Where does consciousness come from?

Consciousness is a weird thing. Being aware of your own feelings, being able to plan out and think through your actions and the consequences of those actions...and being able to analyze other people and how they would react, is a trait assimilated uniquely with humans. But where does it come from? Richard Dawkins' groundbreaking book on biology, The Selfish Gene, has an interesting take on it.

One of the most interesting methods of predicting the future is simulation. /…/ If simulation is such a good idea, we might expect that survival machines would have discovered it first (he is referring to the use of computer simulation). After all, they invented many of the other techniques of human engineering long before we came to the scene: the focusing lens and the parabolic reflector, frequency analysis of sound waves, servo-control, sonar, buffer storage of incoming information, and countless others with long names, whose details don’t matter. What about simulation? Well, when you yourself have a difficult decision to make involving unknown quantities in the future, you do go in for a form of simulation. You imagine what would happen if you did each of the alternatives open to you. You set up a model in your head, not of everything in the world, but of the restricted set of entities which you think may be relevant. You may see them vividly in your mind’s eye, or you may see and manipulate stylized abstractions of them. /…/ Survival machines that can simulate the future are one jump ahead of survival machines who can only learn on the basis of overt trial and error. The trouble with over trial is that it takes time and energy. The trouble with overt error is that it is often fatal. Simulation is both faster and safer.

The evolution of the capacity to simulate seems to have culminated in subjective consciousness. Why this should have happened is, to me, the most profound mystery facing modern biology. There is no reason to suppose that electronic computers are conscious when they simulate, although we have to admit that in the future they may become so. Perhaps consciousness arises when the brain’s simulation of the world becomes so complete that it must include a model of itself.
- quoted from pages 57-9 of the million copy special edition, emphasis mine

The book is filled with mind-bogglingly simple* but elegant explanations of the world around us. It's a popular science book on biology and more specifically evolution, but there's a lot for everyone to learn from it. I'm not a biology person, but this book definitely has a special place on my popular science bookshelf along with Carl Sagan's Cosmos.

* Simple doesn't mean the conclusion itself was easy to come to. Simple is rather a reference to Occam's Razor.

Consumption to drive China's growth

Shijiazhuang, China. This place is as big as New York, but you've
probably never heard of it before. 5 million living in the
metro area, 11 million in the urban area. Image from Wikipedia

In my previous post, I wrote about China's falling growth rate, its extraordinarily fast debt buildup and how debt was used to finance unsustainable investment projects. With investment bound to shrink as a share of GDP, other sources of growth have to step up for China to maintain economic growth at a rate high enough to avoid social tensions and large scale unrest. GDP growth can only come from four sources: investment, government, consumption and net exports. Since investment growth, as I laid out in my previous post, is out of the picture, let's look at the other three sources.

Government spending

Government, especially local government, who makes a lot money by selling land to real-estate developers, is not a likely source of growth unless it starts issuing bonds or finds a way to beef up revenue by imposing new taxes. A quarter of their revenue is linked to real-estate development and this source of revenue started falling late last year. With debt at 58% as a share of GDP, according to official figures, local governments are in no position to increase debt burdens, especially as revenues are falling. In addition, the central government has imposed quotas on local government debt.

China doesn't offer a lot in terms of public services (education, healthcare, benefits) and some have pointed out that changing this is a possible source of growth. However, the hukou system prevents rural migrants from registering themselves with the city government, which excludes them from the services available to official citizens. Those 'illegal citizens' have no right to social housing or healthcare (if I'm not mistakes, it also excludes their children from public schooling). Migrant workers can choose to stay in the city, forced to live in overpriced cellars or leaky shacks, or return home to the countryside where jobs are tough to find and incomes far lower. Increasing available services would leave close to 200 million, maybe more, without access to those services.

