The New York Times on College Aid

A recent New York Times editorial shows, once again, that the NYT editors have a hard time thinking straight. Here are some excerpts from the editorial, “College Aid Cutbacks” along with my comments.

Government loans also have not kept pace with rising costs. Subsidized loans accounted for only 55 percent of student borrowing in the most recent academic year, down from 69 percent 10 years earlier.

Why should student loans be subsidized at all? If there is a reason to subsidize them, what is the rational for determining the right subsidy? Assuming it is true that “Subsidized loans accounted for only 55 percent of student borrowing in the most recent academic year” is “down from 69% 10 years ago”, does that imply that subsidized loans are down or down per capita? The NYT editors missed all these points and they are the crux of the issue.

Bush administration officials have said repeatedly that the solution to the nation’s growing income inequality is more education. That’s a gross oversimplification, but if they really believed it — and cared about a remedy — would federal college aid be declining?

Without knowing the right level of federal college aid, we cannot know if a decline is good or bad.

As things stand, privatization of college lending is the administration goal that is being advanced. As government aid has declined, loans from banks and other private lenders have soared, climbing to 20 percent of all education borrowing last year, up from 12 percent five years earlier.

This implies nothing about whether students are obtaining the loans they need to attend college or not?

Should all these students be attending college?

The result is towering debt. The same bachelor’s degree will cost a student borrower far more than a student who can afford to pay.

The student borrower pays interest on his loan. The student who pays cash loses the interest he could have earned on his money. The latter’s loss is at the market interest rate, which is higher than that of a subsidized student loan. In this case, the student borrower has a lower (present value) cost than the student who can afford to pay. If the student borrower pays the market interest rate, then there is not much difference between the borrower’s (present value) cost and the cost for the student who can afford to pay.

That’s not a path to greater equality.

I will believe that the NYT editors really want equality when they stop wearing Rolex’s, stop driving expensive cars, and donate the difference between their income and the average income to charity.

Business mathematics

Thanks to Jennifer Young for this one.

What should you do when your boss wants you to give 100%, or even more than 100%?

Here is the math behind this concept.

Represent A, B, C, . . . , Z by the numbers 1, 2, 3, . . ., 26.

Then:

KNOWLEDGE = 96%

HARD WORK = 98%

ATTITUDE = 100%

BULLSHIT = 103%

ASS KISSING = 118%

So, it is mathematically certain that while knowledge, hard work, and attitude will get you there, bullshit and ass kissing will put you over the top.

The Palm Beach Post’s editor wants to make the insurance problem worse

Randy Schultz, the Palm Beach Post’s Editor of the Editorial Page, has an editorial titled “On insurance, will the state get fooled again?”. However, it is Mr. Schultz that is being fooled, and by his own faulty understanding of arithmetic and economics, not by the insurance companies.

Mr. Schultz’s article is an excellent example of the kind of mistaken thinking that I often used in my MBA classes to illustrate that even VIPs spread dumbth.

Here are some excerpts from Mr. Schultz’s editorial, along with my comments.

However the Foley scandal plays out in the race for his congressional seat and other U.S. House races around the country, Floridians will be dealing with the same insurance crisis once the election is over. There's no chance that the Legislature will hold a special session on property insurance before the Nov. 7 election, since there's no consensus on what to do. Also, Gov. Bush would have to call it, and a special session would remind voters how little he and the Republican-led Legislature did this year and last year.

Given the proposed solutions that typically come from government and the Mr. Schultz’s of the world, doing nothing is preferable to making things worse by doing something.

Ideally, the next Congress would deal with the problem by creating a federal disaster fund similar to the National Flood Insurance Program. Both candidates for governor favor such a program, and why wouldn't they? It would solve the problem for them.

A federal disaster fund, if experience to date is any guide, would encourage overbuilding and inadequate construction in hurricane prone areas. The real problem is that nobody who lives in these areas wants to pay the economic cost. The “solutions” proposed by politicians and Mr. Schultz invariably have the innocents pay for the consequences of the inappropriate behavior of the irresponsible.

The real solution is to have those who insist on living in hurricane prone areas (like Mr. Schultz and me) pay the full average cost of living there. This requires that those living in hurricane prone areas pay for all the hurricane damage, averaged over a suitably long term. That requires a real, economically viable insurance industry, not one required by law to charge “affordable” premiums that are below the average loss and to build up a reasonable reserve.

In reality, though, the Legislature will have to act. For nearly 60 years, Congress has left insurance regulation to states, which enables the industry to set rates state-by-state and work the system to its advantage. That's how the property insurers made record profits in 2005 despite Hurricane Katrina and two bad storm seasons in Florida.

Rates should be set state by state, or even better by risk area. Why should someone who decides not to run the risk or expense of hurricane losses be forced to subsidize those who do so that the latter can live where they shouldn’t in homes that are inadequately constructed?

Focusing on profits in one year when the problem is losses over many years is wrong. Do we want the insurance company to go broke precisely when the big loss is incurred? How can that be prevented if the insurance company is not allowed to have big profits in years when the losses are below average or when reserves are below where they should be?

Yet Gov. Bush continues to insist that Florida has "more a hurricane problem than an insurance problem." The committee he formed to study property insurance is to seek only solutions that restore the private market.

Gov. Bush is right and Mr. Schultz is wrong. If private insurance is not economically viable, presumably due to government meddling, neither will be public insurance. Politicians are smart enough to realize that they will have to bill citizens for the average loss and that the average loss will be just as large as what private insurers will charge. When the big loss comes, we will simply get an enormous tax bill and a partisan outcry about the failed government insurance program set up by the other party.

Test question: Why might the average cost of private insurance be less than the average cost of government provided insurance?

That would be the same private market that has dumped hundreds of thousands of higher-risk policies onto the state, restricted what their policies will cover, sought relief from having to cover certain perils, delayed or refused to pay some claims - then acted as though Floridians should be grateful that the private market is still here.

It appears that Mr. Schultz thinks that an insurance company should be forced to run at uneconomically viable insurance premiums. This is obviously impossible. Who would invest in the insurance company?

If an insurance company is not allowed to charge a premium appropriate to the risk, it would be foolhardy to sell the policy? If price controls make some segment of the insurance market a long term loss, the message is that government has done something that will, on average, hurt its citizens. If Mr. Schultz wants more risks covered, he shouldn’t be fighting for lower premiums.

There's a case to be made that the solution for Florida is to leave the private market out of any solution, since the private market has brought about the crisis. Making that case is Americans for Insurance Reform, which proposes "a privately run state insurer for the hurricane wind portion of homeowners' insurance coverage." Private companies would continue to write non-wind coverage, covering fire, theft and liability. Democrats in the Legislature supported this approach, but they didn't get a serious hearing.

To think that the private market has brought about the crises is wrong. It is the Mr. Schultz’s of the world who have messed up the insurance market by demanding “affordable” insurance when no such thing is possible. The only insurance premium viewed as affordable by the Mr. Schultz’s of the world are well below the average loss they are supposed to cover.

Fortunately, the Democrats didn’t get a serious hearing . . . . , or did they? A serious consideration should take no more than 60 seconds and should lead to rejection.

The key to any such plan would be how much to charge. That, in turn, would depend on who decides what the risk is. Americans for Insurance Reform suggests using models that are developed by state government and run by state government. As the group notes, Florida insurance regulators now have to rely on the industry's computer-generated risk models. One of those private models, Risk Management Solutions, said this year that projections now will be based on five-year periods. That means Floridians are paying property insurance based primarily on 2004 and 2005. Is that spreading risk?

Mr. Schultz is indeed misinformed. No hurricane loss models are accurate year by year. Even if they were, paying the current year’s expected loss each year would lead to wildly fluctuating premiums. The whole point of hurricane insurance is to average over years. Yes, Mr. Schultz, 2004 and 2005 should be included.

Mr. Schultz, have you any idea what the right tail of a probability distribution is? If so, do you have any idea of the implications for insurance?

On this one, really, get past politics.

Past politics and past the kind of dumbth Mr. Schultz and the politicians espouse.

Politics may keep some Republicans from taking Americans for Insurance Reform seriously. The group is part of the Center for Justice & Democracy, which gets money from those dreaded plaintiffs' lawyers Republicans like to criticize unless one of them - Sen. Mel Martinez, for example - is running as a Republican. Also, Michael "Fahrenheit 9/11" Moore sits on the Center for Justice & Democracy's board.

Well, those are some pretty good reason for expecting Americans for Insurance Reform to make the problem worse. I don’t see how anyone could take AFIR seriously, given what it is trying to accomplish.

Last Sunday's Post featured an update on how drastically higher premiums are hurting homeowners and the real estate market. Combined with higher tax bills from soaring values, the costs threaten to undermine the state's economy. Florida has managed to get by as a low-cost, low-wage state, but Florida can't be a high-cost, low-wage state.

Too bad. That is the cost of living in Florida. If you don’t want to pay for your cost of living here, move. Don’t try to force others to pay the cost of your inappropriate decision.

The sad truth is that Florida is a high-cost state.

What would help is high enough insurance premiums to make it worth while to build stronger structures that make economic sense instead of the weaker structures that make sense when you can count on having your damage paid for by others who don’t choose to run your risk.

A decade ago, after Hurricane Andrew, the state created another committee to study property insurance. Under the changes that became law the next year, Floridians were supposed to get this deal: Rates won't go down a lot when there are few storms, but rates won't go up a lot when there are lots of storms. If the insurance companies didn't live up to their end of the deal the last time, why should Floridians think that they would do so this time?

The only way to achieve level rates is to have high level rates.

Of course, all that said, I am willing to continue to be subsidized if you are silly enough to elect politicians who will do me the favor.

Tradeoffs. The New York Times editors on the national debt

Here is an editorial, “Deeper and Deeper” from the New York Times. The title is apt. The editors get themselves deeper and deeper into analytical trouble as they go along.

