Friday, December 6, 2013

Rule-based Ethics are Uneconomic, and Therefore Impossible

Or: Why Objectivists are Wrong, and should try empathy instead.

After an exchange with Prof. Dan D'Amico on Twitter earlier today about the duty to care for others I realized my own ethical viewpoints are a bit eccentric, especially when expressed in a 140 character format. This post is to explain why I think the morally absolute arguments espoused by libertarians, objectivists, and small-government conservatives are lacking, the implication of that lack in spreading the libertarian cause, and finally some ideas of how a reformulation of libertarian ethics through empathy might lead to interesting places.

What are rule-based ethics? With this phrase I'm referring to deontological or Kantian claims, which say we should base our behavior off of universal rules. According to this logic, I should only act on a principle if I would want it to be universally enforced. Lying in general is bad, so I personally should never lie or else I break the rule against lying. I would not want to be stolen from, so I should never endorse theft being imposed on others.

Rule-based ethics have the advantage of clarity and they avoid contradictions, which is philosophically appealing. The downside is that nobody lives up to the standard of consistency and clarity that philosophers crave because the cost of doing so is too high. I'll explain why I think this is true below.

Rule-based ethics are uneconomic

In economic parlance, a universal obligation against stealing means that the demand to prevent stealing should be infinite: regardless of the price of doing so, the prohibition against stealing should never change. Otherwise it ceases to be a universal rule.

Ethical compliance can be seen as an economic good, and if so, why should it be beyond pricing? The only justification for an infinite price is that if some violations of the rule are allowed, then the rule as a whole will break down. A common libertarian argument is that if we allow government theft to support some good cause, then we lose the authority to stop government theft in general.

The difficulty with this argument is that it implies a public goods problem; if I personally refrain from supporting theft, it does not stop others from doing so. Put in another context, imagine Hardin's classic problem of the commons: I can graze my sheep in the pasture (support government redistribution for a "good cause") but if my neighbors all graze their sheep as well, the pasture is depleted (the state organizes massive theft for causes most people don't agree with). Even if everyone agrees that it would be best to let the pasture recover (theft should be universally reviled), breaking that rule brings me private benefit (ethical satisfaction) that I do not bear the full cost of.

These commons problems can be resolved in some settings, between individuals who know each other, can bargain, and have the benefit of a legal system to enforce those bargains. None of those conditions are met when trying to oppose ethical demands for government to redistribute.

Libertarians are optimistic that people can bargain intelligently to solve collective action problems, but when the good being bargained over is an absolute principle which by definition cannot be compromised, then how is it even possible for a bargain to be struck? Philosophers tackle these conflicting ethic problems (duty to protect vs. duty to non-aggression, etc.) and maybe come up with some answers, but the process of doing so is difficult. In other words, the transaction costs are very high. This is another reason to doubt that the collective action problem of enforcing a universal ethic will ever be solved.

Rule-based ethics are functionally impossible. Even if everyone agrees in the general principle, they will prefer to be able to violate it occasionally. If everyone can violate it occasionally, it is useless as a general principle.

So how do people make ethical decisions? 

My own view: people act ethically toward others because they feel empathy towards them. If I feel I can relate to or understand another person's suffering I want to help alleviate it, because it could be me suffering in their place. Moral principles are then chosen after-the-fact to justify the decision we have already arrived at through empathy.

Mental adherence to Kantian ethics makes us lie to ourselves so we can think our decision to help (or ignore) someone in need is purely rational, when in fact it is based almost exclusively on feeling. Justification is made easy by the plasticity of moral principles; given many conflicting rules to follow and with the idiosyncrasies of each still generating publications in top philosophy journals, it is easy for me to pick and choose which moral rule will apply best to get to the conclusion that I want.

Empathy easily explains the conflict between libertarians/conservatives and progressives over the welfare state. Conservatives empathize more with hard-working taxpayers than they do with the poor who made bad decisions to get where they are. Progressives empathize more with the downtrodden workers than they do with exploitative businesses who rob them of their labor surplus. Even if both sides agree that avoiding theft and helping the needy are moral obligations, differences in empathy lead to opposite conclusions. Saying "but my moral principle is stronger!" is justification after-the-fact by both sides and has no chance of being persuasive.

Empathy for others brings their well-being into my own economic calculus, so that my happiness is somewhat dependent upon theirs. This, in my view, is the best foundation for ethical action because it does not require subverting my own self-interest or reconciling complex philosophical problems. Instead, I offer help when I feel the need to do so and the cost to me is such that I find it worthwhile.

Many progressives would agree with the above paragraph, and then say that empathy necessitates even more government redistribution to help the poor. This is a misreading of empathy, however. If a progressive feels that some group is receiving an insufficient share to satisfy their feelings of empathy, they are welcome to personally give more. Saying "I don't have enough resources to do that, so society should pick up the slack" displays a lack of respect for others in deciding how their own resources are spent. It also circles back to the same imposition of universal rule-based morality which I criticize above. How can you treat others with empathy if you assume their moral judgments and autonomy are less valid than your own?

People can have different degrees of empathy for different groups, not everyone will feel the same way, and that is not a problem if charity is voluntary. Echoing Bryan Caplan's argument about the deserving poor, I feel a great deal more empathy toward people in less-developed countries who are never given the chance to become affluent than I do for Americans who had the great opportunity of being born here and then squandered it. By guaranteeing income to everyone living in America it may undercut the support for letting in foreigners who could benefit from being here even more (hat tip to Zac Gochenour, who is studying the political economy of immigration related to this idea).

Where does this leave libertarian activism? 

Saying "taxation is theft, abolish the welfare state" is pretty much a dead end strategy in my view. In spite of what I say above, neither I nor most people would feel good about the results if all social assistance were suddenly cut (whether it could be improved or reformed in many ways is an open possibility, however). The poor will always draw more empathy than the people who are taxed, and that is unlikely to change anytime soon.

There are plenty of other areas where the costs of government policy are easy to see: the 174,000 pages of federal regulation that cost the economy $1.8 trillion last year;  lives wasted through imprisonment in a failed war on drugs; poor health and environmental damage from sugar and corn production subsidized through our agricultural policy, and so on.

The sooner that libertarians can get away from abstract and abstruse moral claims and toward the lived reality of individuals, the better. Jettisoning the rhetoric of rule-based morality is a first step in that direction. If that means leaving some strident objectivists outside the tent, well, I'll admit that's one area my empathy is lacking.

Thursday, December 5, 2013

Structural holes and Twitter strategy

I'm reading David Knoke's Economic Networks (2012) for dissertation research. In it, he mentions Ronald Burk's take on social capital, which centers around the existence of structural holes.

A structural hole is a gap in communication between one party, who has information, and another who would like to receive it. This creates a power position for a broker who can create a link between those two. It's like being the middle-man in a market for information, who gains in status by exploiting the needs of the other two.

A company PR department issuing a press release, for example, has information which might be valuable to investors, customers, and competing companies. However, each of those groups would have to invest significant resources to read every PR release that might potentially interest them. This is where a (reputable) media source comes in, separating the wheat from the chaff and economizing the cost of providing information to interested parties. In return, that media agency gets to pay their staff's salary.

