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China Financial Markets: Building Debt

Published February 6, 2012 China Leave a Comment
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Discussing the Flyvbjerg paper in the light of China’s massive infrastructure spending, Michael Pettis wrote:

It is not a very happy paper in general, but I am pretty sure that many people who read it probably had a thought similar to mine: if infrastructure spending can be so seriously mismanaged in relatively transparent systems with greater political accountability, what might happen in a country with a huge infrastructure boom stretching over decades, much less transparency, and very little political accountability? Isn’t the potential for waste vast?

Michael Pettis at China Financial Markets has been looking into China’s capital misallocations for some time. Here he quotes from a recent Caijing article:

(…) rail lines were built where few people live on the outskirts of the Hunan Province city of Changsha, said Wang Chengli, an urban transit professor at the city’s Central South University. Today, exit gates for some of the city’s finished subway stations lead to farm fields.

Wang said Changsha authorities installed far fewer kilometers of track in the city’s center than in its suburbs. Each project was approved by the central government, he added.

Zhang says China learned important lessons from the fast-track subway program. For example, he now thinks subways should never have been built in “many cities.”

Doesn’t this mean defaults? Not in China, because the central government will backstop the defaults. But the debt service can only be managed by means of more financial repression. In that light how can China grow the consumer side of the economy?

The fact so few of the companies have accumulated that much debt suggests a bigger problem, says Fraser Howie, the Singapore-based managing director of CLSA Asia-Pacific Markets who has written two books on China’s financial system. “You should be more worried than you think,” he said of Bloomberg’s findings. “Certainly more worried than the banks will tell you.

(…) The problem, then, is not that there will be defaults. The problem is that the only alternative to default is to service the debt, and this is what will cause the real damage to the economy. If the economic benefits generated by the investment are less than the correctly-valued debt-servicing costs, as they almost certainly are, the difference has to be made up in the form of a transfer of resources from some sector of the economy.

As we saw in the last debt crisis, a decade ago, debt-servicing costs are only manageable in China thanks to financial repression – i.e. extremely low lending rates funded by even lower deposit rates — which implies a huge transfer, equal to several percentage points of GDP annually, from household savers to corporate and government borrowers. Households, in other words, typically clean up banking messes.

Only consume!

The problem with this solution is in what it implies about future growth in demand. If investment is being wasted, it must be reduced or it will create a debt crisis eventually. If the external environment is tough, the demand impact of a sharp drop in investment cannot be made up for by a surge in the trade surplus – in fact the trade surplus may actually contribute negative demand. So where will the demand come from needed to pull the Chinese economy? The only possibility is a surge in domestic consumption.

Can consumption possibly surge? No, not if the household sector is going to be forced to clean up the banking mess again. This is the same problem that caused household consumption to drop after the last banking crisis from a very low 46% of GDP in 2000 to an astonishing 34% in 2010.

(…) It isn’t about household savings

The only way to boost household consumption is either to redistribute income from the low-consuming rich to the high consuming poor, or, better yet, to redistribute wealth from the state to households. Both of these have serious political implications that have to be resolved and are unlikely even to be addressed with consumption subsidies. After five years of this argument, during which time consumption has plummeted relative to total savings, you would think they would start to abandon the idea that all we need to do to get consumption to surge is to reduce household savings a little.

FYI, Fraser Howie is coauthor with Carl Walter of “Red Capitalism”. I’m currently reading their book. I recommend you do not read this before sleeping.

Failure of American schools

Published February 6, 2012 Education Leave a Comment
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Joel Klein, former chancellor NYC Schools:

Three years ago, in a New York Times article detailing her bid to become head of the American Federation of Teachers union, Randi Weingarten boasted that despite my calls for “radical reform” to New York City’s school system, Mayor Michael Bloomberg and I had achieved only “incremental” change. It seemed like a strange thing to crow about, but she did have something of a point.