There is fresh evidence, if any more were needed, that excessive borrowing during the Bush years will make the nation poorer.

The NYT editors have yet to realize that what matters most is the size of the government budget, not how it is funded. If the borrowing will make the nation poorer, it is because the government is spending too much.

From the standpoint of a fixed government budget and the country as a whole, there is little if any difference between funding the budget with taxes or funding it with borrowing. Since the NYT editors are for increased taxes, they should not be worrying about the impact of funding those same projects with debt.

Hint: The present value of interest payments on debt is the proceeds of the debt. The present tax required to accomplish the same spending is the amount of the debt.

For most of the past five and a half years, interest rates have been low, allowing the government to borrow more and more — to cut taxes while fighting two expensive wars — without having to shoulder higher interest payments.

The NYT editors fail to appreciate the equivalence of funding spending with debt vs taxes. The additional interest payments from using debt are offset by the additional interest earned by taxpayers on funds they get to keep because they don’t have to pay the equivalent tax.

That’s over now. For the first time during President Bush’s tenure, the government’s interest bill is expected to rise in 2006, from $184 billion in 2005 to $220 billion this year, up nearly 20 percent. That increase — $36 billion — makes interest the fastest-growing component of federal spending, and continued brisk growth is likely. According to projections by Congress’s budget office, the interest bill will grow to $249 billion in 2007, and $270 billion in 2008.

So, one year’s increase is a permanent growth rate?

All of that is money the government won’t have available to spend on other needs and priorities. And much of it won’t even be recycled back into the United States economy. That’s because borrowing from foreign countries has exploded during the Bush years. In 2005, the government paid about $77 billion in interest to foreign creditors in China, Japan and elsewhere.

If foreigners buy US Debt, the US gets their money. US taxpayers do not have to pay now, either in the form of taxes or debt. The interest they pay later has a present value equal to the tax or debt they would have paid. Moreover, if the foreigners don’t treat us right, we can renege on the debt.

And that’s not the worst of it. While foreign investors were putting up most of the $1.5 trillion the federal government has borrowed since 2001, they were also snapping up hundreds of billions of dollars in private sector securities, transactions that have been a big source of the easy money that allowed Americans to borrow heavily against their homes.

Let’s see, having willing buyers for private debt makes it more difficult for Americans to borrow? Isn’t borrowing selling debt?

The result, as The Wall Street Journal reported last week, is that for the first time in at least 90 years, the United States is now paying noticeably more to foreign creditors than it receives from its investments abroad. That is a momentous shift. It means that a growing share of America’s future collective income will flow abroad, leading to a lower standard of living in the United States than would otherwise have been achieved. Americans deserve better than this financial mess.

The future collective income flowing out is offset by the debt proceeds flowing in now? If the consequence is a lower standard of living, it is due to a government budget that is too large, not how it is financed.

A nice lesson from STATS (checking out the facts behind the news)

Here is a link to a STATS article, “Fingering the Media”. It shows why much of the statistical quotes in the media are nonsense.

Here are a few excerpts from the article.

The media just loves a finger story. Last year, the Express Newspaper of the U.K. reported on a study finding that male aggression is linked to finger length – the longer the ring finger is as compared to the index finger, the more likely the male is to be aggressive.

The problem with these kinds of studies is two fold. First, these researchers don’t have a plausible mechanism to justify their claim.

Secondly, there are rarely studies published about what finger-length is not correlated with. Some might argue this is irrelevant, but it actually is extremely relevant from a statistical point of view.

Any time you test for a correlation, there is a small possibility (about five percent) that you will measure a relationship (such as finger-length and athletic talent) when it isn’t actually present in the whole population. These “findings” will seem as “true” as any other statistical finding, such as the fact that lung cancer and smoking are correlated. But this means that if you try to correlate twenty different traits to finger length –even if none of them are actually related to finger length – you will likely find some correlation, just by chance.

The Washington Post editors miss a fine point

An editorial in the Washington Post titled “A Healthy Response” lauds new Washington, D.C. legislation that funds healthcare with tobacco settlement funds. However, the editors make the common mistake of thinking the source of the funds is relevant for deciding the best use of the funds.

Clearly the method of funding the measure -- through the use of the city's tobacco settlement funds -- makes sense. Tobacco use, as Mr. Catania has noted, contributes to five of the 10 leading causes of death in the city. Tobacco use is also the leading cause of cancer deaths in the District. What better use for the settlement funds?

Hanle in the Washington Post on The Education Issue

Paul Hanle has an article in the Washington Post titled “The Education Issue”. Its first paragraph is amusing, although Hanle did not intend it to be. Here it is.

I recently addressed a group of French engineering graduate students who were visiting Washington from the prestigious School of Mines in Paris. After encouraging them to teach biotechnology in French high schools, I expected the standard queries on teaching methods or training. Instead, a bright young student asked bluntly: "How can you teach biotechnology in this country when you don't even accept evolution?"

Hanle characterizes the student as bright. Hanle makes a recommendation about teaching in France. The student criticizes the US. The student claims that nobody in the US accepts evolution (plural “you”). The student implies that it is impossible to teach a concept that nobody in the US accepts (yes, I am purposely ignoring the probability that the student may have been referring to the operational aspects of the issue).

This student sounds abrasive and dumb, not bright.

The New Yorker gets an F in statistics

Thanks to Don Luskin at “Conspiracy to Keep You Poor and Stupid” for steering me to the New Yorker article this post is about.

The 9/25/06 issue of the New Yorker contains an article, “Wagers of Sin” by Suroweicke. Suroweicke laments in part that the ban on online betting has serious adverse consequences. Here is an excerpt from his article.

Furthermore, the ban on online betting is hindering the development of new markets that could predict far more important outcomes than that of the N.B.A. finals. In the past few years, a host of prediction markets, as they’re usually called, have appeared online, offering people the chance to speculate on subjects ranging from the box-office performance of Hollywood films to the outcome of Presidential elections and the spread of bird flu. These markets’ forecasts have proved remarkably accurate—just as bettors collectively do an exceptionally good job of predicting sports results. (In 2004, for instance, Tradesports, a Dublin-based prediction market, called thirty-three out of thirty-four races in the Senate correctly, and called all fifty states correctly in the results for the electoral college.) But in the U.S. these markets have to use play money, because using real money would constitute gambling. The online gambling ban prevents these markets from getting bigger and more accurate.

I favor online betting and believe that there are times when a betting market provides valuable predictions. However, Suroweicke’s article is misleadingly optimistic.

The idea behind betting markets’ accuracy is, roughly, that each individual bettor’s estimate is unbiased, can be viewed as the sum of true value plus mean zero error, and that the errors across bettors are approximately independent. If this property holds, then the error associated with the average estimate across bettors becomes very small as the number of bettors increases.

If betting markets really reflected these assumptions, future events could be predicted as accurately as desired by using the average prediction of a large number of bettors. Suroweicke gives the impression that this possibility is likely. In fact, it is to be expected that it is unlikely, particularly for any prediction where great accuracy is valuable. And Suroweicke’s quoting a few lucky exceptions to the rule does not invalidate that fact.

One problem is that a prerequisite for an accurate prediction to be valuable is that an accurate prediction is not easy, or even possible. Another problem is that bettors prediction characteristics are not characterized by Suroweicke’s implicit estimation assumptions. Moreover, at best, unbiased estimates provide an accurate estimate of the mean. Where there is large volatility around the mean, there is still great uncertainty.

Bettors’ estimates are often biased in the same direction and highly correlated. This does a betting markets’ prediction accuracy in just where prediction accuracy is most valuable.

To drive the ridiculousness of Suroweicke’s optimism home, see if you agree that the following events can be predicted accurately by simply using the average forecast of a large number of forecasters.

Next year’s price of xyz stock.

Next year’s price of a broad stock market index.

Your year of death.

The year New York will suffer a nuclear attack by terrorists.

Tradeoffs: The New York Times denies the obvious

A recent New York Times editorial, “Everyday Low Wages”, blasts Mayor Richard Daley of Chicago for vetoing a plan to force large retailers to pay higher wages and benefits. The editors miss just about every point there is to miss.

Here is the editorial, along with my comments.

Mayor Richard M. Daley of Chicago wielded the first veto of his 17-year tenure this week — and the City Council supported him — striking down Chicago’s short-lived plan to force behemoth retailers like Wal-Mart to pay higher wages and benefits.

In this round, Mr. Daley, the retailers and local Wal-Mart suppliers argued that mandating higher compensation would do more harm than good by driving business and employment opportunities away from low-income neighborhoods.

Every basic microeconomics textbook points out that price controls have a net negative impact on people’s welfare. Mandating higher wages is price control on the price of labor. Mr. Daley, the retailers and local Wal-Mart suppliers are right and the NYT editors are wrong. Strike one for the NYT editors.

But the choice — between no jobs or low-wage jobs — is probably a false one. Wal-Mart and other mega-retailers, like Target and Home Depot, need market share. With suburban areas saturated, cities are the logical places to grow. Wal-Mart especially needs more American consumers, having recently pulled the plug on unsuccessful attempts to expand in Germany and South Korea. It is currently planning to expand in Santa Fe, N.M., where local laws require higher wages than the company normally pays.

Wal-mart and other mega-retailers need market share only if it is profitable. By raising costs, some locations that were profitable become unprofitable. Some jobs that might have been created by Wal-mart, et al, are not. The fact that not all locations where there are mandated higher wages and benefits, such as Santa Fe, become unprofitable does not invalidate the argument. That the NYT editors use this fallacious logic is, unfortunately, not a surprise. Strikes two and three for the NYT editors.

The notion that Wal-mart needs more American consumers, even if they reduce profits, is just silly. Strike five for the NYT editors.