Social media changes the picture somewhat because there are millions of people out there all trying to be that media outlet, and they generate their own chaff in addition to helping separate out the wheat. Knoke observes "A large volume of information obtained from redundant sources is less valuable than high-quality new information acquired through connections to diverse sources." The perfect source is one which will do all the separating for you, leaving only the wheat. But, that source should be widely connected themselves so the quantity of information generated makes them worth listening to.

I'm starting to notice this at work on my Twitter feed, where I've been liberal in following pretty much any and everyone who might occasionally have something interesting to say. Unfortunately, the result has been a lot of noise to very little signal, and the news I care about is often reported redundantly or buried under items that are unimportant.

The optimal Twitter strategy for a news-consumer would be to pick out other people who follows lots of others and retweet often, but are extremely selective in who to retweet. The "retweeter" account can them take advantage of the structural hole between the flood of Twitter posts and the news consumer interested in a very few of them.

I'm sure there are some Twitter accounts out there which provide this retweet-screening service, but more commonly I see retweets being used as a sort of currency which is valuable to the person being retweeted but not necessarily to their followers. The use of retweets as a primary input for "influence" in applications like Klout makes this an attractive way to game the system. Also, retweets by mass-followed Twitter celebrities can be purchased as a way of building up a following, which is then later exploited for commercial purposes.

This has gone a bit longer than I'd intended, but I think the big takeaway is that there could be some unexploited opportunities for brokers to use the retweet system and serve as screening agents for their followers. Next stage: profit?

Monday, December 2, 2013

Micro-Modeling a Bitcoin Bubble with Selection Effects

Tim Worstall from Forbes has declared Bitcoin to be in "South Sea Bubble Territory" as other crypto-currencies are swept up in Bitcoin's dramatic rise past the $1000 mark. Lots of possible explanations for why this might be the case, but I'll start with two stylized facts about Bitcoin and see how far they can go in explaining why it is a bubble, and perhaps make a few predictions about how it will all shake out.

"Fact #1": by design, Bitcoin is deflationary, that is, the value of each unit will increase over time. This is contrary to most "fiat" currencies, which can have their supply expanded by a decision from a central bank. Unlike the number of dollars (or pesos or Yen), the amount of Bitcoins available is capped.

"Fact #2": most of the things that people use Bitcoins for exclusively are illegal or unsavory. While Bitcoins are not really anonymous, the difficulty of tracking any particular transaction makes them a useful medium for shady business on the internet.

Starting with #1, the deflationary nature of Bitcoin is a serious obstacle to it becoming a mainstream currency. If a Bitcoin tomorrow will be worth more than a Bitcoin today, your incentive is to save it rather than spending it. Investing in Bitcoins is largely based on the hope of a "greater fool" who will eventually purchase them from you. The exception to this is #2, the people who get Bitcoin for quick, often shady transactions.

So, you're a ForEx trader looking at bringing Bitcoin into the portfolio. The high volatility does create opportunities for arbitrage, and the prospect of future deflation in value should make it an easy profit. However, knowing that Bitcoin is commonly associated with risky transactions, the chance of a regulatory crackdown and collapse in value is high.

To put it bluntly, if Bitcoin investors are hoarding Bitcoins in anticipation that others will come along to buy those Bitcoins and in turn use them for recreational chemicals (the "greater fools"), and suddenly lots of people are being tracked down for those illegal purchases, the bottom falls out of the Bitcoin market and the currency collapses.

Anticipating this risk, mainstream currency investors stay out of Bitcoin. The ones who are left holding the bag are more risk-loving by definition. It sounds like a classic case of irrational exuberance in action. Risk-averse investors are scared away from Bitcoin by the threat of a regulatory action, justified or not, and the resulting selection effects make a bubble more likely.

This does not imply that all Bitcoin enthusiasts, or even most of them, are illegal or should be stigmatized. But you can see in some of the fervent defenses of the alternate currency that most do not have "mainstream" economic views, either, and might be subject to some bias which would prop up a bubble.

There is reason for optimism in Bitcoin as a new technological medium, but until more hurdles have been passed and it has entered into more mainstream usage, it's far too risky to think of as more than an ongoing (but promising) experiment. At the current prices, I'd say it's likely that a few of the current adopters will be losing their shirts before the experiment is over.

Saturday, August 31, 2013

Storage Wars Strategy: Vindictive Bidding?

I'm in my hometown visiting family right now, so I have access to cable TV. Watching Storage Wars on A&E, saw one of the bidders (Jarrod?) say something like the following:
Yeah, I don't want this locker. But I'm going to bid on it to spend their money!
Just sounds plain mean. Why would you want to hurt the business of your peers?

One explanation: maybe if a newcomer enters the auction and loses money, they don't come to the next one, so you get better prices in the future. But, if you believe in the Revenue Equivalence Theorem, number of bidders is not important to the final price paid.

Three possibilities: either Jarrod is ignorant about his own business (unlikely), a vindictive person (couldn't say), or some assumption of RET has not been met (highly probable). In any case, economics continues to make reality television a bit more fun!

Monday, August 19, 2013

Hugo Schwyzer and what's broken in the market for Feminist Thought

There's a schism on my Facebook: left-leaning academics and law students from my under-grad debate career, and right-leaning economists and libertarians I've met since. One advantage is that I get access to juicy drama I'd otherwise never hear about from my current circles. A recent example is the meltdown of male feminist Hugo Schwyzer, the backlash, and counter-backlash that has resulted.

I had never really heard of Schwyzer before his scandal, but what I've gathered since: he has attained online recognition in feminist circles as a man who can write about gender issues without putting a foot too far into his mouth (a rare skill), and has been awarded tenure at a California college where he taught classes on gender and history... Until recently. He has published in no scholarly journals and admittedly took only two classes on gender in college. (With my concentration in gender studies, I feel positively over-qualified -- can I have tenure too please?)

Schwyzer has a checkered past, including drug abuse and sexual relationships with students, however these flaws have been woven masterfully into a redemption story and apparently make him qualified to talk about sex from a feminist perspective... Until last week, when he had a meltdown on Twitter and cut himself off from online communication. Describing himself as sociopathic, manipulative, drug- and attention-dependent, his recent Twitter self-flagellation is like an awful car accident: disgusting and cringe-worthy, but somehow impossible to stop looking at.

If there is an "economics of feminist scholarship", Schwyzer is an interestingly perverse example of unintended consequences at work. Here are some stylized facts and the interpretation I attach to them:

1. The feminist movement has gained increasing power in academia. The need to publish has pushed feminists in increasingly radical directions. Some branches of radical feminism seem overtly hostile towards men. Learning about these theories makes many men uncomfortable, so men who are formally educated about gender issues are rare (the supply side).

2. To continue advancing the goal of gender equality, most feminists would like to see men involved. Men can broaden the scope of feminist literature, and help counter the popular perception that feminists are "anti-male." Men who are marginally capable scholars but able to discuss feminist issues therefore have augmented job opportunities (the demand side).

3. Supply of male feminists is restricted, and demand is high, so economics would predict that the price (wage) for male feminists would go up. But, in most public universities, there isn't much flexibility in salaries -- and paying men in the gender studies department more than women certainly is not going to fly. How do markets compensate? Either male feminists get non-pecuniary benefits, or they offer lower quality services to compensate for the below-market wage. Schwyzer is an embodiment of both effects.