(…) To comprehend the depth of the problem, consider one episode that still shocks me. Starting in 2006, under federal law, the State of New York was required to test students in grades three through eight annually in math and English. The results of those tests would enable us, for the first time, to analyze year-to-year student progress and tie it to individual teacher performance—a metric known in the field as “teacher value-added.” In essence, you hold constant other factors—where the students start from the prior year, demographics, class size, teacher length of service, and so on—and, based on test results, seek to isolate the individual teacher’s contribution to a student’s progress. Some teachers, for example, move their class forward on average a quarter-year more than expected; others, a quarter-year less. Value-added isn’t a perfect metric, but it’s surely worth considering as part of an overall teacher evaluation.

After we developed data from this metric, we decided to factor them into the granting of tenure, an award that is made after three years and that provides virtual lifetime job security. Under state law at the time, we were free to use these data. But after the New York City teachers union, the United Federation of Teachers, objected, I proposed that the City use value-added numbers only for the top and bottom 20 percent of teachers: the top 20 percent would get positive credit; the bottom would lose credit. And even then, principals would take value-added data into account only as part of a much larger, comprehensive tenure review. Even with these limitations, the UFT said “No way,” and headed to Albany to set up a legislative roadblock.

Seemingly overnight, a budget amendment barring the use of test data in tenure decisions materialized in the heavily Democratic State Assembly. Joe Bruno, then the Republican majority leader in the State Senate, assured me that this amendment would not pass: he controlled the majority and would make sure that it remained united in opposition. Fast-forward a few weeks: the next call I got from Senator Bruno was to say, apologetically, that several of his Republican colleagues had caved to the teachers union, which had threatened reprisals in the next election if they didn’t get on board.

As a result, even when making a lifetime tenure commitment, under New York law you could not consider a teacher’s impact on student learning. That Kafkaesque outcome demonstrates precisely the way the system is run: for the adults. The school system doesn’t want to change, because it serves the needs of the adult stakeholders quite well, both politically and financially.

Let’s start with the politicians. From their point of view, the school system can be enormously helpful, providing patronage hires, school-placement opportunities for connected constituents, the means to get favored community and business programs adopted and funded, and politically advantageous ties to schools and parents in their communities.

During my maiden testimony before the State Assembly, I said that we would end patronage hires, which were notorious under the old system of 32 school districts, run by 32 school boards and 32 superintendents (a 2002 state bill granting Bloomberg mayoral control of the city’s schools abolished the 32 boards). At my mention of patronage, the legislators, like Captain Renault in Casablanca, purported to be “shocked.” Nevertheless, after the hearing, when I went to thank committee members, one took me aside and said: “Listen, they’re trying to get rid of a principal in my district who runs a Democratic club for us. If you protect him, you’ll never have a problem with me.” This kind of encounter was not rare.

Read the whole thing »

Survival of the unfittest: why the worst infrastructure gets built

Published February 6, 2012 Economics Leave a Comment
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(…) a rapid increase in stimulus spending, combined with more investments in emerging economies, combined with more spending on information technology is catapulting infrastructure investment from the frying pan into the fire.

– Bent Flyvbjerg, Oxford 2009

The abstract of Flyvbjerg’s paper is good short summary:

The article first describes characteristics of major infrastructure projects. Second, it documents a much neglected topic in economics: that ex ante estimates of costs and benefits are often very different from actual ex post costs and benefits. For large infrastructure projects the consequences are cost overruns, benefit shortfalls, and the systematic underestimation of risks. Third, implications for cost–benefit analysis are described, including that such analysis is not to be trusted for major infrastructure projects. Fourth, the article uncovers the causes of this state of affairs in terms of perverse incentives that encourage promoters to underestimate costs and overestimate benefits in the business cases for their projects. But the projects that are made to look best on paper are the projects that amass the highest cost overruns and benefit shortfalls in reality. The article depicts this situation as ‘survival of the unfittest’. Fifth, the article sets out to explain how the problem may be solved, with a view to arriving at more efficient and more democratic projects, and avoiding the scandals that often accompany major infrastructure investments. Finally, the article identifies current trends in major infrastructure development. It is argued that a rapid increase in stimulus spending, combined with more investments in emerging economies, combined with more spending on information technology is catapulting infrastructure investment from the frying pan into the fire.