Although many have advocated for the reform of the hukou system, which keeps migrant workers in conditions similar to illegal immigrants, city governments are heavily opposed to it. Increased demand for services offered by the cities would strain their budgets and lead to more migrants flocking in once the system has been reformed, with potentially dire consequences for rural economies. A funding shortfall could be met by transfers from the central government, but so far that idea hasn't gone down well. In any case, services have to be funded somehow. Financing growth in government spending with debt is an open question, but raising taxes, as we shall see, is not really a good idea, as it would decrease household incomes (more below). The government might sell bonds domestically, but selling bonds on the international market would drive up the RMB exchange rate, which China as an export oriented nation is keen to avoid. All of this is to say that government spending is not a likely source of growth in the near future.

Exports

Export growth has been falling even faster than China's overall growth rate. Current account balance as a share of GDP stands at 2% compared to more than 4% between 2006 and 2011. Underutilized manufacturing capacity would allow for more export growth if it only weren't for weak global demand. Also, wage growth has been on a tear lately and this has put pressure on industries where labor costs are a significant part of the total cost of production. A lot of companies have moved their plants from the coastal region closer to Mongolia or even to other countries such as Vietnam and Bangladesh, where labor is cheaper. In fact wages have risen so fast that some Western companies are bringing manufacturing back home. On demand manufacturing (which is time critical) and automation, when combined, make it cheaper for some companies to produce goods closer to the home market. 

The export-oriented manufacturing sector is mostly producing goods with no local input in terms of product development, marketing or branding. As a result, the manufacturers suffer from low margins. Their only competitive advantage is mass production at a low price. Chinese goods have already flooded the world market and it is questionable how much more of that the world can absorb. China could step up its game by moving further up the value chain, and there are a few success stories such as Xiaomi that prove it can be done, at least domestically, but it takes years to penetrate world market. And don't expect Western companies to give up without a fight. Xiaomi might be a success in China, but it will face companies like Samsung and Apple who have more money, talent and experience once it wanders out its home territory. Furthermore, large scale asset purchase programs, designed to reflate asset prices, are also boosting Western manufacturing through lower exchange rates. So it is not difficult to arrive at the conclusion that exports are not going to the savior of China's GDP growth.

Household spending

Consumption only makes up about 35% of China's economy. That's very low compared to Western countries where consumption makes up 55-70% of the economy. In fact China has one of the lowest shares of household consumption in the world, it's only eclipsed by a few oil exporters, Luxembourg and Macao. Obviously, something is holding back household consumption in China. That something is financial repression and an underdeveloped financial sector. An underdeveloped financial sector means Chinese household don't have a lot to choose between when saving money for the future. Chinese household can't invest abroad so they're limited to bank deposits, stocks and real estate. Let's look at stocks and real estate first and then return to bank deposits.

Stocks
Long term investors in Chinese stocks haven't benefited from economic growth, because listed companies, national regulators nor brokerages have investors' objectives at heart.

For more than 20 years, China's capital market has been known not only for its heavy government influence but also as a rumor mill. So much speculative news does the rounds that it is possible to find fairly accurate information about a listed company's financial performance even before any official announcement. - from Caixin

Below is a chart comparing the Shanghai stock market in blue (lhs) and China's GDP market by dots (rhs). This chart alone should be proof enough that China's stock market performance has no correlation to China's economic growth. Although wealthy Chinese have ways of getting their money out of the country and investing in foreign stocks, average citizens are limited to whatever is available in China.

Chart from TradingEconomics

Most people in China don't make enough money to buy real estate. Also, Chinese banks are so backwards that they don't even offer mortgages, which means that everything has to be bought outright. There's also no consumer financing in China (ie. no credit cards, auto loans or anything of the sort). Most people who want to invest in real estate, or anything else for that matter, do so through shadow banks.

A decade ago, conventional banks, which are almost all state-owned and tightly regulated, accounted for virtually all lending in China. Now, credit is available from a range of alternative financiers, such as trusts, leasing companies, credit-guarantee outfits and money-market funds, which are known collectively as shadow banks. Although many of these lenders are perfectly respectable, others constitute blatant attempts to get around the many rules about how much banks can lend to which companies at what rates. - from The Economist

These companies operate in a regulatory no-man's land, which allows them to escape scrutiny by regulators but also investors. Stories of people who have lost everything are commonplace.