Another argument propounded by Wal-Mart is that paying higher wages would compel the company to raise its prices, hurting low-income consumers. Wage gains do not automatically lead to higher prices. They could be absorbed by higher productivity or by a narrowing of profit margins. Given Wal-Mart’s profits, the company could improve its wage structure and still beat the competition.

In order for a business opportunity that has become unprofitable due to mandated higher wages and benefits to become worthwhile, it must become profitable. That implies higher prices. The fact that higher productivity is possible is irrelevant because that possibility was factored into the original assessment of profitability. Narrowing profit margins is not acceptable for a project that just meets minimum profitability requirements. Strikes six and seven for the NYT editors.

The Chicago ordinance raised legal and technical questions. If Mr. Daley had not wielded the veto, it would surely have faced a court challenge. But proponents of living wages have the moral high ground, and are increasingly finding a political voice. Chicago hasn’t heard the last of them, and Washington hasn’t either.

The moral ground does not go to those who, intending to or not, make things worse. Strike eight for the NYT editors.

It is impressive that the NYT editors can make so many fundamental errors in such a short editorial. The NYT editors have definitely struck out.

Iraq in perspective

Here is a comment by Victor Hanson, a Professor Emeritus at Fresno State University in California and a Senior Fellow at the Hoover Institution at Stanford University.

Thanks to my friend Bob Taubert for sending it to me.

War-torn Iraq has about 26 million residents, a peaceful California perhaps now 35 million. The former is a violent and impoverished landscape, the latter said to be paradise on Earth. But how you envision either place to some degree depends on the eye of the beholder and is predicated on what the daily media appear to make of each.

As a fifth-generation Californian, I deeply love this state, but still imagine what the reaction would be if the world awoke each morning to be told that once again there were six more murders, 27 rapes, 38 arsons, 180 robberies, and 360 instances of assault in California - yesterday, today, tomorrow, and every day. I wonder if the headlines would scream about "Nearly 200 poor Californians butchered again this month!"

How about a monthly media dose of "600 women raped in February alone!"Or try, "Over 600 violent robberies and assaults in March, with no end in sight!" Those do not even make up all of the state's yearly 200,000 violent acts that law enforcement knows about.

Iraq's judicial system seems a mess. On the eve of the war, Saddam let out 100,000 inmates from his vast prison archipelago. He himself still sits in the dock months after his trial began. But imagine an Iraq with a penal system like California's with 170,000 criminals - an inmate population larger than those of Germany, France, the Netherlands, and Singapore combined.

Just to house such a shadow population costs our state nearly $7 billion a year - or about the same price of keeping 40,000 Army personnel per year in Iraq. What would be the image of our Golden State if we were reminded each morning, "Another $20 million spent today on housing our criminals"?

Some of California's most recent prison scandals would be easy to sensationalize: "Guards watch as inmates are raped!" Or "Correction officer accused of having sex with under-aged detainee!" And apropos ofSaddam's sluggish trial, remember that our home state multiple murderer, Tookie Williams, was finally executed in December 2005 - 26 years after he was originally sentenced.

Much is made of the inability to patrol Iraq's borders with Iran, Jordan, Kuwait, Saudi Arabia, Syria, and Turkey. But California has only a single border with a foreign nation, not six. Yet over 3 million foreigners who sneaked in illegally now live in our state. Worse, there are about 15,000 convicted alien felons incarcerated in our penal system, costingAbout $500 million a year. Imagine the potential tabloid headlines: "Illegal aliens in state comprise population larger than San Francisco!" or "Drugs, criminals, and smugglers given free pass into California!"

Every year, over 4,000 Californians die in car crashes - nearly twice the number of Americans lost so far in three years of combat operations in Iraq. In some sense, then, our badly maintained roads, and often poorly trained and sometimes intoxicated drivers, are even more lethal than Improvised Explosive Devices. Perhaps tomorrow's headline might scream out at us: "300 Californians to perish this month on state highways! Hundreds more will be maimed and crippled!"

In 2001, California had 32 days of power outages, despite paying nearly the highest rates for electricity in the United States. Before complaining about the smoke in Baghdad rising from private generators, think back to the run on generators in California when they were contemplated as a future part of every household's line of defense.

We're told that Iraq's finances are a mess. Yet until recently, so wereCalifornia's. Two years ago, Governor Schwarzenegger inherited a $38 billion annual budget shortfall. That could have made for strong morning newscast teasers: "Another $100 million borrowed today - $3 billion more in red ink to pile up by month's end!"

So is California comparable to Iraq? Hardly. Yet it could easily be sketched by a reporter intent on doing so as a bankrupt, crime-ridden den with murderous highways, tens of thousands of inmates, with wide-open borders.

I myself recently returned home to California, without incident, from a visit to Iraq's notorious Sunni Triangle. While I was gone, a drug-addicted criminal with a long list of convictions broke into our kitchen at 4 a.m., was surprised by my wife and daughter, and fled withour credit cards, cash, keys, and cell phones.

Sometimes I wonder who really was safer that week.

The New York Times misses several points but gets one right

In a recent editorial “Cashing Their Chips”, the NYT’s editors discussed Intel in the context of the American Jobs Creation Act.

This week, Intel announced that it would be cutting 10,500 jobs, or about 10 percent of its work force. The company’s chief executive, Paul Otellini, said that while it was a difficult decision, the move was “essential to Intel becoming a more agile and efficient company.”

That kind of cutback is par for the course in today’s business environment. What’s notable about it is that Intel was also one of the major corporations that took advantage of the American Jobs Creation Act (AJCA), a one-year tax holiday for American businesses operating overseas that lawmakers claimed was going to act as an engine for job growth. By reducing taxes on repatriated profits, it was supposed to generate cash for companies to use in underwriting new hiring at home.

In reality, it was little more than a multibillion-dollar giveaway. Intel repatriated $6.2 billion under the program, which taxed foreign profits at a rate of just 5.25 percent, compared with the normal rate of 35 percent. Now, instead of creating new jobs, it is cutting existing ones.

The NYT wants you to believe that the AJCA failed to create US jobs. But the fact that one company, Intel, cut US jobs after taking advantage of the tax break implies nothing about whether the AJCA created US jobs in the aggregate. Nor does the NYT appear to understand that if the AJCA caused Intel to cut fewer US jobs, then the AJCA created US jobs. In other words, the NYT’s editors didn’t even know how to think about the issue.

It is not clear to me why a firm that is able to bring back overseas money with less taxes will want to use that money for US job creation. Giving credit to the NYT, they did point this out. However, the NYT missed all the subtleties. Less money paid to Government means more money to do other things. If the extra money is distributed to shareholders, then shareholders have more money and spend it. If the extra money is sent back overseas and creates overseas jobs, well, what are the overseas payees going to do with their dollars? They will spend them, and the dollars will end up buying US goods. That, presumably, requires US jobs to create the additional goods that are bought. No matter what alternative you consider, it is likely that more jobs of a more useful kind are created (because governments spend too much money and spend it inefficiently).

On the other hand, the NYT might rightfully respond to me that no matter how the tax system is modified, the total tax bill will remain the same. In which case, the NYT might say, I missed some of the subtleties, at least if I hadn’t included this paragraph. But then, the issue is pretty much moot and the editorial was superfluous.

However, the NYT’s editorial was right on one point.

The moral is this: Businesses will slash jobs when they deem it wise and build plants when they think it’s cost effective. All the Jobs Creation Act accomplished was to hand companies a nice little present with a big, fat price tag and a misleading name.

Businesses do make decisions based on profitability, not unrelated tax breaks. However, even here, the NYT’s editors could not resist letting their emotions get the better of them. The AJCA does not have a big, fat price tag. Government taxes are the big, fat price tag, not tax cuts.

More incompetent media economic analysis

The media’s comments about the economic data from the Census Bureau have been mostly negative, despite that the median household income in 2005 rose slightly in real terms. The major media complaints have been remarkably uniform. For example, a recent Palm Beach Post editorial complained as follows.

The stories behind the numbers are nothing to celebrate. The meager 1.1 percent rise in family income, to $46,326, is the first increase since 1999, but it didn't come from higher wages. The rise came because 23 million households headed by someone 65 or older are doing better with investments and retirement income. Such numbers are hardly the vital signs of an overall healthy economy. In Florida, many households are keeping inflation at bay only because more family members are working longer hours or holding second jobs. Last year, salaries for full-time working men and women declined. Again.

It is increases in wealth that count. Wages are only one source of wealth increases. Disparaging other sources of income and profit is silly.

Many households headed by someone under 65 benefited from (1) income and profit on tax deferred investments, which is not included in these households’ reported income and (2) tax deferred contributions to retirement plans, also not reported as income. The Underground Economy is not included either, and that is rampant in Florida.

In South Florida, the number of people living in poverty increased by about 50,000. Driven by tourism and the robust service industry, the state again leads the nation in job creation, and registered an enviable 3.5 percent unemployment rate - but don't ask what those new jobs pay.

Erstwhile unemployed workers are better off with jobs than without them. Thus, the economy has improved.

Job creation implies that more people are working. Presumably, the comment “but don’t ask what those new jobs pay” means that the new jobs don’t pay much. All else equal, if some unemployed workers become employed at low level jobs, the percentage of low paying jobs (e.g., below the poverty level) increases, there is no change in the median income level (which lies well above the poverty level), and there is a decline in the average income level. As the old adage says, “figures don’t lie, but liars (and editors) figure”.

The number of Floridians without health insurance rose to 19.6 percent, well above the national average of 15.9 percent; only Texas (24.6 percent) and New Mexico (21.1 percent) are worse. Most of the job creation Gov. Bush likes to crow about comes without benefits or career possibilities. Don't get sick and don't count on a future.

With respect to lack of health insurance, there are many sources of free health care. For example, many hospitals are required to provide emergency room treatment regardless of patients’ ability to pay. The percentage of people without health insurance overstates the percentage of people who cannot obtain adequate health care.