Rethinking the Way College Students Are Taught

Published February 5, 2012 Education 2 Comments
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Harvard students Ryan Duncan (right) and Kevin Mazige in their lab for Eric Mazur’s physics class. (Photo: Emily Hanford)

Harvard physics prof. Eric Mazur has been rethinking his own teaching process since the early 1990s. “Peer-instruction” is one of his innovations:

“And something happened in my classroom which I had never seen before,” he says. “The entire classroom erupted in chaos. They were dying to explain it to one another and to talk about it.”

Mazur says after just a few minutes of talking to each other, most of the students seemed to have a much better understanding of the concept he’d been trying to teach.

“The 50 percent who had the right answer effectively convinced the other 50 percent,” he says.

Here’s what Mazur has figured out about what goes on when the students talk with each other during peer instruction:

“Imagine two students sitting next to one another, Mary and John. Mary has the right answer because she understands it. John does not. Mary’s more likely, on average, to convince John than the other way around because she has the right reasoning.”

But here’s the irony. “Mary is more likely to convince John than professor Mazur in front of the class,” Mazur says.

“She’s only recently learned it and still has some feeling for the conceptual difficulties that she has whereas professor Mazur learned [the idea] such a long time ago that he can no longer understand why somebody has difficulty grasping it.”

(…) Mazur now teaches all of his classes using a “peer-instruction” approach. Rather than teaching by telling, he teaches by questioning. Mazur says it’s a particularly effective way to teach large classes.

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Udacity: Reinventing Education

Published February 4, 2012 Education Leave a Comment
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Thrun says he can no longer teach at Stanford University. He says he was presented with the red pill and the blue pill. “You can take the blue pill and go back to your lecture of 20 students. But I’ve taken the red pill and seen wonderland.”

– Sebastian Thrun

High on our list of role models for our grandchildren are Paul Romer and Sebastian Thrun. One of the most-coveted prizes for a professor is tenure at Stanford University. Because they are so committed to their respective social ventures, both Romer and Thrun resigned their Stanford tenure. [see end-note]

We have been writing about Paul Romer’s Charter Cities and his New Growth Theory for some time. Meanwhile we have been following Sebastian Thrun mainly in the context of the Google and Stanford self-driving-car programs.

This post is about innovation in education. Background: last August we posted a brief note on Stanford’s free Introduction to Artificial Intelligence Course offering. That announcement was very exciting – but it wasn’t practical to for us to “attend” the course while touring Europe. Well, it turned out that Dr. Thrun and co-professor Peter Norvig got a lot more out of that online course than they anticipated. With the staggering online signup of 160,000 students around the world, the famous professors had to work nearly to exhaustion to develop new approaches that would be effective at such a scale.

At the 2012 Digital Life Design Conference, Sebastian describes his learning experience teaching the course, Closing his presentation Dr. Thrun announces that he is resigning his Stanford tenure so that he can devote his full energies to the new education startup Udacity cofounded by Sebastian and Prof. David Evans.

We believe university-level education can be both high quality and low cost. Using the economics of the Internet, we’ve connected some of the greatest teachers to hundreds of thousands of students all over the world.

We’re hiring: We are a rapidly growing company located in Palo Alto, California looking for great people to join our team. We’re looking for a wide variety of backgrounds – the only thing in common is a passion for improving education.

The Udacity online course offerings are free to world. To my delight, one of the first courses is CS 373: Programming a Robotic Car, which will be taught by Dr. Thrun himself, starting February 20, 2012. And you can audit their courses, so sign up now!