Shadow banks, which barely existed before China’s credit surge in 2009, now have assets of at least 30 trillion yuan ($4.9 trillion), or more than 50% of GDP, according to estimates by ANZ, a bank. The government’s attempts to slow the pell-mell growth in credit extended by conventional banks have only steered more business to their shadowy cousins. In fact, investments from mainstream banks have been the shadow banks’ biggest source of funds. - from The Economist

Small and medium-sized real estate developers and businesses have limited access to bank financing and are therefore reliant on shadow banking. SEOs also lend money to shadow banks, those loans are in turn bought by well-connected bankers in state controlled banks and are mostly left unreported on the balance sheet. Ordinary citizens have also used shadow banks to invest in real estate projects, but as the real estate boom begins to deflate, many have lost their money, especially in smaller cities off the coast. The state has tried to crack down on shadow lending practices, but as soon as it puts out one type of financing, another one pops up. China has resisted developing its proper capital markets, but that void was filled by untrustworthy financiers operating in the shadows with no accountability. And all of that, as we shall see, was done to fund economic growth, at the expense of stagnant household income, of course.

Financial repression

The state has kept interest rates deposits artificially low for years, resulting in cheap, below market cost, loans to state owned enterprises (SEOs) and well-connected manufacturers. A subsidized price always increases demand. Keeping interest rates lower than they otherwise would be makes previously unprofitable investment project seem more lucrative, which led to an investment boom that I covered in my previous post.

With no good alternatives to deposits (shadow banking is a recent development and not a very secure one), households were forced to save more of their income the lower the interest paid on deposits. This is in part because of the backward nature of China's capital markets (no mortgages, no consumer financing), but also because China doesn't offer much in the form of social welfare (education, healthcare), especially to migrant workers in cities who are stuck between a rock and a hard place because of the hukou system. The capital markets are underdeveloped precisely because the state wanted to use the deposits to fund investment in the tradable goods sector. Purchases of consumer durables, real estate, education and healthcare are funded with savings. The lower the interest rate, the more you have to save, simple. Suppressed interest rates are the reason why China's savings rate is so ridiculously high. It has nothing to do with national characteristics as some would say.

Anything that reduces consumption, in other words, without changing total production or total investment, must cause an increase in exports relative to imports. - from The Great Rebalancing, by Michael Pettis

What's more, total production didn't remain the same - a lot of those savings got pumped into new manufacturing capacity designed to increase exports. Since consumption was hampered by the need to save, export growth far outpaced import growth. Exporting capital means importing demand, but also exporting unemployment. Employment growth has been an important part in keeping social tensions under a lid. To further increase exports, thus securing employment in the manufacturing sector, China kept its exchange rate artificially low.

Devaluing the currency is the equivalent of transferring resources from net importers (which includes primarily the household sector) to net exporters, which is composed mainly of the tradable goods sector. In so doing it reduces consumption by reducing disposable household income and increases production by lowering input costs, thus pushing up the savings rate. - from The Great Rebalancing, by Michael Pettis

China is already a manufacturing powerhouse and there's not enough demand in the world to absorb any meaningful increase in Chinese manufacturing. Debt driven investments are also slowly deflating and local governments are weighed down by debt and falling revenue from real estate developers. Consumption is the only source of growth that could power China's growth in any meaningful way. To increase consumption, household income has to grow, and it has to grow faster than GDP. Alternatively, the state could start offering public services. That would not increase incomes, but it would decrease the need to save. Potential solutions include reforming the hukou system, offering more public services, deregulating interest rates, developing a modern, functioning capital market by reforming and liberalizing banking and lending (which could include legitimizing but also regulating shadow banks, ie turning them into proper banks). Opening up the capital account would also be a step forward, but it's obvious that the Chinese capital market is not ready to compete with foreign banks and investment funds.
***
A lot of what I wrote in this post has been gleaned from Michael Pettis' blog posts and his book The Great Rebalancing. For anyone interested in global capital flows, Pettis' blog is a must read. He sheds light on the European debt crisis from a capital and trade account perspective, which is very refreshing. I highly encourage you to start by reading his latest post, here.