Complaining about the type of job creation and linking it to career possibilities misses some points that invalidate the complaint.

Most workers move through a life cycle, as Thomas Sowell has discussed endlessly. They start at low paying jobs (including currently highly paid editors) and move up the pay scale. Many of those currently with incomes below the poverty level are young and will move to higher income levels as they age.

A better indication of how the economy is doing is the implied time average income of workers over their working lives. The low end of this measure is far higher than the low end of the point in time income distribution. Yet, it the latter that the media focuses on. Perhaps it is an unreasonable to expect the media to do otherwise; that would take some economic insight.

Low unemployment rates mean less if the nation gets there with low-quality jobs.

I can accept this statement. But it does not imply that low-quality jobs are worse than no jobs and that those who take low-quality jobs never move up the income ladder.

A final point. Cost of living indicators are biased in a manner that understates standard of living improvements. Today, even those with incomes below the poverty level live far better lives than their corresponding cohort did in the past. That is, in part, because the huge price declines in technological products are not reflected accurately in cost of living statistics. Today, for example, even “poor” people have cell phones, TVs, etc. They also have access to far more effective medical care, even without health insurance.

A colleague of mine, Jason Greene notes that:

In an economy in which there is an increasing proportion of households in which there are two wage earners, health insurance for one of those wage earners might be unnecessary. For example, if I am employed in a position in which I have family health care coverage at a reasonable cost, my spouse has the luxury of seeking employment in a job that she likes, but which does not offer health insurance. I believe that she would be counted among the workers without health insurance, since these surveys usually do not account for the entire picture. Thus, I expect the under insurance problem is overstated.

More polluted California law

An article in the New York Times, “California Builders Fight Air Pollution Fee”, by Carolyn Marshall, is another example of polluted California law.

According to the article:

The fees are part of a new regulation by the San Joaquin Valley Air Pollution Control District requiring builders of commercial and residential projects to use energy-saving technology and traffic-reduction features in their projects. The rule requires payment into a fund for pollution control. The idea is to make developers more accountable for the explosion in traffic and emissions that typically accompany building.

The ultimate cause of pollution and traffic is people, not builders. By charging builders, all those who do not live in new homes escape the fees, even though they are responsible for just as much, and often more, per capita pollution and traffic. Older homes also experience a one-time positive relative price change.

If people are the cause, isn’t it more sensible to charge people? On the other hand, existing people are not responsible for being born; their parents are. Shouldn’t parents be charged to have children (sorry, I couldn’t resist)? Alternatively, shouldn’t polluters be charged for the amount of pollution they produce?

Requiring specific energy-saving technology doesn’t make sense, either. If too much energy is being consumed, raising energy prices will reduce consumption by the same amount but in a way that leaves people better off, on average (marginal benefit equal to marginal cost).

Of course, who is to say what price should be charged for pollution or that too much energy is being consumed or that too many babies are being born? Certainly not the environmental activists. On the other hand, if it is me, fine.

U. S. Representative Robert Wexler on the Medicare D “Doughnut Hole”. Spin or dumbth?

Wexler’s article, “’Doughnut hole’ a black hole for seniors; allow Medicare to negotiate drug prices” was published in the Palm Beach Post. Here are some excerpts with my comments.

After being rushed by the Bush administration to sign up for a drug plan under Medicare Part D and avoid paying stiff penalties, an estimated 7 million seniors are receiving a rude awakening as they find themselves plummeting into an abyss of prescription-drug non-coverage known as the "doughnut hole."

This carefully crafted clause in the Part D program is nothing more than a large gap in drug coverage that occurs between $2,250 and $5,100, where seniors and the disabled are required to pay 100 percent of their prescription-drug costs . . .

You receive a rude awakening if something is a surprise. The doughnut hole was not a surprise.

Presumably, those who signed up for Medicare D did so because it was an improvement over alternatives, even with the doughnut hole.

Many who signed up have a low probability of reaching the doughnut hole. For these people, Medicare D with the doughnut hole is a far better alternative than it would be if it did not have the doughnut hole. Why? Because they aren’t forced to buy doughnut hole coverage they don’t want or need.

Others who signed up have excessive drug costs and will go far beyond the doughnut hole. Their total drug cost will be lower with Medicare D than with alternatives.

The fact is that Medicare D is an improvement for every rational person that signed up, not a disaster.

President Bush and Republicans in Congress, in cooperation with the pharmaceutical and insurance industries, devised a flawed program that conveniently omits benefits for beneficiaries when they need it the most.

Mr. Wexler’s rhetoric is good, but his logic leaves much to be desired.

Some of those who need it most are those whose drug costs far exceed the doughnut hole range. These people are far better off with the superb coverage beyond the doughnut hole range and the doughnut hole than they would be without the doughnut hole and no extensive coverage beyond it.

Less obvious is the fact that those who need drugs the most often do not reach the doughnut hole range. Equating need with total cost is fallacious. You can save a life on $100 monthly.

This goes against the principle of what it means to be insured. Usually, the purpose of insurance is to protect individuals against large losses; contrarily, the Medicare Part D doughnut nut hole leaves seniors completely unprotected, facing skyrocketing prescription-drug costs that they cannot afford.

Great spin, but only spin.

The insurance principle is to spread the cost across a suitable cohort for those who find the tradeoff between average cost certain versus probability distribution of loss and risk aversion favorable. No rational person wants too pay for too much insurance.

The fact that Medicare D has a doughnut hole is not the same as leaving seniors completely unprotected. What would be leaving seniors completely unprotected would be no Medicare D and no alternatives. That is not the case.

With respect to affordability, there is a negligible chance that people who define affordable as below cost (as many of the complainers do) will ever find a sensible Medicare drug program affordable.

The argument made by proponents of the Republican prescription-drug program is that the doughnut hole was necessary to keep the cost of the program down and save taxpayers money. In fact, the only effects resulting from the doughnut hole are huge windfalls for pharmaceutical companies and inadequate drug coverage for millions of seniors. Ironically, according to a recent report issued by the Center for Economic and Policy Research, if Medicare had been allowed to bargain directly with pharmaceutical companies - as is currently done by the Veterans Administration and state Medicaid programs - the savings would be more than twice the size of the doughnut hole. Direct bargaining by Medicare with pharmaceutical companies would completely eliminate the doughnut hole, in addition to providing substantial savings for the federal and state governments.

Mr. Wexler is pulling a bait and switch.

The current style of program would cost more without the doughnut hole.

Direct bargaining would change the program by slowing the development of new drugs. Cheaper drugs lead to less effective drugs over time, because pharmaceutical companies will slow development of new drugs if their profitability is reduced. There is no free lunch, no matter what Mr. Wexler says.

Those who are griping about the high cost of newer drugs can put themselves into Mr. Wexler’s world by simply refusing to buy any drug developed more recently than, say, twenty years ago. These generically available drugs are cheap. You will never reach the doughnut hole by buying them.

Don’t blame me; blame Charles Wilder

My friend Charles Wilder doesn’t want to be blamed either, because someone sent it to him.

1. A bicycle can't stand alone; it is two tired.
2. A will is a dead giveaway.
3. Time flies like an arrow; fruit flies like a banana.
4. A backward poet writes inverse.
5. In a democracy it's your vote that counts; in feudalism, it's your Count that votes.
6. A chicken crossing the road: poultry in motion.
7. If you don't pay your exorcist you may be repossessed.
8. With her marriage she got a new name and a dress.
9. Show me a piano falling down a mine shaft and I'll show you A-flat miner.
10. When a clock is hungry it goes back four seconds.
11. The guy who fell onto an upholstery machine was fully recovered.
12. A grenade fell onto a kitchen floor in France resulting in Linoleum Blownapart.
13. You are stuck with your debt if you can't budge it.
14. Local Area Network in Australia: The LAN down under.
15. He broke into song because he couldn't find the key.
16. A calendar's days are numbered.
17. A lot of money is tainted: 'Taint yours, and 'taint mine’.
18. A boiled egg is hard to beat.
19. He had a photographic memory which was never developed.
20. A plateau is a high form of flattery.
21. The short fortuneteller who escaped from prison: a small medium at large.
22. Those who get too big for their britches will be exposed in the end.
23. When you've seen one shopping center you've seen a mall.
24. If you jump off a Paris bridge, you are in Seine.
25. When she saw her first strands of gray hair, she thought she'd dye.
26. Bakers trade bread recipes on a knead to know basis.
27. Santa's helpers are subordinate clauses.
28. Acupuncture: a jab well done.
29. Marathon runners with bad shoes suffer the agony of de feet.

Hurricanes: Forecasting and insurance

A recent article in the Sunday New York Times, “Researchers Lower Estimate of Hurricanes This Season”, provides perspective on how little credence the media, politicians, and environmental activists deserve when they confidently forecast either doom or the absence thereof.

Forecasts of the number and intensity of hurricanes on a one-year basis are not accurate and cannot expected to be accurate. Neither are forecasts for several years very accurate.

Hurricanes, in a particular part of the country, such as Florida, are not insurable, i.e., the total loss cannot be reliably predicted for one year or several years.

It may be that hurricanes are not even insurable in the aggregate, at least for time intervals of several years. This is because they are too few in number to average out over only a few years.

The worst hurricanes may not be insurable over any reasonable time interval. By definition, such hurricanes are the worst storms. That means they are low probability events. Trying to average out events drawn from the extreme right tail of a probability distribution takes a lot of draws and the volatility is enormous.

One implication is that hurricane insurance losses cannot be forecast very accurately and insurance companies that charge what the media, politicians, and consumers view as fair hurricane insurance premiums are likely to money.

The same perspective applies to predicting and insuring against most low probability events.

Reinsurance works only if you don’t go too far into the right tail of the probability distribution.

Here are some excerpts from the New York Times article.