If you would like to share our excitement about these education innovations, I suggest the following sequence of references:

University 2.0 Sebastian Thrun: this is prof. Thrun’s 2012 Digital Life Design presentation (you may wish to skip the first 5 minutes of introduction). In his concluding remarks Sebastian says “I can’t teach at Stanford again” as he explains that he is abandoning his tenure to devote full attention to Udacity.com.

Reinventing Education with Khan Academy and Artificial Intelligence Class: this is a 45 minute recording of the December Google+ Hangout led by Khan Academy founder Sal Khan and Stanford professors Peter Norvig and Sebastian Thrun. The Google+ Hangout was one of what Norvig/Thrun called their “office hours” supporting the Stanford AI Course. This segment of “office hours” is initially attended by invited groups of students from other prestigious computer science schools.

Sal Kahn at TED 2011: Salman Kahn was perhaps the prime mover in online education at scale. See our earlier post Khan Academy is getting recognition…. Certainly Thrun and Norvig benefited from Kahn’s ground-breaking experience (and I’ll freely speculate that they consulted heavily with Sal as they developed the AI Course).

Kahn Academy: 2,800 free video learning tools — enjoy! Now that Bill Gates and the Google Foundation are providing additional financial backing, Sal Kahn and his development team are innovating at a blistering pace.

The Stanford AI Course website: while the 2011 course is closed, you are invited to audit the course at their YouTube channel.

An excellent briefing on the course by Stanford AI Lab professor Daphne Koller (originally titled at NYTimes Death Knell for the Lecture: Technology as a Passport to Personalized Education).

The Udacity (formerly Know Labs) website.

For more please explore the Seekerblog/Education category.

Update 2/4/12: very interesting. Researching Sebastian Thrun and Udacity I noted that Sebastian has posted on his personal homepage a correction on his Stanford tenure resignation. My introduction at the beginning of this post isn’t accurate. Here are his words:

There is a misrepresentation about my tenure situation that I’d like to correct. I did on my own volition resign from my full tenured position, effective April 1, 2011. However, this was primarily to continue my employment with Google, and it predates my online classes. Stanford has generously appointed me as a research professor without tenure, which means I remain a voting member of the Academic Council. I continue to advise students and help the department with administrative issues. And in all clarity: Stanford is an amazing place!!! I love Stanford.

That said, here is the exciting part of Sebastian’s Welcome! page:

One of the most amazing things I’ve ever done in my life is to teach a class to 160,000 students. In the Fall of 2011, Peter Norvig and I decided to offer our class “Introduction to Artificial Intelligence” to the world online, free of charge. We spent endless nights recording ourselves on video, and interacting with tens of thousands of students. Volunteer students translated some of our classes into over 40 languages; and in the end we graduated over 23,000 students from 190 countries. In fact, Peter and I taught more students AI, than all AI professors in the world combined. This one class had more educational impact than my entire career. Just watch this video.

Everyone’s afraid of Amazon

Published February 3, 2012 Uncategorized Leave a Comment

David Streitfeld for the NYT, on “Amazon Signs Up Authors, Writing Publishers Out of Deal“:

“It’s always the end of the world,” said Russell Grandinetti, one of Amazon’s top executives. “You could set your watch on it arriving.”

He pointed out, though, that the landscape was in some ways changing for the first time since Gutenberg invented the modern book nearly 600 years ago. “The only really necessary people in the publishing process now are the writer and reader,” he said. “Everyone who stands between those two has both risk and opportunity.”

Zappos, Stratfor, Sony, Gawker; Got your attention? Good, now start using a password manager!

Published February 3, 2012 Technology Leave a Comment

Troy Hunt explains why you really, really need to start using 1Password:

Another week, another major security incident with a significant website. So the news this time is that Zappos – those guys who sell shoes (among other things) – to folks in the US may have, uh, accidentally disclosed somewhere in the order of 24 million user accounts. Bugger.