What is the economic prediction? Male feminists are especially likely to be opportunists. Maybe, like Schwyzer, they start off in another field (history) but then realize the pickings are better if they re-brand as feminists. Male feminist scholars then end up being lower quality than the female feminist scholars. Alternately, manipulative, borderline-sociopathic men recognize they can gain non-wage benefits from working around lots of young women (something Schwyzer admits to openly). Either way, the feminist movement feels betrayed from within.

Keep in mind that I'm speaking in terms of averages, and of course not every male feminist will be like Schwyzer. But, given the forces at work in the market for feminist scholars, I don't expect much great work to be done by male feminists, and I do expect them to be more likely to have personal scandals than the average professor.

One counter to this argument is to say that learning about feminism makes men more enlightened about gender equity so they are less likely to take advantage of women. Maybe this is true. But, learning how to use the rhetoric of feminism is also a powerful tool for manipulation if that man is not so genuinely enlightened. It's a scary prospect for feminists, as this whole Schwyzer scandal illustrates.

The problem I'm highlighting boils down to selection effects in the men who take feminist courses in college (and potentially pursue graduate degrees in gender studies to become professors). I'm not sure there are any good solutions.

Given the current feminist curriculum which focuses on women's experience, men who complete the courses are often either (1) largely in agreement with feminism, but realize that they don't have much to contribute without being accused of "mansplaining" or similar, so they either write extremely bland pro-feminist articles or specialize in a non-gender field or (2) are clever opportunists, and realize they can write articles aimed at "reforming men" while having extremely shallow adherence to feminist ideas, and then capitalize on the benefits that their "scarce perspective" brings to them, i.e. the Schwyzer path.

My prediction: like any expert manipulator, Schwyzer will claim to be reformed (again) in the next few months, will return to his old ways, and functionally nothing will change except the titles of the outraged Tumblr posts.

Saturday, August 10, 2013

Diversifying eBay Accounts

I was shopping on eBay last week to buy a wrist brace (so I don't destroy my arm with repetitive clicking) and found a seller specializing in wrist braces. Yesterday, I went to buy a pack of aircraft cable key rings, and found a Hong Kong seller who retails nothing else. When I went to buy a case for my iPod headphones, there was a vendor who sold those exclusively as well.

There are plenty of all-purpose eBay sellers, but I'm noticing more and more with narrow specializations. What is the economic justification for this?

One possibility is vertical integration: the producer is a monopolist, and takes over the retail side as well. Given the low cost of online selling and the broad reach of eBay, this is believable for some small product producers, but it's hard for me to imagine this is the majority of cases. After all, there are hundreds of sellers of aircraft cable key rings, specialized or otherwise.

(This leads to an interesting tangent: why are some goods cheaper on Amazon than eBay, or vice-versa? I've found that compact, name-brand products on Amazon are often a better deal, while eBay is excellent for small and inexpensive items. I suspect this is because eBay benefits more from "informal outsourcing" i.e. Chinese sellers, while Amazon's stricter seller policy makes this impossible. But I digress.)

I think the more likely cause for specialized eBay accounts is to diversify away risk. Selling more volume on eBay has a benefit (more good reviews give a better reputation, and can move the seller closer to the top of listings) but also a cost, because even a few bad reviews can taint a seller's profile and hurt their business. Bad reviews are also somewhat hard to predict, especially if you're selling from overseas -- e.g. if some American doesn't understand that shipping from China can take a few weeks, they might leave bad feedback for uncontrollable reasons. And, bad feedback can beget more bad feedback; it's easier to trash a seller for an issue when you see others doing the same thing. With multiple accounts, if a certain product gets a lot of negative replies, it needn't taint all the others.

So why don't more sellers diversify, and why do we see general-purpose eBay sellers with many different products (I'm thinking of giants like 1SaleADay). Partly to develop a name brand, and signal that they are investing in higher customer service. Most eBay sellers give excellent service because the terms of use heavily favor buyers in disputes. In fact, the worst seller customer service I've seen was delivered by yours truly -- I tend to be a jerk and not accept returns. Bigger sellers, especially ones trying to make a name for themselves, can't afford that in the same way an anonymous, amateur seller like me can.

When I buy from a specialized eBay seller with lots of good reviews I still expect to be treated well and get the product I ordered, and it's often at a better price. However, implicit in that good price is a slightly higher margin of risk. When I'm buying 10 keychains for $3.99 that risk is not very troubling, but if I were shopping for a new laptop it might be. This helps to explain why there are relatively less specialized sellers for high-end goods, but low-price goods are often sold by single-purpose eBay accounts.

Monday, August 5, 2013

Student loan rates on the market -- a mixed blessing

Congress responded to public demand for lower student loan interest rates, and passed legislation which ties borrowing rates to T-bill prices (USAToday reports).

On the one hand, it's generally a favorable change to tie interest rates to market conditions rather than the whims of politicians. Students will benefit from lower borrowing rates, and save a bit of money on their education overall.

There are a few costs worth keeping in mind, though:

1. Student loan rates are fixed by that year, but can change in between years. Imagine a first-year student starting in 2016, who decides to borrow at 3.9% (the current rate). Then, the next year, suppose the economy picks up and interest rates jump by 10%. With one year of sunk costs, that student might decide to keep borrowing at the higher rate... Even though, knowing that in advance, he/she might have decided to avoid the cost of college altogether. Varying interest rates are risky when you might have to borrow each year of a 4-6 year education.

2. The education market is heavily state-controlled currently. Does one bit of liberalization really help that much? In particular, students cannot discharge student loan debts in bankruptcy. More students taking loans means more potential debt servitude in the future, and the Federal Government is a tough creditor to satisfy.

I can see it now: in 10 years, this policy results in many students suffering from worse debt. Then critics say "look, we tried the market solution and look what happened!" I'm cringing preemptively now....

Liberalization or privatization is often good, but not always when the rest of the relevant market is bound up in red tape. I'd call the student loan reform a potential step in the right direction, but also one fraught with future stumbling blocks. To really help students, we should be rethinking our overall education system - perhaps with a change toward vocational education, as Bryan Caplan recently suggested.

Friday, July 26, 2013

Why do campus stores price higher than the vending machines?

File this one under "economics of trivium..."

Noticed this today: At the GMU mini-food-store, you can get pretty much all the same stuff as you'd find in the vending machine across the hall. However, they're all a bit more expensive. Dasani water for $1.59 instead of $1.50; Candy bars for $1.29 instead of $1.25. What's going on here?

If students are economic agents we'd expect them to go with the cheaper option, especially when it's only about 100 feet away. So how does the store get away with marginally higher prices? Put another way, why doesn't the student store undercut the vending machine prices, and take all their business?

I can think of a few possible reasons.

1. A convenience charge. The store has better variety than the vending machine, and it's more convenient to buy all your snacks at once. If I show up for chips that the machine doesn't have, maybe I unthinkingly grab a candy bar too, and the store can profit from my laziness (or put more charitably, can capture some of my savings in search costs).

2. The vending machine and the store are run by the same people, so they're indifferent which one I buy my snacks from. So why not have the price of one be a little higher, to extract a bit more consumer surplus? However, if this were true, I'd expect store prices to be much higher, rather than just a little bit. Maybe the goal is to avoid perceptions of unfairness by keeping price differences trivial.

3. Covering fixed costs. The campus store has to pay a cashier, while a vending machine just sits there and is restocked occasionally.

4. Positive value placed on human interaction. The cashiers are always pleasant. Maybe some (lonely) students appreciate that bit of social contact, so they put up with slightly higher prices than the totally impersonal vending machine.