China is reverting to the mean, predictably so

A photo of one of China's ghost cities, from the Daily Mail.

Lately, China's economics growth figures have disappointed to the downside. To many observers, this wasn't a surprise. A reversion to the mean was bound to happen, as described by Lant Pritchett and Lawrence Summers in Asiaphoria Meet Regerssion to the Mean:

However, predicting future levels of output by the extrapolating the current growth rate into even the near, much less the distant, future is on very weak scientific footing. The single most robust and striking fact about cross-national growth rates is regression to the mean. There is very little persistence in country growth rates over time and hence current growth has very little predictive power for future growth. Hence, while it might be the case that China continues for another two decades at 9 percent per capita growth, given the regression to the mean present in the cross-national data this would be a 3 standard error anomaly. - (this and following emphasis mine)

So it is not at all surprising that China failed to achieve its 7,5% target rate of growth. Indeed GDP growth in China has been falling for several years. It is surprising that China managed to keep such a high rate of growth for so long*.

China has had growth rates of over 6 ppa for 33 years starting in 1977 and this data set ends in 2010. - (that's 37 years if the figures were updated to include 2010-14)

But rare is this so-called super-rapid growth?

First, episodes of super-rapid (>6 ppa) growth tend to be extremely short-lived. The method of dating growth episodes doesn’t allow an episode of less than 8 years. The median duration of a super-rapid growth episode is 9 years, only one year longer than its possible minimum. There are essentially only two countries with episodes even approaching China’s current duration. Taiwan had a growth episode from 1962 to 1994 of 6.77 ppa (decelerating to 3.48 from 1992 to 2010). Korea had an acceleration in 1962 to 1982 followed by an acceleration in 1982 until 1991 when growth decelerated to 4.48 ppa so a total of 29 years of super-rapid growth (followed by rapid growth).  So China already holds the distinction of being the only country, quite possibly in the history of mankind but certainly in the data, to have sustained an episode of super-rapid growth for more than 32 years.

Reversion to the mean, by definition, means that the longer something deviates from the mean, the higher the probability of it reverting back to the mean. Betting against China hasn't been a profitable bet for the last 30 years*, but it might change. How far down might a reversion to the mean take China's GDP growth? Based on historical figures, the authors offer this:

Third, the typical (median) end of an episode of super-rapid growth is near complete regression to the mean. The median growth of the episode that follows an episode of super-rapid growth is 2.1 ppa. So the “unconditional” expectation (or central tendency) of what will happen following an episode of rapid growth is a reversion to not just somewhat slower growth but massive deceleration of 4.65 points (more than twice the cross-national standard deviation).  A deceleration of that magnitude takes growth in India from 6.29 to 1.64 and in China from 8.63 to 3.98.   

A slowdown in overall growth is bound to affect some sectors more than others. Investment (think housing, infrastructure and manufacturing capacity) in particular will take a beating. Investment as a share of the economy has reached 50% and most of it was financed with debt. The overall debt-to-GDP ratio went from 153% in 2008 to 243% in 2014 (see this and this). Debt has grown faster than debt servicing capacity and this is bound to end up in tears for investors, as it already has for investors in some of China's ghost cities. Empty apartment buildings, nearly empty high-speed trains and shopping centers only mean one thing - no revenue, thus nothing to service debts with. China's banking system is intoxicated with bad debt and up to a point it was manageable by simply refinancing the old loans. Every speculative bubble finds its limit and looks like China has met its limit at the 240% debt-to-GDP mark. 

Without substantial growth in I, G or NX, the growth has to come from somewhere else. More on that in my next post.