Now of course at the root of this is inevitably yet more evildoers intent on breaking through website security for financial gain, activism or just plain old kicks. Regardless of the modus operandi of these incidents, the fact remains that a significant number of accounts have been exposed and there’s now the real possibility that usernames and passwords – perhaps your username and password – are going to be floating around the internet being seen by who knows how many people.

(…)

[From Zappos, Stratfor, Sony, Gawker; Got your attention? Good, now start using a password manager!]

Nuclear vs Nuclear vs Nuclear

Published February 3, 2012 Nuclear Power 1 Comment
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Another terrific George Monbiot essay. David MacKay has gone public with burning the UK nuclear ‘waste’. George explains that we have three technology choices to elect for waste: bury it, MOX recycle, IFR full recycle. George favors the GE Hitachi full reprocessing package; i.e., the IFR design.

Here’s a quick excerpt — more tomorrow.

We can’t wish nuclear waste away: we must choose one of three options for dealing with it.

By George Monbiot. Published on the Guardian’s website, 2nd February 2012

Duncan Clarke’s article in the Guardian today should cause even the most determined anti-nuclear campaigner to think long and hard about the choices that confront us. He reveals that David McKay, chief scientific adviser to the government’s energy department and author of Sustainable Energy: Without the Hot Air, has endorsed a remarkable estimate. The UK’s stockpile of nuclear waste could be used to generate enough low-carbon energy to run this country for 500 years.

If the material we have seen until now as waste is instead seen as fuel, it has the potential to solve three problems at once: the UK’s contribution to climate change, possible future energy shortfalls and a significant component of the massive bill – and massive headache – associated with cleaning up the current nuclear mess.

The technology with the potential to solve these problems is the fast reactor, ideally the integral fast reactor (IFR), about which I wrote in December. It exploits the fact that conventional nuclear power plants use just 0.6% of the energy contained in the uranium that fuels them. IFRs, once loaded with nuclear waste, can, in principle, keep recycling it until only a small fraction remains, producing energy as they do so.

(…) GE Hitachi has offered to build a fast reactor to consume the plutonium stockpile at Sellafield, though not yet the whole kit (the integral fast reactor). It has offered to do it within five years, and to carry the cost if it doesn’t work out. This is the proposal the government is now considering. I would like to see it go further and examine the case for the full works: an integral fast reactor (incorporating a reprocessing plant) that generates much more energy from the waste pile.

Read the whole thing »

I confess to being a bit excited to see George taking up this vital issue. And the extent of the commentary he is generating. Read the comments – see what you think. So far I would rate about 25% of the comments as being constructive and engaged. And less than 50% are of the typical unthinking anti-nuclear sort. Those comments are usually being thoroughly refuted by multiple contributors.

American Airlines Wants to Terminate Its Pension Plan, Lay Off 13,000

Published February 2, 2012 Economics 1 Comment
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Interesting. Somehow these deals have to be recut or the jobs just go away. Megan McArdle:

Details of the American Airlines bankruptcy are emerging. And the details are that AMR wants all of its creditors to take a deep haircut, especially the workers:

The company aims to cut labor costs 20% under bankruptcy protection, and will soon begin negotiations with its three major unions. Some management jobs would also be cut.

AMR also proposes to end its traditional pension plans. The move has been strongly opposed by the airline’s unions and the U.S. pension-insurance agency.

CEO Thomas Horton said the company hopes to return to profitability by cutting spending more than $2 billion per year and raising revenue by $1 billion per year.

. . . Horton said cost-cutting will include restructuring debt and aircraft leases, grounding older planes, and changing labor contracts.

This is just the opening salvo in what promises to be a bruising negotiation with the unions. It’s not clear that the company actually expects to be allowed to terminate the pension plan. But the threat certainly gives them leverage with the unions, especially the pilots, because if the plan is terminated and taken over by the Pension Benefit Guaranty Corp, the payouts will be capped at around $50,000 a year–far less than pilots get from the current plan.