Anything else I might have left out?

Sunday, June 16, 2013

Antony Davies' Allocation Experiment Falls Flat

Right now I'm at the Liberty and Society conference, sponsored by the Institute for Humane Studies (IHS) at Bryn Mawr College this week. For students of a classical liberal persuasion, it's a great chance to network and hear ideas from relevant philosophers and economists.

Today I heard a lecture on "Knowledge, Prices, and Order" by Dr. Antony Davies. While Davies is an excellent speaker and polemicist, the "experiment" which he started his lecture with is overly simplified, and ultimately counterproductive to the conclusion he wants to reach.

The Experiment: each student is given a chart which shows payoff levels for given amounts of red and blue poker chips, which represent consumption goods (as an aside, kudos to Dr. Davies for his persistence in buying out every poker chip in the greater Pittsburgh area in order to make this experiment possible). The goal is to compare different social outcomes under varying systems for allocation.

Scenario One: Dictatorship. The students elect a "benevolent dictator" who will distribute the chips as best he can, although he does not know either how many chips there are or how many students they are to be distributed to. While the distribution rule started out as even amounts (5 red, 5 blue chips) for each person, by the end the red chips were running out. I ended up with just 5 blue chips and a utility level of zero.

Scenario Two: "Chaos" (or first-come-first-served). Students are invited to rush up to the bucket of chips and grab as many as they can. One enterprising fellow at the front got a massive double-handful of chips, while the slower and less motivated (like me) got zero.

Scenario Three: "Private Property." Each student is given a bag of either a dozen all red or all blue chips, then is invited to trade with neighbors to improve their utility level.

At the end, we all report our number of chips in each scenario, then a fancy spreadsheet spits out the total social utility for each. Unsurprisingly, the "private property" outcome is closest to optimal, "chaos" is the worst, and dictatorship falls somewhere in between. This is intended to illustrate how knowledge problems make central distribution by even a perfectly altruistic dictator inefficient.

The Problem: there are several, but I'll focus on the one I find most interesting. This experiment flies in the face of core micro-economic reasoning, and arrives at its conclusion by semantic tricks and ultimately pure assumption.

In fact, this experiment does not compare different politico-economic systems at all, because those are concerned with how goods are exchanged and distributed. Instead, it compares different ways of allocating initial endowments. Assuming that zero trade can occur under dictatorship or chaos is patently false, from observation of the real world. Why would we suppose that people can only trade when property rights are perfectly protected? With imperfect private property divisions there are higher transaction costs to trade, but that does not make trade completely impossible -- if this were so, then three-quarters of the world (or perhaps all of it) would still be in the Stone Age.

Even more interesting, if trade is allowed under each scenario then micro-economics indicates total social utility would be exactly the same in every allocation! Why? Consider the "chaos" case with one guy who controls half the chips. Making some fairly common assumptions such as convex preferences (i.e. I prefer to have a combination of goods rather than all one or the other) and diminishing marginal utility of consumption, his 100th chip has very little value to him, while for me with zero chips, the value is nearly-infinite. We would arrange some trade. These trades would continue occurring until everyone has reached the point where the value of another blue chip is exactly the same as another red chip, and vice-versa. Similarly, under "dictatorship", I'd be willing to trade several of my five blue chips to get just one red.

This is a core result of general equilibrium theory: if all trades are realized, then initial endowments can be changed in whatever way without affecting total social utility. It is this exact finding that makes center-leftist economists so enthusiastic about redistribution from the rich to the poor. While I am sure Dr. Davies disagrees with this application, it is part of the canon of Neo-Classical economics and its implication should not be ignored.

The "private property" allocation where everyone starts with the same number of chips is actually a welfare economist's dream of perfectly equal endowments, which does not exist in any free market economy I've ever heard of; people have varying endowments of talent, entrepreneurial ability, cognitive capacity, and so on. Free markets work because different individual endowments exist (otherwise there would be no need for trade, another result from general equilibrium theory), and it's both misleading and contrary to Dr. Davies' point to suppose that everyone starts with equal chips. In fact, starting with the same amount of chips (but conveniently, in opposite colors) is the exact opposite of his support for low government intervention and deference to private decision-making!

To Recapitulate: Antony Davies experiment presupposes its own conclusion by only allowing trade in the "private property" scenario, when trade in any of the other scenarios would have - at least in theory - resulted in exactly the same total level of utility.

Ironically, a defender of redistribution could actually make much better use of this experiment than a classical liberal. They would simply reframe the "chaos" scenario as the free market allocation: "first mover advantage! Whoever gets to the resources first grabs them all! Look how unfair that is! Government should give everyone some base level to work with, and then markets make it efficient after that!" This argument can be easily refuted but not within the realm of the assumptions given, once the unrealistic "trade can't occur without private property" restriction is lifted.

To give some credit, this experiment is a useful way to show the benefits of trade and troubles of central distribution to an audience unfamiliar with economics. However, when drawn to the logical conclusion, it collapses.

Wednesday, May 22, 2013

How much do CEOs really make?

The Huffington Post observes that pay for "[t]he head of a typical large public company" was $9.7 million in 2012, a record high. But what really is the "typical" large company, anyways?

From the BLS, the mean Corporate Executive pay is $176,840, and the median $168,140. Obviously the well-paid outliers drive up the mean, which explains why it's higher than the median. However, the enormously well-paid executives are indeed outliers.

There are roughly a quarter of a million Corporate Executives employed in the U.S., and the vast majority are not seeing seven-figure salaries. The public furor over excessive corporate pay is an anomaly for the profession, not the norm. But depending what sample you look at, there is always something to feel outraged about.

Tornadoes and nuclear weapons

The recent tornado in Oklahoma is a great disaster, but the comparisons it has spawned are perhaps just as disastrous.

Fox News:
Several meteorologists consulted by the Associated Press estimated the tornado's energy released during the storm ranged from 8 times to more than 600 times the power of the Hiroshima bomb, with more experts at the high end.

True perhaps, but also highly misleading.

1. The tornado lasted 50 minutes, vs. a nuclear bomb going off instantly. In terms of "power per second", the tornado barely compares.

2. As modern nuclear weapons go, the bomb dropped on Hiroshima was tiny. It was 15KT, while the largest weapon tested was 15MT - a thousand times more powerful.

So yes, the tornado was bad, really bad. But comparing a natural disaster to a man-made catastrophe is rather deceptive.

Tuesday, April 2, 2013

Memorious Social Science?

I read the short story "Funes, the Memorious" by Jorge Luis Borges today. In addition to being beautifully written, it holds some interesting lessons for social scientists (sociology, economics, poli sci...) or people generally interested in explaining the world.

The story is a fictional, first-person account of meeting a young man who, after being paralyzed, could remember each detail of every moment in his life. He created a new numerical system, where each distinct number could be identified with an image or an identity [aside: this is the actual memory technique used by competitive memory superstars; recent book Moonwalking with Einstein covers the topic in a very accessible fashion]. Unfortunately, as that numerical system abandoned all forms of abstraction, it was incoherent to any other person.