Hurricane researchers at Colorado State University predicted Thursday that this year’s hurricane season would not be as bad as their earlier forecast had indicated, and they said a monster storm like Hurricane Katrina was unlikely.

In December, the researchers predicted nine hurricanes, five of them intense. On Thursday, they reduced those numbers to seven and three.

“Moreover,” they said, “these forecasts do not specifically predict where within the Atlantic Basin these storms will strike.”

Minimum wage laws

To make things simple, assume no inflation, fixed technology, and employers that always employ labor with a specified skill set up to the point where the cost of an additional worker equals the benefit (e.g., incremental profit). Then raising the minimum wage will cost the lowest end workers their jobs. If this case is realistic, then advocates of increased minimum wages hurt the people they are, ostensibly, trying to help.

The same conclusion holds if there is inflation as long as the minimum wage increase is specified in real terms.

Although this characterization is somewhat simplified, the history of increases in the minimum wage suggests a substantial increase in the unemployment rate over time, which has not been observed.

Abstracting from changing skill sets and improvements in technology, one reason could be that the real minimum wage has not trended up over time.

A useful perspective is that microeconomic equilibrium is tied to relative prices, not absolute prices. Roughly, if the minimum wage is doubled and the result is a 100% one time inflation, then the same equilibrium could hold in real terms, including no change in the unemployment rate.

While this analysis is a bit simplified, it suggests that most of the minimum wage discussions you hear are, at best, misguided and perhaps intellectually dishonest.

Here is an example from a recent Palm Beach Post editorial.

The case for the wage increase is compelling and shouldn't be burdened by political opportunism. Workers who earn the current minimum of $5.15 an hour, less than $11,000 a year, fall far below the poverty line. About 36 million Americans - roughly one in eight of us - live in poverty, a quiet disgrace. Congress hasn't raised the minimum wage in nine years, but lawmakers have given themselves $35,000 in raises during the same period. Think of how costs of living have risen since 1997 - what it was like to go to the supermarket midway through the Clinton administration and what it's like now - and the idea of a minimum wage frozen at $5.15 an hour seems absurdly unfair. Congress has neglected the raise for so long that many states have done it on their own, including Florida, which increased it to $6.40 through constitutional amendment.

One gathers from this editorial that those earning less than the proposed new minimum wage would earn the new, higher, minimum wage, i.e., no jobs would be lost. Furthermore, it seems that the editor presumes that there would be a corresponding permanent increase in these workers’ real wage. If this perspective is accurate, then it is easy to make us all rich, in real terms, by raising the minimum wage to, say, $1000 per hour.

As you can see, most of what you read about minimum wages is BS.

The housing market: The New York Times makes me laugh again

Vikas Bajaj and David Leonhardt have an article in the New York Times, “Housing Slows, Taking Big Toll on the Economy”. It is not a bad article (by NYT’s standards), but it has a few humorous bloopers. Here are a few of them.

The housing slowdown is perhaps the clearest effect of the Federal Reserve’s two-year campaign of raising interest rates in a bid to tap the brakes on the economy and reduce inflation.

The role of overbuilding and excessive speculation, in other words the fact that the housing market has been experiencing a large bubble is, of course, only a minor, ignorable factor. Perhaps Bajaj and Leonhardt should read up on the tulip craze.

The biggest risk, economists say, is that the optimism that fed the real-estate boom will reverse dramatically.

Wait a minute, I thought you just finished blaming interest rates. Was there a real-estate boom or not? If there was, do we need higher interest rates to end it or do bubble markets sometimes just crash on their own?

For much of the last five years, housing — along with health care — was also one of the only reliable generators of jobs. From the start of 2001, when the Fed began cutting its benchmark rate to steady a faltering economy, until early last year, the housing sector added 1.1 million jobs.

The rest of economy lost 1.2 million jobs over the same period, according to an analysis by Moody’s Economy.com.

There are a limited number of workers, hence a limited number of jobs. If demand increases in one sector relative to another and workers move to that sector, wouldn’t jobs in the other sector have to decline? Does that imply that if the first sector’s demand had not increased that the second sector’s jobs would still have decreased?

The situation is somewhat different elsewhere. An official at the International Union of Bricklayers and Allied Craftworkers said housing work was more difficult to find, but most of its members had been able to find work on commercial building sites.

“If something were to happen with both markets, that would affect us — and everybody for that matter,” said Robert A. Fozio, director of the union’s Northern Ohio district.

Yes indeed. Resources could then be devoted to things that are not in relative oversupply. We would be better off.

Tradeoffs: Subsidized housing is a waste of money

Every so often you hear of a project, often funded or subsidized with tax money, for building low cost homes and selling them to low income families at bargain prices. Bargain prices means below fair market value.

According to the Miami Herald’s ongoing investigative report, one such project was gamed by non-low income people. They bought the houses at the below market prices and flipped them at a profit. Naturally, the Herald is upset at this. But the Herald failed to appreciate reality. As in hurricane disaster relief and low income housing, much of the benefit intended to go to people in need does not go there and this is a pervasive problem that is not likely to be eliminated.

The far more important issue, which the Herald missed completely, is that these kind of projects are inherently inefficient. Providing housing to low income people is, necessarily, a waste of money even if the housing does go to low income people.

To see why consider two alternatives. First, that a house worth $100,000 is provided to a low income family at a price of $80,000. Also assume that the house costs $80,000 to build. That means that the family has been given a gift of $20,000. Second, consider giving the family $20,000 to do with as they please.

In the second case, the family can spend the $20,000 in whatever manner makes them happiest. In the first case, they are forced to spend the $20,000 on housing.

There are two possibilities, either housing is the family’s optimal use for the $20,000 or it is not. For some families the optimal use for the $20,000 will not be housing, or at least not all for housing. These families could be made happier by giving them $20,000, not a discounted house. Families where the optimal use of the $20,000 is the house would be no worse off receiving $20,000. They could still buy the equivalent house.

The moral of the story is that gifts with strings attached are not as valuable as gifts without strings attached.

The basis for this moral is the mathematical fact that maximizing a function with constraints yields a result that is, at most, as great as maximizing a function without the constraints.

Freakonomics author Steven Levitt: Incompetent? Unethical?

Steven Levitt (along with Donohue), the well known economist author (along with Dubner) of Freakonomics, advocated the theory that the advent of legalized abortion in the 1970s is responsible for much of the steep and persistent drop in the crime rate during the 1990s. The research behind this claim was a paper by Donohue and Levitt. However, as Foote and Goetz [2005] showed, it turned out to be wrong.

Donohue’s and Levitt’s mistake is so elementary as to suggest incompetence or the intent to mislead. These two possibilities also are consistent with Donohue’s and Levitt’s criticism of John Lott’s research showing that allowing honest citizens to carry concealed weapons reduces violent crime.

Donohue has written copiously on Lott’s work, all of it negatively. However, as Plassman and Whitney show in their Stanford Law Review article “Confirming More Guns Less Crime”, Ayres and Donohue’s work appears to be substandard, including statistical errors and claims not supported by the data. Moreover, Donohue has continued to make negative claims in the face of several papers pointing out his errors. Here, too, the mistakes and continued apparently incorrect claims are so elementary and pervasive as to suggest incompetence or the intent to mislead.

Levitt has taken up Donohue’s cudgel and attacked Lott in Freakonomics, saying:

Then there was the troubling allegation that Lott actually invented some of the survey data that supports his more-guns/less-crime theory. Regardless of whether the data were faked, Lott’s admittedly intriguing hypothesis doesn’t seem to be true. When other scholars have tried to replicate his results, they found that right-to-carry laws simply don’t bring down crime.

In fact, Lott’s results have been replicated and supported by other researchers. This was known in the field. Indeed one researcher sent the following email to Levitt.

I also found the following citations – have not read any of them yet, but it appears they all replicate Lott’s research.

Levitt’s response was:

It was not a peer refereed edition of the Journal. For $15,000 he was able to buy an issue and put in only work that supported him. My best friend was the editor and was outraged the press let Lott do this.

Levitt’s response misstated the facts.

It seems that Levitt now has a record on at least two important issues, abortions and guns. In both cases he has confidently and repeatedly espoused a position that is probably wrong and that he should have known was probably wrong. In one case, he has compounded the error by apparently acting unethically, i.e., by possibly libeling a competent researcher in lieu of admitting his own likely mistake.

Here is Foote and Goetz’s abstract.

State‐level data are often used in the empirical research of both macroeconomists and microeconomists. Using data that follows states over time allows economists to hold constant a host of potentially confounding factors that might contaminate an assignment of cause and effect. A good example is a fascinating paper by Donohue and Levitt (2001, henceforth DL), which purports to show that hypothetical individuals resulting from aborted fetuses, had they been born and developed into youths, would have been more likely to commit crimes than youths resulting from fetuses carried to term. We revisit that paper, showing that the actual implementation of DL’s statistical test in their paper differed from what was described. (Specifically, controls for state‐year effects were left out of their regression model. ) We show that when DL’s key test is run as described and augmented with state‐level population data, evidence for higher per capita criminal propensities among the youths who would have developed, had they not been aborted as fetuses, vanishes. Two lessons for empirical researchers are, first, that controls may impact results in ways that are hard to predict, and second, that these controls are probably not powerful enough to compensate for the omission of a key variable in the regression model.

Here is the abstract from Ayres’s and Donohue’s paper “Shooting Down the More Guns, Less Crime Hypothesis”.