(…)

Read the whole thing »

High renewables penetration means eye-watering costs and massive overbuilding

Published February 2, 2012 Energy Policy Leave a Comment

Figure 5: Solar capacity is 21% of the wind capacity. Weekly snapshot.

In comments on Steve Skutnik’s “Interminable innumeracy” Frank Eggers made the case for a real-world instrumented test of the popular thesis that “smart grids and geographic dispersion” will allow large scale deployment of unreliable renewables:

(…) As I see it, to prove that, it would be necessary to have sensors at all locations (or at least a large number of locations) where it would be reasonably possible to have wind and solar power installations. The data would have to be transmitted, in real-time, to a central location where it would be continuously analyzed to see how much power would be available reliably with no interruptions. So far as I know, that has never been done.

Thanks Frank, all good comments. Germany is well-situated to perform your instrumented experiment – but do you think they would want the results to be public? E.g., see Eye-watering cost of renewable revolution.

While not as good as real-world instrumentation, but in my view very persuasive, are the simulations published by Finnish physicist Jani-Petri Martikainen at BraveNewClimate. I think his two guest posts are an important contribution to the study of how costly will be large scale wind and solar deployment. There are two posts, intended to be read in the following order, where the first analysis examines unreliable wind added to an existing reliable grid, the second analysis adds solar to the mix:

[1] Geographical wind smoothing, supergrids and energy storage

[2] Solar combined with wind power: a way to get rid of fossil fuels?

Based upon real-world data sets, with the data chosen to be extremely favorable to wind and solar, the simulations indicate that an idealized case of optimal solar/wind deployment requires a massive overbuilding of dispatchable power sources. The total magnitude of the dispatchable power will need to be about 90% of peak demand. This supports the rough rule of thumb that high unreliable penetration will require overbuilding capacity by about 2x. Given the speed at which such as Germany are spending on wind/solar, that reliable power will be mostly fossil. Policies such as Germany’s are a creating an enormous fossil lock-in and hence a climate train wreck.

To summarize Dr. Martikainen’s conclusions I will cherry-pick from concluding paragraphs:

Only scenarios which are based on reliable energy sources from the beginning seem to avoid the problems discussed here. Scenarios based on unreliable sources become progressively harder as their share of electricity supply increase. Reducing GHG emissions sufficiently requires, in practice, total decarbonization of the electricity supply, and the emissions reductions achieved by the time erratic sources run into trouble are far too low. I cannot avoid the conclusion that approaches based on renewables will mainly, at a very large expense, end up delaying the real decisions we must eventually make to lower emissions to acceptable levels. The alternative zero-carbon baseload source seems rather obvious…

(…) How about choosing the solar capacity to be the “optimal” 0.21 of wind power capacity? Then we need reliable power plants with a capacity of 89% of peak demand. They will have a capacity factor of 14% and amount to 19% of total production. So, yes! Adding solar power to the mix can sometimes help, by reducing the electricity produced with fossil fuels from 21% to 19%. Unfortunately, the required capacity of reliable power plants is actually slightly higher than with wind only. I will not dare to compute the cost of CO2 abatement under such a scenario.

(…) To conclude, I note that adding solar power and wind without massive storage to the mix does next to nothing to remove the need for fossil fuel based energy infrastructure. Scenarios based on wind and solar power are fundamentally reliant on fossil fuels and sooner this is understood the better it is for climate. Currently the mirage of purely unreliables based energy production essentially maintains the use of fossil fuels for as long as the eye can see both for technical and financial reasons.

While doing these exercises I occasionally get a feeling that I am fencing with a tetraplegic. You might say this is not sportsmanlike, but unfortunately the political reality is that the mirage of solar and wind based solutions is a tetraplegic which hampers us from confronting the real and difficult issues with respect to climate change. By offering an easy “alternative” this mirage effectively acts as a cover for the damage anti-nuclear activities are causing for attempts to mitigate climate change. Unfortunately fencing must continue since this cover must be removed.

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