Toward the end of the story, this passage particularly stuck with me. 
It was very difficult for him to sleep. To sleep is to be abstracted from the world; Funes, on his back in his cot, in the shadows, imagined every crevice and every molding of the various houses which surrounded him. (I repeat, the least important of his recollections was more minutely precise and more lively than our perception of a physical pleasure or a physical torment)...
Without effort, he had learned English, French, Portuguese, Latin. I suspect, nevertheless, that he was not very capable of thought. To think is to forget a difference, to generalize, to abstract. In the overly replete world of Funes there were nothing but details, almost contiguous details...
The bolded passage is a worthy lesson for anyone trying to model social interactions, mathematically or otherwise. A common complaint about economics is that it oversimplifies, reducing complex human motivations to "rationality" or "selfishness." However, humans are so complicated that some reduction is necessary in order to think about their behavior clearly.

A map with a one-to-one scale is simply the terrain; a model which includes every aspect of human psychology is just as incomprehensible as having no model at all. Providing guidance or prediction means abandoning detail and abstracting at one level or another. The relevant question is which details to ignore and which to include, and in this regard economics (especially when informed by insights from psychology) performs pretty well.

Funes reminds me of post-modern theorists (and other critics of social science) who demand ever more detail and less "reductive" ways of understanding human behavior. Laudable goals indeed, but by implication, theory becomes incoherent and the theorist cursed to never sleep.

Tuesday, March 26, 2013

Scarcity and Benevolence

I'm reading Democracy and Decision: The Pure Theory of Electoral Preference. Brennan and Lomasky have a very pithy reply to those who make prescriptive claims based on ethical standards:
...in deriving claims about what states of the world are feasible, one must take account of the scarcity not merely of the standard resources - time, ingenuity, and so on - but also of human benevolence and individual ethical sensibility. As Dennis Robertson remarks, one of the chief roles of the economist is to offer a warning bark whenever someone proposes a policy arrangement that demands much in the way of the scarce human resource "love." On this view, an ethical theory of social phenomena that fails to take adequate account of how people actually behave is at best irrelevant to real-world decision making and at worst deeply misleading. (5)
In other words, policy analysis (and related ethical claims) should deal with the world as it is, not as we would wish it to be. Nearly any human problem could be attributed to a lack of love for other people, but simply exhorting others to be more "loving" is not likely to fix those problems.

Tuesday, March 19, 2013

Subsidize Courtesy?

By "courtesy" I mean making others feel comfortable during interactions they have with you. This has some overlap but is still distinct from "good manners", which to my mind are more formalized and less situation dependent; manners can occasionally be discourteous (e.g. griping at someone for using the wrong fork at dinner).

In my personal life I consider myself a very courteous person. Why do I bother? Two reasons, the first being social convention and the second being economic reasoning. The cost of courtesy is basically zero, and as anyone who's been through microeconomics will tell you, when a good costs nothing you consume as much of it as you can.

So why are some people discourteous? Either they take enjoyment from others' discomfort, or face some cost greater than zero for exercising courtesy. Both reasons seem a bit silly, but the continued existence of discourtesy is pretty good evidence that both do matter in the real world.

Courtesy helps the courteous person (I enjoy social interactions more, and get what I want with less frictions from other people) but it also has obvious positive externalities: both for the person I am courteous towards, and maybe society in general when people are happier and have less strife. Imagine how productivity would increase if everyone in the workplace was kind and genial (but still firm and resolute) towards each other...

With its zero cost and social benefit, there's probably a lot less courtesy in the world than most people want. So why not have the government subsidize courtesy? Maybe each person could have a Yelp score, and strangers could rate their day-to-day demeanor, then collect a check (or a "tax break" if its more palatable) from the state governor on a monthly basis.

This probably seems a bit ridiculous, and I don't actually think courtesy deserves a subsidy. However, the case laid out above is just as (if not more) solid than many of the arguments made for other goods and services the government does decide to subsidize (education, medical care, the fine arts...).

Why does courtesy fail the laugh test and these other subsidies do not?

Social pressure and personal embarrassment are often enough to motivate courteous behavior ("virtue is its own reward"), but arguably those same forces could spur private contribution toward other public goods.

Or, maybe courtesy is just such a personal decision that the government has no capacity to control it -- just like smoking, littering, and bottle recycling -- right?

If someone can give a clear standard which divides courtesy from these popular "public goods" I'd be curious to hear it.

Thursday, February 21, 2013

Point Estimates and Division of Labor vs. Technocracy

In his recent book, Public Policy in an Uncertain World, Charles F. Manski notes
Modern democratic societies have created an institutional separation between policy analysis and decisions, with professional analysts reporting findings to representative governments. Separation of the tasks of analysis and decision-making, the former aiming to inform the latter, appears advantageous from the perspective of division of labor...
However, the current practice of policy analysis does not serve decision makers well. The problem is that consumers of policy analysis cannot trust the producers...I recommend that journalists reporting on policy analysis should assess whether and how researchers express uncertainty about their findings, and should be deeply skeptical of studies that assert certitude. That caution and advice extend to all readers of policy analysis. (pp. 173-174)
The rest of the book is quite good, and makes the case for expressing social science results in confidence intervals rather than point estimates, which give (at best) a feeling of false precision. An example of this methodology in practice can be found in Manski's paper on recidivism with Daniel Nagin (1998).

Returning to the quote above, an implication seems to be that technocracy (having the analysts make the decisions in addition to doing the analysis) might be more desirable than representative democracy. It would foster more accountability on both ends - politicians can't blame analysts for policy mistakes after the fact, and vice-versa - and I'd speculate that the benefits of division of labor in politics are a bit overstated.

However, it's hard to imagine the personality types represented by statisticians and actuaries as running successful political campaigns, so division of labor is what we've got, like it or not. Manski's caution about the false precision of point estimates might be a step in the right direction though. For example, the CBO would be a lot more credible if they gave estimates in confidence intervals, instead of specific estimates that are consistently wrong.

Tuesday, February 19, 2013

Grounding "Methodological Individualism"

This topic came up indirectly today in conversation about communitarian ethics versus classical liberalism.

Classical liberals usually envision a human subject who can choose who and what to associate with, joining or leaving various communities depending on which offers the best "bundle" of services. This search by individuals, finding their private optimums, is supposed to induce efficiency between providers of services who want to attract as many users as possible. The result, classical liberals say, is a spontaneously generated system of social goods which emerge from individuals' entry and exit into various associations.

The communitarian critique (represented by Habermas, Barber, etc.) is to say that people are social animals; we develop our selves through interaction with others. Classical liberals, according to this account, underrate the role of community which can both enrich life beyond what mere individualism can offer, and also restrict the free exercise of choice which classical liberal social theory depends on.

The classical liberal retort to this is "methodological individualism." It is simply a truism that at the core, all choices must be made by individuals so it only makes sense to ground political/philosophical views on individual choices. A community does not exist beyond the coordinated actions of its members, so to speak of "collective preferences", or similar, is just the fallacy of composition writ large.

Methodological individualism is the basis for most good, mainstream economics and from a practical standpoint I think it makes a lot of sense. Talking about the "good of the community" without addressing the incentives of its members invites fuzzy-headed thinking and bad policies which sound good on paper but never work out in the real world. In practice, most people's everyday political heuristics operate on some notion of communal good, so a strong counter-dose of methodological individualism can often lead to improved conclusions.