John Lott and David Mustard have used regression analysis to argue forcefully that “shall issue” laws (which give citizens an unimpeded right to secure permits for concealed weapons) reduce violent crime. This article shows that the claim has support from certain facially plausible statistical models, but that these are rejected by a variety of statistical tests. Estimating more statistically preferred disaggregated models on more complete data, we show that in most states shall issue laws have been associated with more crime. Using our expanded data set and our preferred jurisdiction-specific regression model, we show that more states have experienced an upturn in crime than have experienced a downturn in crime after enacting the law and that the apparent stimulus to crime tends to be especially strong for those states that adopted in the last decade. We estimate that on net the passage of the law in 24 jurisdictions has increased the annual cost of crime somewhere on the order of half a billion dollars. We also provide an illustration of how our jurisdiction-specific regression model has the capacity to generate more nuanced assessments concerning which states might profit from a particular legal intervention.

Here is an excerpt from the introduction to Plassman’s and Whitney’s Stanford Law Review article “Confirming More Guns Less Crime”.

Quite a few empirical papers have examined the impact of right-to-carry laws on crime rates. Most studies have found significant benefits, with some finding reductions in murder rates twice as large as the original research. Even the critics did not provide evidence that such laws have increased violent crime, accidental gun deaths, or suicides.

Unlike previous authors, Ian Ayres and John Donohue claim to have found significant evidence that right-to-carry laws increased crime. However, they have misread their own results. The most detailed results they report. following the change in crime rates on a year-by-year basis before and after right-to-carry laws were adopted.clearly show large drops in violent crime that occur immediately after the laws were adopted. Their hybrid results showing a small increase in crime immediately after passage are not statistically significant and are an artifact of fitting a straight line to a curved one. When one examines a longer period.from 1977 to 2000.even this type of result disappears.

Ayres and Donohue.s efforts have been valuable in forcing others to reexamine the evidence, extend the dataset over more years, and think of new ways to test hypotheses, and we appreciate their efforts. They are both highly regarded and well-known for their research, such as claiming that the legalization of abortion can account for half the drop in murder during the 1990s. Unfortunately, their research on this issue inaccurately describes the literature and also fails to address previous critiques of their work. For example, Ayres and Donohue claim that "[w]hen we added five years of county data and seven years of state data, allowing us to test an additional fourteen jurisdictions that adopted shall-issue laws, the previous Lott and Mustard findings proved not to be robust". All their tables report results for "Lott's Time Period (1977-1992)" and compare those estimates with the "Entire Period (1977-1997)". Yet, whatever differences in results arise, they are not due to the inclusion of more data for a longer period. Their paper gives a misleading impression as to how much their research extends the data period, since Lott's book and other work examined both the county and state data up through 1996. Ayres and Donohue's work thus extends the county-level data by one year, from twenty to twenty-one years.

STATS on PCBs in salmon: The media, activists, and others are wrong again

STATS is a non-profit, non-partisan Statistical Assessment Service (STATS) that provides perspective on the use and abuse of science and statistics in the media. Its latest assessment on the risk of PCBs in farmed salmon shows that the media, activists, and others are, once again, just plain wrong.

Here is the introductory STATS article. The entire report can be found here.

The evidence in favor of eating fish rich in omega-3 fatty acids, such as salmon and trout, keeps on mounting. On July 10, the Archives of Opthalmology published a new study showing evidence that these acids reduced the risk of macular degeneration. The association isn't backed by clear evidence of a causal mechanism, but it builds on earlier research which found similar correlations. As the Seattle Post Intelligencer reported, "if you are still balancing the risks of and benefits of eating fish, stop. There is no contest."

And then the very next day, the PI sort of backtracked by warning that the risk of cancer from PCBs in salmon needed to be taken into account:

" there is another side to this story. As we've reported when we took on the matter of contaminants in salmon here, the calculus for any individual consumer needs to be, well, individual."

"For example, cancer tends to get my people, so PCBs in salmon are something to be concerned about because PCBs promote cancer. My wife's forebears, on the other hand, tend to kick the bucket while clutching their hearts. So the dilemma for us is: how can she get the omega 3s -- "W-D 40 for the brain," according to this wide-ranging and worthwhile what-you-should-eat piece in yesterday's Vancouver Sun -- while I avoid the PCBs? "

Click on "here" and you are taken right back to the study that launched a global health scare: Hites et al. And it's not just the Seattle Post Intelligencer. The New York Times Dining Section warned readersin March that "studies have shown that salmon farms can pollute the waters around them with their waste and the fish can contain dangerous levels of contaminants like PCB's and dioxin."

"Consumer Reports' August issue also advises readers to buy wild Alaskan salmon because farmed salmon may contain higher levels of PCBs. Actually, a brace of studies have shown the opposite to be true - not that it matters either way, the levels being so low in both wild and farmed fish, and radically diminished after cooking and removing the skin. "

In fact, even if you accept the worst-case scenario of the fish-scare mongers, the U.S. public is at much, much greater risk for injury and death from falling television sets. Really. Which, when added to what the media missed when they covered the publication of Hites et al. two years ago, is another reason to consider the sight-enhancing benefits of eating salmon.

Time magazine on the Israeli-Arab conflict: Mistaking words for solutions

Time magazine has an article, “6 Keys to Peace” by Michael Elliott that illustrate how fatuous and vacuous are journalists’ “solutions” to the Israeli-Arab conflict.

• 
  The problems with pundits like Mr. Elliott include:
• 
  Proposing “solutions” that don’t solve the problem.
• 
  Proposing solutions that cannot be implemented.
• 
  Representing goals as solutions, with no workable proposals for reaching the goals.
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  Representing prerequisites for a solution as the solution.
• 
  Representing assertions as fact.

Here are some excerpts from the article that illustrate some of these points, along with my comments.

1 GET THE U.S. INVOLVED

Washington can talk to the Israelis and, occasionally, convince them that their best interests require them to talk to those whose motives and behavior they despise.

Point 1 is fatuous and the discussion is vacuous.

What if the motives and behavior between the two parties are incompatible and cannot be changed by discussion? What if substantial violence and bloodshed are a prerequisite for changing the motives and behavior? What if there is no way to change the motives and behavior, except by forcibly eliminating them?

2 DON'T FORGET THE PALESTINIANS

For the Arab states, it is axiomatic that a second key for curing the ills that have plagued the region is peace between Israel and the Palestinians.

Point 2 is fatuous and the discussion is vacuous.

Peace is a goal, not a solution. Mr. Elliott has adopted the approach that the way to cure the problem is to cure the problem.

There is little disagreement among states in the region or outside it about what an ideal peace between Israel and the Palestinians would involve. Since before World War II, most reasonable observers have known that sooner or later, two states--one with a Jewish majority, one with an Arab one--would share the land between the Jordan River and the Mediterranean.

Israel has seen suicide bombers flock to its cities from the West Bank and watched rockets sail into its towns from Gaza and Lebanon, areas from which it had withdrawn all its soldiers--in the case of Lebanon, a full six years ago. Within that context, it isn't the details of a two-state solution that matter now; it is something much more elemental. Israel needs to know that in any deal with the Palestinians, its people will be safe.

Suppose it is correct that two-states is a prerequisite, along with safety for Israel. How is it to be achieved? Mr. Elliott leaves this out.

Prerequisites for a solution are neither a solution nor the means of achieving one.

3 GUARANTEE ISRAEL'S SECURITY

THE THIRD KEY TO PEACE is to find a way to convince Israelis that they and their children can sleep easy at night.

Point 3 is fatuous and the discussion is vacuous.

This may be a prerequisite for a solution, but is not a solution. Mr. Elliott provides no basis for thinking that it is even possible.

4 STABILIZE LEBANON

the fourth key to peace is to stabilize Lebanon. In part, that means propping up the fragile government of technocrats led by Fouad Siniora and pumping donors to help Lebanon rebuild itself

But it also means ensuring that Hizballah can no longer use its strongholds in the south to threaten regional peace.

Point 4 is fatuous and the discussion is vacuous.

How? Mr. Elliott has no practical suggestions for stabilizing Lebanon or preventing Hizballah from threatening regional peace.

Mr. Elliott’s approach to the oil problem might be to find a way to burn water.

5 HANDLE IRAN

European officials talk of a "constructive dialogue" with Tehran that involves recognizing it as an important regional power while maintaining the right to sanction it if it breaks the nuclear rules. But Israel--along with many supporters in the U.S.--thinks dialogue with a nation whose leader has said that Israel "must be wiped off the map" is a waste of breath.

Point 5 is fatuous and the discussion is vacuous.

In other words, nobody can agree on how to handle Iran. Mr. Elliott’s approach is to tell us what people think, which is not a solution.

THERE IS, FINALLY, THE MATTER OF IRAQ.

Yes indeed, there is Iraq, where, clearly, everybody knows the solution. Unfortunately everybody’s solution is different from everybody else’s.

The Miami Herald's bad logic, bad statistics, and possible contribution to a higher death rate

The 7/16/06 Miami Herald has an editorial on air cargo safety. It follows “A Miami Herald investigative series last week -- Deadly Express by Ronnie Greene” that “described the air-cargo industry's troubled history.”

Both the investigative series and the editorial show a lack of understanding of flight safety and statistics. The scare language in both is not supported by the quoted statistics, most of the relevant characterizations about flight safety and who is responsible for it are incorrect, and there is a failure to address relevant tradeoffs.

Once again, the print media has shown that it can write well but is unable to refrain from writing about topics it does not understand.

Here are some excerpts from the editorial, along with my comments.

Air cargo service in America is like a ticking time bomb. One day a cargo plane -- with an exhausted pilot or mechanical problem -- will crash into a crowded mall or school and kill scores of people. The Federal Aviation Administration mustn't wait for such a tragedy to jump-start it into action.

This kind of statement is characteristic of the investigative report and the editorial. Slim possibilities are blown out of proportion and presented as emergencies.

It is virtually certain that, sooner or later, a mall or school crash will occur and kill scores (“Scores” means large numbers) of people. It also is virtually certain, assuming that the Miami Herald remains in business, that one of its delivery trucks will eventually crash into a group of grade school children, somewhere, killing scores of them. We can eliminate this possibility by closing down the Miami Herald.