*There is evidence that China has been manipulating inflation, income and spending statistics, see this and this. But even if we assume a quarter or even half of the GDP growth is fake, the China's growth is still unprecedented. Some have pointed to the quality of leadership in China, or the extensive industrialization (China was a rural economy before the 70s), or the size of China which allowed them maintain a high rate of growth by pumping money into less-developed regions as wealthier regions slowed down, or the quality and efficiency improvements of their manufacturing. A plethora of explanations have been offered, but the persistence of super-rapid growth remains a mystery.

Jevons paradox

Photo from Pixabay (CC licence)

Economics is sometimes defined as the study of how society allocates scarce resources. Technological improvement is the means by which resources are put to better uses to produce more goods at cheaper prices. Theoretically, improving the efficiency of a resource-consuming activity would lead to a decrease in the amount of that resource being used. Or so you would think. In practice, the theory is of very little help as it only explains first round effects.

In 1865, the English economist William Stanley Jevons observed that technological improvements that increased the efficiency of coal-use led to the increased consumption of coal in a wide range of industries. He argued that, contrary to common intuition, technological progress could not be relied upon to reduce fuel consumption. - all excerpts from Wikipedia

The very first steam engines were used to pump water out of mines, thus allowing the miners to deeper and access more coal. An improvement that would increase the engine's output would allow the miners to go even deeper or to build a smaller, less costly, engine. This improvement in efficiency would be of great advantage to the owners of the mine who would now have a cost advantage. It would mean more output and/or lower prices for coal, compared to their competitors, of course. The engine itself would consume less coal per ton of water displaced, which, as put forward by the theory, should decrease the use of coal (as far as production remained roughly the same). Alas, it is only at that particular mine that we might witness an decrease in the use of coal.

It is not long before second round effects start having an impact. Businesses that couldn't afford a steam engine when it was first introduced might now want to take a second look. Low-lying areas that had more water to pump out but also distant mines where coal mining would be profitable were it not for the high transport costs can both benefit from a cheaper and more efficient steam engine. As a result, more steam engines are built necessitating the use of more coal to keep them running. Further improvements in size, output and weight would herald the rise of the factory and the steam locomotive. All of this is to say that an improvement in efficiency will drive down the relative cost of using that technology, which will increase the demand for that technology. 

The Jevons paradox will trump all efforts at efficiency and conservation. A cheap, fuel efficient car will have a larger impact on overall fuel usage (and pollution) than a big, gas-guzzling SUV simply because it is more affordable and several times more units will be sold. The Tata Nano is a great example - its initial $1'600 price brought tens of thousand of new drivers on the road, drivers that used very little if any fuel before the car was introduced. It is virtually impossible to escape the paradox. Recent improvement in LED technology have made screens so cheap and energy efficient that they even show up at fast food restaurants in place of printed menus. Instead of reducing energy use, as was once thought, improvements in LED affordability and efficiency are now having the opposite effect. The same goes for household appliances, electronics, basically anything you can think of.

The Jevons paradox has been used to argue that energy conservation may be futile, as increased efficiency may increase fuel use. Nevertheless, increased efficiency can improve material living standards.

And that is the whole point. Improvements that drive down costs make technology more affordable and life less miserable. The reduction in cost and improvement in efficiency of the washing machine and other household appliances has given women more choices and liberties than the feminist movement. The right to vote isn't worth much if the woman still has to cook, do laundry and clean the house without the opportunity to educate herself and realize her potential in the labor market. With all that being said, is there anything that can be done to conserve resources? 

As the Jevons paradox applies only to technological improvements that increase fuel efficiency, policies that impose conservation standards and increase costs do not display the paradox.

The obvious conclusion is that efficiency improvement are not enough to fight global warming. Jevons paradox is the reason why all the cheer for better LEDs and similar technological improvements will result in naught. Intergovernmental agreements, conservation standards and entirely new technologies are necessary. And if fighting global warming seems silly to you, consider that all fossil fuels still pollute the environment (China is a prime example), whether you accept people's role in global warming or not.