But, from a philosophical perspective, it's not clear that this fully resolves the communitarian critique of classical liberalism. Indeed, how can we say that methodologically individualist stance is an objective one, derived by us wise political economists with the uncommon privilege of standing outside all the social structures which block the view of others? To put it differently, if we are always already situated within social roles (to borrow some annoying post-modern rhetoric) then perhaps the classical liberal stance simply emerges from growing up in a society where classically liberal and individualistic values are commonly accepted.

Of course, the communitarian stance falls prey to this as well, because Habermas et al are also socially situated in their formulation of communitarian ethics. They have no privileged "eye from above" stance either. At this point we spiral into a long infinite regress of navel-staring and the entire discussion of political economy is put on hold, perhaps indefinitely.

Is there any grounding for methodological individualism, aside from the tautology that "only the individual chooses for the individual"? I can see two possible resolutions for this dispute.

1. Look to results (pragmatism). Which stance works better? From the historical record it appears that individualist societies have grown and prospered much more so than others.

However, there are no pure cases in the real world, and a dedicated communitarian could probably look for the social roots of Western historical success, and/or piously lament the crisis that overly-individualized society has brought upon us today.

2. Dismiss the search for grounding entirely. It may be that no code of social ethics can claim a solid foundation, and all philosophy is built upon chutzpah, pulling itself up by its bootstraps, and assuming its own foundational values into being. In this case we are left with large mental edifices that have been built upon sand, but appear to be functioning pretty much okay, so maybe it's better just not to worry about these grounding questions at all.

In an earlier time this grounding issue could be resolved with an appeal to God, divinely inspired creation, innate human dignity, and so on. But, in an era of secularized social science, competing social perspectives seem to be engaged in an endless bootstrap-pulling competition.

Friday, February 15, 2013

Future of the Welfare State -- is there one?

This was the subject of a talk I attended earlier this week. Loosely titled "The Future of the Welfare State", it featured two discussants to address the funding and politics of the redistributive state. I'll give the highlights here for those who weren't lucky enough to attend, along with some of my own thoughts along the way.

Professors Kent Weaver and Kimberly Morgan speaking at Mason Hall.


The first to speak was Professor Kimberly Morgan of George Washington University, whose presentation was titled "The American Welfare State: How We Spend So Much Yet Achieve so Little". A large part of her talk was dedicated to clearing up factual misunderstandings about the welfare state.

Some figures she cites that are worth knowing:

  • Public Social Spending in United States is ~16% of GDP (2007). Closest comparable countries: Australia, Ireland. Largest in this category is France at 28%.
  • In net social expenditure as % of GDP we're in 5th place, next to Sweden and the UK.

Net social expenditure is defined as public social spending, plus tax breaks for social purposes, plus publicly mandated private spending (not done very much in the U.S.) plus voluntary private spending (e.g. employer provided health insurance), minus taxes levied on benefits.

An implication of this net social expenditure measure is that the U.S. implicitly subsidizes many groups through the tax code, e.g. the Earned Income Tax Credit (EITC).

In the private voluntary spending category the U.S. is #1, at above 10% of GDP. Next in line is the Netherlands at ~6%. A big part of this is made up of employment-related benefits; U.S. employers spend about $15,000 per employee in health care.

Comment: I see the logic of including private health care spending as "net social expenditure" because it all goes toward public well-being in some fashion, but I object somewhat to lumping this in with government money as if private employer spending is also a variable of choice for public policy. Admittedly, the entire provision of health care by employers is a rather silly relic of wage controls passed during WW2 which has become the "new normal", but it is still distinct from government provided services and should not be treated as a dollar-for-dollar substitute.

  • In average indirect tax rates, the highest is Denmark at 26% (followed closely by other Northern European countries) lowest is the U.S. at 4%. This is largely money taken in consumption taxes, e.g. VAT. The upshot is that while the U.S. spends less in benefits, we also "claw back" less of that money than Europe does.

Startling fact: Once you count up all these different social spending categories the US is roughly equal with Sweden as % of GDP! Sweden is famous for its generous welfare state, but voluntary spending in the U.S. is what makes up the big difference.

This begs the question, if we spend so much why are the outcomes so unsatisfactory? Dr. Weaver identifies the biggest cause as how those benefits are distributed; namely, they aren't progressive enough.

  • 18% of the U.S. economy goes to health care. Next is the Netherlands, at 12%. In spite of this the American health care system isn't very good in many respects: we're strong on technology, weak on primary care, and nearly worst on "preventable mortality" among developed nations.
  • Distribution of entitlement spending in the U.S by income: the middle 60% gets 58%, bottom 20% gets 32% (from the Center on Budget and Policy Priorities).
  • Distribution of "tax expenditures": Top 20% gets 66%, bottom 20% gets about 4%, the rest goes to the middle.
Comment: describing a tax break as an "expenditure" seems questionable to me. Dr. Morgan defends this by saying that this money is "given" (i.e. not taken) to promote various social goals, so we should be observant of which sectors of society are given back to the most. To me, this distribution of "tax expenditures" seems inherently obvious: the top 20% pays the lions share of federal income taxes, so obviously there's just more to give back in the form of deductions. It's simple arithmetic.

Dedicating more tax expenditures towards the bottom 20%, who pay little if any income taxes, basically implies a negative income tax ala Milton Friedman. That's a worthy proposal to make and can be debated on its own merits, but the tinge of class warfare in this framing seems amiss.

The next to speak was Kent Weaver, Georgetown professor of public policy. His talk was entitled "Future of the Americaan Welfare State: Constraints and Options". I took less detailed notes during this section; partially because the coffee was wearing off, and partially because he made his points more often with editorial cartoons than charts or graphs, which I personally find less engaging.

He noted the demographic change occurring in America: there are increasingly less workers per retiree, a problem that is even more pressing for Japan and much of Europe. Politicians are also caught in a trap: they can only keep promising high benefits when economy is increasing.

The incentive for politicians becomes focused on NOT punishing groups rather than finding ways to benefit them. This is an interesting point, and one that could be explored in more detail through public choice economics.

Overall both speakers were good, although I enjoyed Dr. Morgan's half of the talk much more. The facts she presented were useful regardless of which ideological persuasion you came from, while Dr. Weaver was more focused on how to expand and continue the welfare state, not necessarily just reform it to accomplish its goals at the same (or lower) cost.

What I took away from their presentation is that, regardless of whether you think government redistribution is a good idea or not, the current way we're doing it in the U.S. is far from optimal. I think this provides some common ground for liberals and conservatives on entitlement reform: if the goal is to provide a social safety net without going toward cradle-to-grave coverage, policies need to be better tailored to accomplish that goal instead of the hodge-podge we have now. Of course, how to get there from here is the real struggle.

Wednesday, February 13, 2013

Development of the Cayman Islands as a Banking Center -- paper commentary

Tomorrow at George Mason's Philosophy Politics and Economics (PPE) seminar series, Prof. Andrew Morriss of U. Alabama law school will be coming to present his paper, "Creating Cayman as an Offshore Financial Center: Structure & Strategy since 1960", written with Tony Freyer (also of University of Alabama). The paper is still in a draft stage but quite good, although unfortunately, not easily available online (yet). These are my comments upon reading it.

From the paper, I understood there to be three main causal factors which led to financial market development on the Cayman Islands:

1. Relative independence granted by Britain which allowed institutional experimentation

2. As a seafaring nation there was limited ability to tax the locals directly. Instead they used indirect taxes like import duties and stamps, which stalled the growth of redistributive government and encouraged flexible policy

3. Historical timing. In the 1950s better transport and communication technology were becoming available, and the government encouraged access through air/sea travel. This allowed the banking sector to flourish even though it was far from population centers in Europe, which might not have been possible 50-100 years earlier.