What counts is the probability of such an air cargo crash and the cost of reducing it, not that such a crash is possible. The editorial’s own statistics suggest that the probability is small enough so that saving lives with scarce resources warrants using those resources elsewhere.

Given air cargo's track record -- one fatal crash per month on average since 2000 -- the FAA should tighten the industry's safety rules and oversight now, particularly for small cargo carriers that have the worst accident rates.

Air cargo is the deadliest segment of commercial aviation. Sixty-nine fatal crashes since 2000 have taken 85 lives.

The editorial fails to note the large number of air cargo flights. Nor does it strike the editor that sixty-nine fatal crashes since 2000 taking 85 lives implies a very low number of fatal crashes per year and a fatality rate of less than 2 per crash. This fatality rate per crash probably is far lower than for cars, bicycles, boating, etc.

The data implies an average fatality rate of less than 2 per fatal crash. This suggests the probability of crashing into a crowded mall or school and killing scores is very small. Why didn’t the Editor point this out? Two possibilities are that the Editor didn’t realize it and that the Editor did realize it but decided objectivity doesn’t sell enough papers. Neither possibility reflects well on the Editor or the Miami Herald.

Given air cargo's track record -- one fatal crash per month on average since 2000 -- the FAA should tighten the industry's safety rules and oversight now, particularly for small cargo carriers that have the worst accident rates.

Isn’t it true that the smallest air cargo carriers can be expected to have the lowest fatality rates per fatal crash? It might make sense (why might it not?) to spend more money on preventing airline crashes, where the fatality rate per fatal crash is often in the hundreds. What is the number of fatalities per year from the airlines? Is it higher than from air cargo? Where is the cost-benefit discussion?

The industry is hampered by aging planes, tight deadlines and overnight flights. Pilots fly under extreme pressure to meet tough deadlines. Many get paid only after the delivery.

Pilots often fly in hazardous weather, sometimes without enough sleep. Many fly planes that have mechanical problems, which is unthinkable in passenger flights.

Despite the problems, fewer FAA safety rules apply to cargo planes than passenger planes. For example, cargo pilots can fly 40 percent more hours per year; they are not required to have eight hours' rest 24 hours prior to a flight, as are passenger pilots. Small cargo planes aren't required to have ''black boxes'' that help determine the cause of a crash and can lead to safety improvements.

Old planes taken proper care of are safe. Overnight flights are safe and are common in airline schedules. Pilots are usually under pressure to meet deadlines, air cargo and airlines.

Pilots do not often fly in hazardous weather. They do often fly in weather. Very few pilots, air cargo or otherwise fly with mechanical problems that are serious. FAA regulations already prohibit such flying.

Perhaps FAA safety rules should be less restrictive for air cargo, because the consequences are less serious and the cost/benefit ratio favors less restrictive rules. Black boxes are desirable, but are they worth the cost?

Lax enforcement only worsens safety concerns for cargo carriers. In many cases, the FAA allows cargo firms to continue flying despite egregious maintenance lapses and crash histories. For example, the FAA has yet to ground one firm with four crashes involving seven deaths since 2002. That Ohio firm, Grand Aire Express, and its affiliate TriCoastal Air Inc. have had three dozen accidents or incidents since the 1980s, according to FAA records.

In 2000, the FAA fined Grand Aire $290,000 for operating a plane for 20 days without repairing a known problem and for other maintenance failures. Yet the companies continue to fly and accidents continue to happen. The latest crash took a pilot's life in February.

Remember the Chicago airline crash where an engine fell off on takeoff? That was due to two things. First, improper maintenance procedures. Second, pilot training that called for procedures that were inappropriate for the loss of an engine (as opposed to loss of an engine’s power). Did the FAA shut down the airline? Does the Herald’s Editor think the airline should have been shut down? That single, avoidable, crash killed more people than the sum total of air cargo fatalities, 85, quoted in the Herald’s editorial.

Grand Aire Express and TriCoastal do sound bad, and they may be. However, Luck plays a role, too. What is the probability that one properly run air cargo firm would suffer this kind of record from bad luck? What is the probability that at least one air cargo firm among many would suffer this kind of record from bad luck? I haven’t done the analysis, but neither has the Herald. I guarantee you the probability is much higher than you think (how does (1-p)^n behave?). Looking for the worst accident or fatality rate and implying that it is wholly due to poor maintenance, etc., is bad logic and bad statistics. If the Herald’s Editor and reporter do not know this, they are incompetent. If they do, they are dishonest.

The FAA says it has to be cautious before grounding planes because of the threat of lawsuits. Yet the cost of lawsuits, improved safety and more stringent enforcement should be weighed against the potential loss of life in the sky and on the ground.

Finally a tradeoff is considered. But, as usual, the cost to the industry and consumers of saving a few lives is ignored. One would have thought that this was the important tradeoff.

By pilot skill or luck, that crash hit a vacant lot and exploded just short of an industrial park west of Miami International Airport. The crash claimed five lives, including one on the ground. The toll could have been much worse. Had the plane come down just a little to the south, the plane could have plunged into the Mall of the Americas. Had the flight gone east, it could have exploded in dense residential neighborhoods or downtown Miami.

The fact that this crash and all the others quoted in the Editorial did not come down into a Mall and did not explode in a dense residential neighborhood or city says something about the probability of such an occurrence. Possibilities do not necessarily appreciable risks make.

Yet there can be no excuse for indifference to the threat of a potentially disastrous air-cargo crash. The FAA should take seriously its obligation to prevent death from raining down from our skies.

And, here, we have the final platitude. If the probability of a potentially disastrous air cargo crash is low enough and the cost of reducing it further is expensive enough, no effort should be made to reduce the probability further. “Death raining down from our skies” is a nice line, but irrelevant. Come to think of it, that is what the Herald’s investigative report and Editorial are; irrelevant. No, that is wrong. They are disasters themselves. To the extent the public and Government assigns resources as the Herald advocates, the Herald probably will cause an increase in the death rate due to the likelihood that assigning the same level of resources elsewhere would save more lives.

Tradeoffs: Walter E. Williams knows how to spot them

Walter E. Williams holds a bachelor's degree in economics from California State University (1965) and a master's degree (1967) and doctorate (1972) in economics from the University of California at Los Angeles. His recent column “The Pretense of Knowledge” shows that he knows how to find tradeoffs that others miss.

Here are some excerpts.

One of the great contributions of Nobel Laureate economist Friedrich Hayek was to admonish us to recognize the insurmountable limits to human knowledge. Why? Not even the brightest minds, and surely not the U.S. Congress, can ever have the knowledge to shape an economic system entirely to our liking. To think we can represents the height of arrogance and a pretense of knowledge. The billions upon billions of interrelationships between an economic system's human and non-human elements defy human capacity to know.

Let's examine just a few pretenses of knowledge. Under Social Security law, Congress forces workers to set aside a portion of their earnings for retirement. Take a 25-year-old -- let's call her "Mary" -- who earns $40,000 a year. Her Social Security tax is about $2,500. Here's my question to you: Was having $2,500 forcibly taken out of Mary's pay for retirement her best possible use of that money? Mary might have saved and invested several years to open a small business. She might have put it toward private schooling or music lessons for her child, or any number of things that might have made her, and possibly our nation, wealthier in the future.

How about Congress' mandate for more fuel-efficient cars? According to a National Research Council of the National Academies of Sciences 2002 report, delivered by Dr. Leonard Evans to the Washington-based Competitive Enterprise Institute, Corporate Average Fuel Economy (CAFE) standards have contributed to between 1,300 and 2,600 traffic deaths a year. Congress' mandate for higher gasoline mileage leads to the production of lighter, smaller and less crash-worthy cars, resulting in unnecessary deaths. Through technological innovation and natural market forces, cars were already becoming more fuel efficient before CAFE standards were mandated. But more important, how does Congress know whether this loss of life is worth the amount of fuel saved? Do they even know or care about the tradeoff?

Why investment managers' performance tends to be disappointing after they are hired

Institutional investors often have the discouraging experience of hiring an investment manager who, despite good historical performance, has disappointing performance after being hired. One reason for this is the difficulty most institutional investors have assessing the a priori probability that an investment process is effective. Another is an excessive reliance on good past performance.

Some sophisticated institutional investors compute the probability of observing a performance history as good as the manager’s or better, assuming that the manager’s investment process is not effective. In statistical parlance, this is a test of the null hypothesis that the manager’s true performance is zero (i.e., due to luck).

If this probability is substantial, then the observed performance is consistent with the hypothesis that it is due to luck. If this probability is small, then the assumption that the observed performance is due to luck implies a great coincidence and it may be more reasonable to assume that it was due to an effective investment process.

Typically, the historical performance is attributed to an effective investment process if the computed probability of achieving the observed performance or better from luck is below 5% or thereabouts. What most investors who use this approach do not realize is that this choice is arbitrary and virtually assures disappointing future performance.

Suppose the probability of achieving the observed performance or better from luck is 1%. Is that sufficiently small to attribute the observed performance to an effective investment process? Doesn’t the answer depend on what is the investment process? Suppose the performance was achieved by choosing stocks at random? Or, to put it more accurately, suppose the performance was achieved through a process that one cannot imagine should work? Or, to put it even more accurately, suppose the investment process has an a priori probability of being effective of 0.000001%?

On the other hand, suppose the probability of achieving the observed performance or better from luck is 25%. Is that sufficiently large to attribute the observed performance to luck? Doesn’t the answer depend on what is the investment process? Suppose one cannot imagine that the investment process would not work? Or, to put it more accurately, suppose the investment process has an a priori probability of being effective of 99%?

What the typical statistical testing leaves out is the a priori probability that an investment process is effective.

