Overall it was a big reduction in security from my 2000 and 2003 visits, where before getting on the Europe-Tel Aviv flight I was made to open up my laptop and give the security officials a PowerPoint presentation on programming the Oracle database.

The gleaming new terminal in Tel Aviv stands in stark contrast to what the Italians have going for them, a good reminder of high quickly an advanced country can decline and how quickly a motivated country can grow (Israel was a poor nation with a big welfare state and a lot of regulations strangling business; a combination of deregulation and the immigration of well-educated citizens from Russia has fueled a boom since about 1990). Questions by the immigration officer were perfunctory.

On a trip to Israel in 1992 I remember picking up hitchhiking soldiers carrying rifles. Today the soldiers get free bus rides back home and are seldom out and about in uniforms. One of my friend’s nieces is a beautiful long-haired stylishly-dressed 20-year-old. At lunch I asked her what she did with her life. “Three days a week I am at home with my mommy and daddy. The other four days I train soldiers how to unpack, assemble, aim, and fire a 70-kilogram M47 gun. At a Bar Mitzvah celebration in the Old City of Jerusalem, somehow a 5′ tall teenager in civilian clothes was wandering around with what we would call an “assault rifle” (magazine taped to the side, so plainly not loaded). One of our American gang clucked disapprovingly “Why is that child carrying a gun?” My friend’s brother, who lives in Tel Aviv, said “Oh, it probably belongs to one of the adults and they are just letting the kid have a little fun carrying the rifle.”

A $25 30-minute flight to Eilat involved a 30-minute wait in a security line. Despite the fact that no family with children has ever caused a terrorist attack on an airliner (a pregnant Irishwoman unwittingly carrying a bomb is the closest incident that comes to mind), my friend, her husband, and their three child (6-12; all with U.S. passports) were interrogated at some length.

After following in the footsteps of Indiana Jones at Petra, we flew back to the U.S. from Amman, Jordan so I can’t comment on what security might be in place for international flights departing Tel Aviv.

[Overall it was a very pleasant trip. This generation of Israelis seems to have lost some of the hard edge that their forebears had and consequently the hotel and restaurant experience is more welcoming. Also, thanks to the miracle of Android and iOS, no child was ever heard to say “Are we there yet?”]

According to this White House press release, the federal government is ringing in the new year by simultaneously raising tax rates (i.e., penalizing people for working) and extending payments to two million people who do not work (i.e., rewarding people for playing Xbox). Has this ever happened before at any time in the history of the U.S. (or anywhere else in the world for that matter)?

[Separately, this might be a good time to look at Gregory Mankiw’s October 2010 calculation of his total marginal tax rate as 90 percent (nytimes). Mankiw had already budgeted for the 39.6 percent federal tax rate. He also had budgeted for the 3.8 percent Obamacare supplemental income tax. Mankiw estimated that estate taxes would be 40 percent at the time of his demise, but with the federal estate tax increase to 40 percent and the Massachusetts estate tax rate being 11.2 percent, Mankiw’s 2010 estimate overstates the amount that his children will receive. Instead of $1,000 it will be closer to $830 and the overall tax rate will be 92 percent rather than 90 percent. Mankiw did not say what his children will do with the money. If they spend it here in the U.S., they will likely be subject to a European-style value-added tax (the U.S. can’t run a European-style welfare state forever without European taxes) of around 20 percent. So the $830 will really be $664 and Mankiw’s marginal tax rate is 93.3 percent.]

At a dinner party on Friday evening, the Canadian hosts asked, in light of 2012’s mass shootings, what conceivable purpose could be served by allowing Americans to own such large personal arsenals. Being a parent and a non-gun-owner it was tough for me to come up with a rational argument other than a weak “Well, it is in the Constitution”. Contemplating the question later, however, I wondered if we would still be the same nation without so many passionate gun owners. From a strictly rational point of view it is tough to justify a lot of things that Americans do. We spend a lot of time and energy watching professional football, which is injurious to the players and even more so to the spectators (who should be out exercising themselves or learning Mandarin!).

It is tempting to think that we could pick the best laws from various countries around the world and come up with some sort of optimized society, but perhaps it simply isn’t practical. The Japanese have a national character of craftsmanship. The French have a national character of enjoying rich food and wine. Maybe one aspect of our national character is that a lot of us need to be gun nuts.