One question this invites: Why not Jamaica? The two islands were administratively linked for many years, but Jamaica took a much different development path. The 1960 Companies Law is some explanation because it encouraged company registration in Cayman rather than Jamaica. The authors also note that Jamaica had a more racially-divisive independence movement while Cayman had been racially mixed for a long time, but this "shock" in the 1960s seems inadequate to explain their full divergence.

I'd argue that the Cayman Islands went into finance because they were so small. Lacking much land, population, or other resources besides access to the ocean, Cayman had few other choices but to adopt capital-intensive industries. Jamaica, on the other hand, has more arable land and also tourism revenue which made banking less of a necessity. I'm sure there's more richness that could be added to this story by someone with more expertise in the region.

I thought the section on development of the medical malpractice insurance market in the 1970s was interesting. While the authors use "crisis" to describe the U.S. insurance market of the 1970s there are several journal articles from around that time which contest that framing, and arguably the insurance market in the 1980s was more crisis-like than the 1970s. Malpractice insurance (especially for non-medical professions, like lawyers) was offered primarily by Lloyd's of London or other "boutique" insurers prior to the 1970s, so nearly any increase in tort claims might be classed a "crisis." I can see why a market opened for more foreign providers as demand for insurance increased, but I don't get a full story from the paper as to why the Cayman insurance sector benefited dis-proportionally (if indeed, they did).

Aside from this, the level of detail and description regarding the Cayman Islands as a tax haven, conflicts with the IRS, fighting laundered drug money, and so on is very impressive. Their conclusion, which emphasized the role of stable institutions in allowing Cayman to offer diverse financial services, summed this up nicely. The authors successfully make their point that strong institutions, rather than shady practices or corruption, were the foundation of the Cayman Islands' success. I just wish there had been more of a comparative element which could have contrasted Cayman against some similar nation to show more concretely how those constitutional differences mattered.

Tuesday, February 12, 2013

Review of "The Science of Success" by Charles G. Koch

I picked up a copy of The Science of Success: How Market-Based Management Built the World's Largest Private Company. It's a quick read, at under 200 pages, and I'll post a brief synopsis of my thoughts on the book here.

Science of Success starts with an overview of the history of Koch Industries, its early development and business moves, and then quickly moves into the "meat" of the book which is a discussion of market-based management (MBM). Inspired by the Misesian tradition in Austrian Economics, MBM has five aspects:

  1. Vision - locating where the greatest value can be generated by the organization
  2. Virtue and Talents - getting the right people in the right places
  3. Knowledge processes - recording and applying relevant information
  4. Decision rights - empowering and holding decision-makers accountable
  5. Incentives - giving rewards based on value-creation

(paraphrased from a list on p.26).

The fact that such a book can be written I think illustrates a strong point for Austrian Economics vis-a-vis its competitors. If one believed strongly in the Neo-Classical paradigm, with a Walrasian auctioneer who engineered prices to achieve constant social equilibrium, what role would there even be for effective management or entrepreneurship? Neo-Classical economics does have some powerful tools for predicting or forecasting social behavior, but it's not particularly useful in a non-academic setting (at least in its most common academic applications). Of course, if Koch Industries had followed the most extreme strands of Austrian thinking which are hostile to measurement and quantification, it's also unlikely they would have been so successful. However, the Austrian emphasis on entrepreneurship and discovery does make an interesting kernel for a management strategy.

As a handbook on management, The Science of Success has many aspects that you would expect: examples of successful and failed corporate experiments, dealing with people, and product development within a competitive market. I found the parts on how to work within a regulated market to be particularly interesting because those seem like areas that an Austrian economic approach, which appeals strongly to free markets, might struggle. I just wish the section on "Practicing MBM in a Political World" had been a big longer and more detailed.

In many ways, the book is directed more toward helping people understand the philosophy which has driven Koch Industries, rather than necessarily showing how to implement it in other contexts. As described in the introduction, The Science of Success is primarily aimed at current or future Koch Industries employees who want to know how the company thinks and operates, and only secondarily toward a more general audience. So, if you're the CEO of a young start-up company this should still probably be on your reading list, but maybe not as the first title.

In addition to its core Austrian influences, other management thinkers are also featured in The Science of Success. Michael Polanyi is quoted several times, and W. Edwards Deming's idea of continuous improvement is also a driving influence. While some might read it as an ideological screed, The Science of Success also sticks to mainstream best practices. Many of the ideas expressed in Austrian economic jargon could probably also be found in other management handbooks, just phrased differently.

I do have some small technical criticisms. A chart on p. 27 compares a $1000 value of Koch Industries growing since 1960 vs. $1000 in the S&P 500 over that time -- the divergence is notable. However, that difference is somewhat driven by survivorship bias; there were many small natural resource companies an investor might have chosen from in 1960, but many of them are now defunct, and their former CEOs have no reason to write a book on management. Similarly, entries in the S&P 500 have changed over that time, always reflecting relatively "mature" companies which have already reached a stable size and stopped growing quickly. If you were to pick, say, Microsoft or Xerox from its inception and track it against the S&P 500 over that same time period you'd see the same sharp returns curve, but that's because you're comparing a company known in hindsight to have been successful (information not available to investors at the time) against an index representing a safe return. It's not a fair comparison.

Overall, The Science of Success is worth reading because it lays out the intellectual driving forces of Koch Industries. Given the prominent role that the Koch brothers have taken in the world of ideas regarding libertarian economics and public policy, this is useful background knowledge for anyone engaged in those discussions. To keep a semi-balanced perspective, perhaps I'll pick up some of the authorial works of George Soros next...

"Portfolios of the Poor" -- active financial lives on $2 per day

I started reading Portfolios of the Poor by Daryl Collins, Jonathan Murdoch, Stuart Rutherford, and Orlanda Ruthven. I'm not very far in yet but I'm already impressed by their data collection methodology, which involves a "financial diary" kept by the people they study.

Discussing borrowing and lending between families in the third world, they note
Because these activites are "informal" and not written down, they are easy to overlook or hide... It was sobering, then, to find that we would have missed much of the action had we undertaken only single, one-time interviews of each household. Using the South African data, we did a "flow of funds" analysis - comparing all inflows to all outflows of money in each time period for each household - and found that, in the earliest interviews, we were often missing more than half a household's financial activity in a given week.
...The frame-after-frame views revealed much greater levels of financial activity than large surveys usually show, and much more active management of finances... We might have blindly accepted arguments that they are especially eager for loans to run a small business, or that, if offered loans, they would fall rapidly into deep debt...
All of those assumptions are right some of the time. But they are wrong much of the time. Uncorrected, they can mislead businesses that plan strategies to work with households like Hamid and Khadeja's, and misdirect policymakers who design interventions to hasten their escape from poverty. (pp. 12-13)
This might be a shock to Western commentators who want to "empower" the poor that the poor are quite empowered already. A lack of physical resources doesn't always imply lack of mental resources.

On the one hand, this is cause for optimism because those in poverty are already actively working to improve their lives, but on the other, it should cause pessimism about policy attempts which assume that the poor will follow along unquestioning with whatever "development" scheme is foisted onto them. The failure of traditional foreign aid over the last fifty years shows the wisdom of both perspectives.

