Sunday, June 29, 2008

Demographics and Groceries

Yesterday my family threw a party for my 30th birthday. At age 80, my grandmother was present both in mind a body, which I find impressive. During dinner, we discussed how trips to the grocery store became more frequent over the years. Apparently one visit a week was the norm in the 50s and 60s (Thursdays evenings), whereas today I keep less than a day of inventory in my cupboard. How could this be?

I first thought that perhaps the cost of going to the store was higher (maybe gas was more expensive). But what caused the changed in habit is family size: I live alone, whereas my grandmother had a husband and three children. Assuming that the utility of a given meal type varies randomly in time (today I want chicken, but I can't predict what I will crave tomorrow), the advantages of preselecting a meal becomes diluted as the number of mouths who will be fed increases. In fact, when one is alone and choses his meal a few minutes in advance by going to the grocery store right before dinner, the cost of imperfect selection is always zero: you choose what you want. Whereas when a couple goes to the grocery store right before dinner, one person get to eat what he wants, and the other will have to tag along for a sub-optimal meal. Thus, given a large family size and a single meal, it becomes impossible to tame the cost of imperfect menu selection. Buying the food just-in-time only helps out one person.

By analyzing the distribution over time of meal preference, it is possible to build a pleasure cost model for couples. To lower the cost, you need to have overlapping preferences, and the distribution should be as flat as possible over time. Otherwise you may have to cook two meals at once.

Tuesday, June 24, 2008

More debt?

I recently came across a 2007 editorial by investment adviser Kenneth Fisher whose main thesis is that people are far too worried about the US federal government’s debt.

He put forward many arguments on why this is so, most of which I disagree with, but I shall concentrate on the one that stuck out at me the most. I will quote the full paragraph to ensure I am not misrepresenting what he said:
“Is the U.S. over- or under-indebted? Since we have total assets of about $120 trillion (according to the Federal Reserve Flow of Funds Account) and a GDP of $13 trillion, our return on assets is 11% after taxes--that's very high. A current fair estimate of borrowing cost is about 6%, or 4% after taxes--much less than our return on assets. We're not over-indebted. Instead, we're falling far short of profit maximization--immorally so!”

This is blatantly wrong, though it is not obvious at first blush why. There are at least 3 major reasons why this argument is incorrect even though the numbers may be good:

1) ROI can’t include the share of labour. $13 trillion of GDP is being created with assets of $120 trillion AND the labour of roughly 150 million people. The aggregate wages of all employees in the United states were tagges at $7.4 trillion in 2006 (when the GDP was roughly $13 trillion). “Net operating surplus”, all the returns due to capital, was $3.2 trillion. So roughly 70% of GDP is due to labour and 30% is due to capital. So the return on assets isn’t really 11%; it’s more like 3.5%, which suddenly makes it a lot less interesting that it used to be.

2) The interest rate shouldn’t equal the total Return on Assets; it should equal the marginal return on assets. Obviously I don’t know what this is, but I do know that it is significantly lower than the total return, since the marginal return always goes down with each extra dollar invested (or somebody made very bad investment decisions initially).

3) This assumes that US government debt is used to finance capital which will be used to grow GDP and to increase effective standard of living. But this simply isn’t the case: most of the government’s expenses go to military expenditure, entitlement programs such as Social Security or Medicare, or debt interest payments. None of these is truly capital investment.

The optimal level of debt of a country depends in large part on what the debt is being used to finance. Debt used to finance infrastructure such as roads, power stations or research (yes, research produces capital!) can be defended up to a point, but debt used to finance consumption is silly, mortgaging future generations’ standard of living in favor of those spending today. If that’s what you’re pushing, fine, but call it what it is.