I have now spent nearly four years in possession of two of the world’s best video cameras: the Canon 5D Mark II and the Mark III. These have a 24x36mm sensor and I have a whole closet full of high performance lenses to stick front of them. Yet I have never become comfortable using either body as a video camera. The first problem is that the $3500 camera won’t autofocus while filming. You’re supposed to “follow focus” like a Hollywood cinematographer, but my 49-year-old eyes aren’t so good at perceiving sharp focus on the rear LCD. The second problem is that high quality video starts with high quality audio and I don’t think the on-camera microphone in the 5D Mark III is especially good. Even if it were, it is in the wrong place for a lot of subjects. I would want a Bluetooth microphone that I could clip onto a subject’s lapel and/or shotgun mic mounted farther away from the noise of the autofocus motor.

These photos show the 5D Mark III mounted inside an IDC System Zero. It seems to solve a lot of the problems described above. With the eyepiece over the rear LCD it becomes possible to evaluate focus more easily. With the big knurled knob it becomes easier to follow focus smoothly. With the big accessory cage it would be theoretically possible to plug in a shotgun microphone and run a cable down to the camera. Does it work? Maybe for a professional movie maker it would, especially if mounted on a tripod. I found the rig too difficult to hand-hold and also too cumbersome to mount and unmount. It would be perfect for a full-day video capture project but it doesn’t work for a parent interested in using one device for both still and moving images of a child.

My most-used video camera right now is the Sony NEX-6. The sensor is smaller than on the big Canon, though the dynamic range is better according to DxOMark. The high quality lenses that I ordered are out of stock so I’m using a $150 kit lens on this camera instead of the $2000 Canon L zoom that I might be using on the 5D Mark III. But the camera will autofocus while capturing video, the microphone seems pretty good, and flip-up LCD screen makes for an awesome 49-year-old parent camera (I would rather hold the camera at waist/child level and look down than stoop to waist/child level.)

Is anyone out there having good luck using a digital SLR such as the 5D Mark II/III as a video camera? If so, what accessories do you find essential? (And I guess it would be interesting to hear from folks who are having good luck with just the raw camera; I know that it can be done.)

The folks at DxOMark have a new measurement, Perceptual Megapixel. This purports to boil down the information from modulation transfer function (MTF) graphs into a number. It proves that a camera with an enormous number of pixels isn’t all that useful unless you have an amazingly high quality lens and, probably, have locked the camera/lens down to a tripod. Folks who have a 20 megapixel camera and a $200 kit lens might be better off simply capturing at 6-10 megapixels. See, for example, a test of a Nikon superzoom lens in which 6 perceptual megapixels was all that could be extracted (third party superzooms came in at 4 or 5 megapixels). This is the resolution that Kodak selected for its consumer PhotoCD system back in the early 1990s.

Summary: the electrical engineers have pushed sensor resolution far beyond the capability of any optics that ordinary consumers are willing to purchase and carry.

[Separately, one of the first tests done using this metric shows that the $900 Sigma 35/1.4 lens dramatically outperforms both Canon’s $1300 equivalent and an $1800+ Zeiss manual focus lens. (The failure of prestige names to dominate objective tests is not new. I remember years ago a European photo magazine did optical bench tests of 50mm lenses and concluded that the $100 to $200 Canon and Nikon 50/1.8 lenses outperformed Zeiss and Leica lenses costing up to $2000. If memory serves, the magazine selected the Nikon 50/1.8 as the best lens overall, considering the balance of sharpness and distortion.)]

Saturday’s New York Times carried an article “How to Attack the Gender Wage Gap? Speak Up”, pointing out that women earn only a fraction of what men are paid. The Times cites some numbers: “77 cents for white women; 69 cents for black women. The final dollar — so small that it can fit in a coin purse, represents 57 cents, for Latina women.”

While for the non-profit organization described in the article this is seen as a problem, a profit-minded business owner might see this as an opportunity. Why not find an industry with mostly male employees, offer jobs at 57 percent of the current wages in that industry, attract an all-Latina workforce, and crush the competition with labor costs that are a fraction of those in the rest of the industry?