Moore's Law and space flight

I wrote about Moore's Law and the second half of the chessboard in a previous post. We've crossed the border between the first and second half and already we're seeing inventions such as the autonomous car, machines that scan legal documents better than humans and a car designed and crash-tested on computers from start to finish (the Tesla Model S).

Elon Musk's private space exploration company, SpaceX, is another company that relies heavily on computers to design and test their products. Among other things they're pioneering the reuse of launch vehicles to make space exploration more affordable. So far launch vehicles have been discarded after use which is like throwing a Boeing 747 airplane into the ocean after the maiden flight. Overall SpaceX has been successful so far and they have a multi-billion contract with NASA to deliver equipment and supplies to the International Space Station to prove it. SpaceX's supply vehicles have successfully reached the ISS, and it's only a matter of time before they perfect the re-usability of the launch rockets (the last test didn't go so well on account of not enough hydraulic fluid to steer the rocket as it landed). Here's an animation of what it would look like:

And here's a test flight of the actual rocket (although it takes the rocket just up to 1'000 meters, it serves as a powerful proof of concept). Also, SpaceX has already achieved substantial cost reductions compared to traditional companies:

Depending on a number of factors, mostly the size and weight of payload, the cost of a single launch ranges from $100 million to $260 million. SpaceX charged SES, a global satellite company, a mere $55 million for this launch. 

And this is just the beginning:

The cost of the Falcon 9 rocket alone is $54 million /.../ but it only burns $200,000 worth of fuel. If each rocket were reusable, and the only costs to launch a satellite were fuel and various ground support services, that would dramatically reduce the cost of getting to space. - this and the previous excerpt from Quartz

Of course, SpaceX is not the only privately funded space exploration company. In fact these days starting a commercial space company is the thing. Amazon's Jeff Bezos and Virgin's Richard Branson are names that come up often when commercial space flight is being discussed, but they have a lot of competition from less known companies.

Starting an aerospace company, unless you want to take humans to space, doesn't necessarily require deep pockets. The fact that you don't need billions of dollars and huge facilities to start a commercial space company is perfectly illustrated by Planet Labs. It's working on building a network of mini-satellites orbiting the Earth, with the aim of providing a live stream of the planet on demand. A technology like this is very helpful for emergency workers during a disaster, farmers can use it to monitor crops, scientists and authorities can use it to monitor the weather, environmental pollution, illegal logging and changes in the course of rivers. Some Wall Street analysts are even using satellite images to estimate the number of customers the likes of Wal-Mart have visiting their stores by the number of cars parked in their parking lots.

Nor will all the nanosats be looking downwards. Sensors facing sideways and upwards from low-Earth orbit will allow researchers to carry out a large number of experiments and to take measurements that have previously been too costly to consider. This includes detecting solar and cosmic radiation, interactions between magnetic fields and other forces which together make up what is called space weather. Measuring and predicting space weather could be used to protect billion-dollar satellites and prevent astronauts from receiving high doses of radiation.

And the cost advantages? To say that they're substantial would be an understatement:

Including the launch, a nanosat of CubeSat dimensions might cost $150,000-1m, rather than $200m-1 billion for a full-sized one. - this and the previous excerpt from the Economist

Planet Labs and other similar companies (read the Economist article for more on that) have been able to achieve these cost reductions, compared to large satellites, thanks to the break-neck speed at which smartphone technology, and consumer electronics in general, has advanced. They're actually building the satellites using smartphone components. All of this comes back to Moore's Law and the second half of the chessboard. Without improvements in microprocessors, memory capacity and cameras none of this would be possible. The nano-satellites are designed to last only a year or two in space, after which they will burn up in the atmosphere after re-entry. But that is all well since replacement satellites will benefit from Moore's Law, carrying with them improved chips, sensors, batteries, radios, memory etc. As if space exploration itself wasn't exciting enough, these technological and cost advances will make space exploration affordable to millions of people, possibly giving paving the way for new technological advances.

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If you're interested in SpaceX and their innovative approach to space technology, I highly recommend you check out this video in its entirety.