What investors ought to estimate is the probability that the investment process is effective, given the observed performance. This depends on both the a priori probability that the investment process is effective and the probability of achieving the observed performance or better from luck (i.e., given that the investment process is not effective). Investors almost never compute, numerically or subjectively, the probability that the investment process is effective, given the observed performance. The reason is that they are usually unable to assess an investment process from an a priori perspective.

To see why the typical approach of computing the probability of the observed performance or better due to luck fails, consider that there are thousands of managers and only those with good past performance show up at the institutional investor’s door.

Here is a dramatic illustration of the kind of thing that goes on. Assume there are 1000 managers and that none of their investment processes are effective. Approximately fifty of them should have past performance that is good enough, due to good luck, so that the computed probability of observing performance as good or better is 5% or less. Naturally, these fifty show up at the institutional investor’s door and the results of his statistical tests are a foregone conclusion. The expected future performance of the fifty managers is zero. The investor’s statistical tests are virtually worthless.

The institutional investor’s only protection is to have a very good a priori reason for thinking that an investment process should work.

Anti-gun academics cannot be trusted

For several years, John Lott has been publishing papers and books, including the best statistical work, on the impact of allowing qualified citizens to carry concealed weapons. His results strongly suggest that the impact of passing these laws is to reduce murders and rapes. There appears to be little or no down side to such laws and a good deal of upside.

The response of some anti-gun academics has been to accuse Lott of incorrect statistical methodology and fabricating data. Lott’s response has been to explain, patiently, why the criticism is unwarranted and to show that it is the statistical studies put forth by these academic that are incorrect.

To illustrate, the lies (my opinion) spread about Lott’s work, consider the following quote from Steven Levitt’s book “Freakonomics.

Then there was the troubling allegation that Lott actually invented some of the survey data that supports his more-guns/less-crime theory. Regardless of whether the data were faked, Lott’s admittedly intriguing hypothesis doesn’t seem to be true. When other scholars have tried to replicate his results, they found that right-to-carry laws simply don’t bring down crime.

In fact, Lott’s results have been replicated and supported by other researchers. This was known in the field. Indeed one researcher sent the following email to Levitt.

I also found the following citations – have not read any of them yet, but it appears they all replicate Lott’s research. The Journal of Law and Economics is not chopped liver.

Levitt’s response was:

It was not a peer refereed edition of the Journal. For $15,000 he was able to buy an issue and put in only work that supported him. My best friend was the editor and was outraged the press let Lott do this.

According to Lott:

Levitt’s e-mail was false and defamatory because the Special Issue was, in fact, peer refereed, and he didn’t “buy” the issue. Nor did he “put in only work that supported him.” Lott says he invited scholars who both agreed and disagreed with him to provide articles.

Failing to obtain redress from Levitt through peaceful means, Lott is now suing Levitt. The most recent legal document filed by Lott’s attorney can be found here.

I am with Lott on this. I think his work is excellent.

Read Lott’s book, “The Bias Against Guns”. It is a good read and enlightening.

Hawala money laundering

The following link to an article “The hawala alternative remittance system and its role in money laundering” is found on an Interpol website. It give some interesting knowledge about how money laundering is sometimes done.

Thanks to my friend Neal Hitzig for the link.

Here are some excerpts.

Hawala works by transferring money without actually moving it. In fact 'money transfer without money movement' is a definition of hawala that was used, successfully, in a hawala money laundering case.

Abdul calls the number, and speaks with Yasmeen. She offers him the following deal:

A fee of 1 rupee for each dollar transferred;

37 rupees for a dollar; and

Delivery is included.

Under these terms (6), Abdul can send Mohammad Rs 180,000. He decides to do business with Yasmeen.

The hawala transaction proceeds as follows:

Abdul gives the $5,000 to Yasmeen;

Yasmeen contacts Ghulam in Karachi, and gives him the details;

Ghulam arranges to have Rs 180,000 delivered to Mohammad.

Even though this is a simple example, it contains the elements of a hawala transaction. First, there is trust between Abdul and Yasmeen. Yasmeen did not give him a receipt, and her recordkeeping, such as it may be, is designed to keep track of how much money she owes Ghulam, instead of recording individual remittances she has made. There are several possible relationships she can have with Ghulam (these will be discussed later); in any case she trusts him to make the payment to Mohammad. This delivery almost always takes place within a day of the initial payment (a consideration here is time differences), arid the payment is almost always made in person. Finally, in some scenarios, he trusts her to repay him the equivalent of either $5,000 or Rs 180,000.

If Yasmeen needs to pay Ghulam the Rs 180,000 that he has given to Mohammad, she can do it by 'under invoicing' a shipment to him. She could, for example, send him $20,000 worth of telecommunications devices, but only invoice him for $15,000. Ghulam pays Yasmeen $15,000 against this invoice. The 'extra' value of goods, in this case $5,000 (the equivalent of Rs 180,000) is the money that she owes him.

In order to move money the other way (in this case, from Pakistan to New York)',over invoicing' can be used. For this example, it is assumed that Ghulam owes Yasmeen $5,000. She could buy $10,000 of telecommunications devices, and send it to Ghulam with an invoice for $15,000. Ghulam would pay her $15,000; this covers the $10,000 for the telecommunications devices as well as the other $5,000.

When compared to a 'traditional' means of remitting money, such as obtaining a check or ordering a wire transfer, hawala seems cumbersome and risky. In this section, we will examine the motivations for using the hawala system.

The primary reason is cost effectiveness. As was shown in this example, Abdul was able to obtain nearly Rs 30,000 more (averaging exchange rates, this is about US$ 880), a significant savings by using the hawala system. Some of the reasons for this cost effectiveness, namely low overhead, exchange rate speculation and integration with existing business activities, will be discussed in the next section of this paper.

The second reason is efficiency. A hawala remittance takes place in, at most, one or two days. This can be contrasted with the week or so required for an international wire transfer involving at least one correspondent bank (as well as delays due to holidays, weekends and time differences) or about the same amount of time required to send a bank draft from North America to South Asia via a courier service (surface mail is not a reliable option where the contents are valuable, and it can also take several weeks to arrive).

The third reason is reliability. Complex international transactions, which might involve the client's local bank, its correspondent bank, the main office of a foreign bank and a branch office of the recipient's foreign bank, have the potential to be problematic. In at least once instance reported to the authors, money for a large commercial transaction (money being sent from the United States to South Asia) was lost 'in transit' for several weeks while trying to conduct such a transaction. When the bank located the money, it was returned to the customer. He enlisted the services of a local hawaladar, who was able to complete the transaction in less than a day.

The fourth reason is the lack of bureaucracy. Abdul is living and working in the United States on an expired student visa; he does not have a social security number (and since he deals almost exclusively in cash, he really does not need one). It would be difficult, if not impossible for him to open a bank account as he does not have adequate identification. In addition, he does not completely trust banks and would prefer not to use them if at all possible. Iqbal and Yasmeen do not operate in a 'bureaucratic' framework, making them a preferable alternative to the bank.

The fifth reason is the lack of a paper trail. Even though Abdul earned the money that he sent to Mohammad legally, he would prefer to remain anonymous (this is a much more important consideration in illicit hawala transactions). Since it is rare for hawaladars to keep records of individual transactions, it is unlikely that Abdul's remittance will ever be identified as part of the business dealings between Yasmeen, Ghulam and their associates.

The sixth reason is tax evasion. In South Asia, the 'black' or parallel economy is 30%-50% of the 'white' or documented economy. Money remitted through official channels might invite scrutiny from tax authorities - hawala provides a scrutiny-free remittance channel.

Money laundering consists of three phases: placement, layering and integration. Since hawala is a remittance system, it can be used at any phase.

In placement, money derived from criminal activities is introduced into the financial system. In many money laundering schemes, the biggest 'problem' here is handling cash. Some jurisdictions, such as the United States, require reporting by financial institutions of cash transactions over a certain amount (in the U.S. it is US$ 10,000) (12), and attempting to circumvent such reporting requirements by making smaller transactions is an offense.

Hawala can provide an effective means of placement. In the example, Abdul gave Yasmeen US$ 5,000 in cash. Since she also operates a business (and also performs remittance services for others), she will make periodic bank deposits consisting of cash and checks. She will justify these deposits to bank officials as the proceeds of her legitimate business. Even though she might prefer it if reports were not filed, she will not object to this as it would arouse suspicion at the bank (and her business provides more than adequate justification). She may also use some of the cash received to meet business expenses, reducing her need to deposit that cash into her bank account.

In the layering stage, the money launderer manipulates the illicit funds to make them appear as though they were derived from a legitimate source. A component of many layering schemes has been seen to be the transfer of money from one account to another. Even though this is done as carefully as possible, when it is done through the 'traditional' banking system it presents two problems to the money launderer. First, there is the possibility that a transaction could be considered to be suspicious and reported as such. Related to this is the paper trail created by these transactions. If any portion of the laundering network is examined, the related paper trails could lead a diligent investigator directly to the source of the criminal proceeds and unravel the money laundering network.

Hawala transfers leave a sparse or confusing paper trail if any. Even when invoice manipulation is used, the mixture of legal goods and illegal money, confusion about `valid' prices and a possibly complex international shipping network create a trail much more complicated than a simple wire transfer.

Both of the authors of this paper have investigated hawala money laundering, and have found that even 'basic' hawala transfers can be difficult to trace and tie to the original, criminal source of money. There is no reason, however, why hawala transfers could not be 'layered' to make following the money even more difficult. This could be done by using hawala brokers in several countries, and by distributing the transfers over time.

In the final stage of money laundering, integration, the launderer invests in other assets, uses the funds to enjoy his ill-gotten gains or to continue to invest in additional illegal activities. The same characteristics of hawala that make it a potential tool for the layering of money also make it ideal for the integration of money. This is when money seems to become legitimate, and, as we have seen, hawala techniques are capable of transforming money into almost any form, offering many possibilities for establishing an appearance of legitimacy.