It seems odd to me that this business strategy is never described by folks who decry wage disparities among groups. At a party the other night I met a young man who is in law school and hopes to, upon graduation, do “public interest” work. He cited the statistic that women get paid only 74 percent of what men earn for exactly the same work. He said that he had gone to “socialist summer camp” as a child and still believed in most of the tenets that he had learned, e.g., that corporations are soulless profit-seeking machines who would destroy society in pursuit of the last dollar. He cited Walmart as an example of the worst possible enterprise. I asked “Couldn’t Target then destroy Walmart simply by hiring an all-female workforce and undercutting Walmart on costs? Consumers don’t usually check to see who works at a big box store before buying paper towels on sale.” His explanation was that otherwise heartless capitalists are generous when it comes to men. In order to perpetuate the patriarchy they are happy to pay a 30-percent premium in order to have a man in a job that a woman would do equally well at a lower wage. This seems potentially plausible for managers in government who can steal from taxpayers in order to indulge whatever favoritism they might wish to use in employment. It also seems potentially plausible for managers and board members at public companies who can steal from shareholders and pay people more than a market wage (see Bob Nardelli at Home Depot and Michael Eisner at Disney, for starters!). But it is tougher to explain why an individually-owned or family-owned business would do this. Would you steal from your children in order to pay a man $100,000 per year to do a job that a Latina would do for $57,000 per year?

[Separately, does this wage gap exist in other countries? Foxconn is frequently pilloried as among the world’s most evil enterprises, enslaving workers in order to fatten Apple’s profit margins by making iPads at the lowest possible cost. Yet http://news.cnet.com/8301-13579_3-57406751-37/apples-supply-chain-a-portrait-of-a-foxconn-factory-worker/ says that about 65 percent of Foxconn’s factory slaves are men. If women would do the work for less, why hasn’t Foxconn figured that out?]

I attended a talk today at MIT by Amy Finkelstein, an economics professor who led a $20 million research study of a group of poor people in Oregon who were randomly assigned either to receive Medicaid or not (paper). Oregon had enough money to do for some of its poor able-bodied adults what ObamaCare will do for all poor able-bodied Americans: give them Medicaid (unlimited river of money as long as it is handed over to the world’s most expensive health care industry; I pointed out in my health care reform article that Americans could have a free house, free cars, free children, and free college education for those children if they cut their health care spending to what Mexicans spend). Oregon did not have enough money for everyone and therefore decided that the fairest way to allocate coverage was to let people apply and then give out coverage by lottery. It was an almost perfect random experiment, except that the program was limited to those who bothered to fill out the paperwork to apply (possibly sicker than average).

The study included actual checkups for thousands of participants, hence the enormous cost.

The conclusion was that Medicaid increased hospital use by about 30 percent, outpatient medical care by about 35 percent, and total spending by 25 percent. Finkelstein noted that advocates for expanding health insurance often predict that use of hospital emergency rooms will decrease when everyone is insured. That turned out not to be true in Oregon. The insured and uninsured used emergency departments at hospitals at roughly the same rate.

An unexpected result was the recipients of the Medicaid card reported themselves to be about 30 percent happier than before, a result equivalent to having doubled their income. As they did not measure all that much healthier this may be partially explained by a feeling of security that they won’t have to deal with the nightmare of being an uninsured individual in an American health care industry that exists to serve insurance companies, not individuals.

Finkelstein closed by noting that this result should not be too surprising. The introduction of Medicare in the 1960s resulted in an enormous increase in hospital usage and then a huge boom in hospital construction.

So if Americans as a whole behave the same as the survey group in Oregon, health care spending on approximately 20 million Americans should go up by 25 percent (Medicaid already consumes about half a trillion dollars every year, about the same as the GDP of Argentina, Belgium, or Norway). We may get some value for that money, though, as these people will be walking around with big grins.

[Note that the study proves Malcolm Gladwell more or less dead wrong. In 2005 he wrote a New Yorker article about how health care was different than anything else people buy. Providing insurance would not increase demand. The “moral hazard” that applied to every other kind of insurance did not exist for health insurance. Related: see my analysis of Gladwell’s Outliers.]