Monday, February 11, 2013

Does credit card fraud have a GDP multiplier?

The exposure of an 18-person credit card fraud ring, which involved 7,000+ fake identities and 25,000 credit cards, got me thinking about parallels between government stimulus and private fraud.

Some of the most popular arguments for government spending go something like this: "companies are sitting on lots of cash, holding out reserves which could be stimulating the economy if they were put to good use." Banks, manufacturers, tech companies... All with big cash stockpiles that make government spending enthusiasts' eyes grow wide.

So what exactly is the difference between government taxing away money and spending it, versus fraudsters tricking banks into lending them money and spending it? The recently uncovered ring is estimated to have stolen $200 million - small potatoes when it comes to stimulus - but it seems the effect on the economy is nearly identical to government spending, just on a smaller scale. If the Keynesian story is correct, all those purchases of luxury cars, jewelry and so on should be applauded because they increased aggregate demand and spurred job growth in associated industries.

Going a little deeper, most of the arguments for why fraud is bad for the economy also apply to stimulus.

1. Fraud takes resources away from higher valued uses to lower ones. But, government stimulus likely does the same, by bidding away inputs from the private sector to the public and investing them less efficiently.

2. Fraud undermines trust which is essential to a market economy. But does anyone really trust that government is spending money wisely either?

3. Fraud causes dead weight costs when businesses try to protect themselves against fraudsters through costly measures. But tax evasion and IRS-dodges are also wasted resources to avoid the grabbing hand of Uncle Sam.

4. Fraud creates bad incentives, causing potentially productive people to exploit others instead of producing. Government service may be less directly exploitative but it tends to generate more paperwork than goods, generally speaking.

5. Government can spend on infrastructure or other public works which generate future growth, but fraud is money wasted on immediate consumption. I think this claim is actually fairly persuasive, although unfortunately most government spending is also consumption - missiles and medical treatment - and lots of supposed "infrastructure" ends up being bridges to nowhere or Solyndra-style investment. But it's at least marginally better than fraud.

The implications are thought provoking. If dedicated Keynesians are convinced our problem is just that austerity-hawks in Congress are damming up the necessary flow of federal dollars to create a robust recovery, it seems like the solution is to encourage more "private Keynesianism" through credit card fraud. If the multiplier works then we should all be happier if banks have their funds stolen and wasted on consumption.

The fact that most of us think this idea is ludicrous and even immoral when done by private agents, but much more plausible when undertaken by the state, says something about the heuristics that people bring into play when talking about government and the economy.

Sunday, February 10, 2013

Legalize voter fraud. An economic case

"Fraud" has such a nasty ring to it; more specifically, I'll argue that voters should have the right to sell their federal ballot like any other economic commodity. Four reasons (five, actually, counting the super-libertarian one, but I'll leave that low-hanging fruit for the Mises Institute) this might be good public policy.

1. Politicians are bought already, and that money should go to voters instead. For all the efforts that have gone into campaign finance reform, limiting donations from lobbyists, the "toothpick rule", and so on, D.C. is still awash in political money. Revolving door jobs for Congresspeople in the industries they formerly regulated are common as well. 

Lots of money is made by being in Congress, and those people hardly even need it! Average net worth for a Senator is about $14 million. Let's democratize the bribery and have some of the spoils go to the common people instead.

2. Direct transfers are better than indirect transfers. Politicians already buy votes through generous entitlements and pork barrel politics for their districts. But, as any kid will tell you, it's better to get a twenty dollar bill than a $20 gift card. People would probably prefer to get direct transfers for their vote, but because that's illegal, the second-best solution is to give lots of indirect transfers instead. These also cause distortions and economic inefficiency, which would be lessened if money was just given in lump sums to voters.

3. Improved fiscal policy. Entitlement programs like welfare, Medicare, Social Security, and so on create vested groups of voters who will vote to keep those programs around during their lifetime, even though they will likely bankrupt the next generation. This makes reform nearly impossible. But what if you could buy out senior citizens by giving them a cash transfer equivalent to their expected Social Security benefits if they vote for reform? 

In effect, purchasing votes introduces Coasian bargaining to the political process, which can help reduce externalities created by majority-rule democracy. If voters choose candidates selfishly, that selfishness can be harnessed for the common good and improve public policy, leaving us all better off. When peanut and tobacco subsidies were cut a similar "buy-out" policy was used to lessen opposition from farmers, so the idea is hardly unprecedented.

4. It has a long and distinguished tradition in America. In early American history, voters were brought to the polls with offers of free food and drink. I suspect reviving this practice would lead to a great increase in voter turnout.

File this away under the "posts which guarantee I'll never have a career in politics" section.

Friday, February 8, 2013

"Tyranny of Political Economy" by Dani Rodrik -- a brief critique

Today Professor Dani Rodrik of Harvard published an article criticizing economists' traditional political economy models which emphasize vested interests, and advocated for the role of ideas in shaping government policy. I enjoyed the article, but at the same time I think it is overly optimistic about the role of economists and completely ignores the role of voters.

A snippet of his argument:
If politicians’ behavior is determined by the vested interests to which they are beholden, economists’ advocacy of policy reforms is bound to fall on deaf ears. The more complete our social science, the more irrelevant our policy analysis.
...By endogenizing politicians’ behavior, political economy disempowers policy analysts. It is as if physicists came up with theories that explained not only natural phenomena, but also determined which bridges and buildings engineers would build. There would then scarcely be any need for engineering schools.
Almost ironically, this stance seems to be driven by his own vested interest. "If vested interests drive politics, there would be no need for the type of courses that I teach. I know that the courses I teach have value, so it cannot be the case that vested interests drive politics!" It cannot be because it must not be. 

If we start from the assumption that what economists teach is both true and useful, this is a valid point, but those assumptions are not verified a priori: it is perfectly plausible that what economists say is true but of no use at all in the realm of politics. It would be unfortunate, but possible. It's premature to rule out policy irrelevance.

Of course, as Dr. Rodrik rightly notes, there are many examples of politicians responding to ideas rather than solely to vested interests. I agree that models which solely focus on the venality of elected officials are missing part of the picture. But are ideas alone enough to fill that gap in? He goes on to say:
There are three ways in which ideas shape interests. First, ideas determine how political elites define themselves and the objectives they pursue...
Second, ideas determine political actors’ views about how the world works...
Most important from the perspective of policy analysis, ideas determine the strategies that political actors believe they can pursue.
This is all true, as far as it goes. But where do the voters factor into this account? If voters are rationally ignorant or, even worse, actively irrational in their policy preferences, the ideas that politicians respond to may not be good ones.

Suppose that tomorrow there was suddenly a 100% consensus among economists that open immigration would boost national GDP and make the general public better off, and that every politician was made aware of this fact. Would that be enough to overcome the public's anti-foreign bias, which makes open immigration a quick ticket to the unemployment line for elected officials? Probably not.

Tellingly, Dr. Rodrik's examples of policy revolution due to the role of ideas - China and South Korea - are/were not particularly democratic states. So bringing good ideas to the ruling elite can have great results, but only if you can bypass all the terrible ideas brought by the general public, which is not an option available to us living in a Western democracy.

In this respect, the "vested interest" story is more optimistic than the "ideas" story. Even if the steel industry gets its way and extracts some rents from the general public through higher prices, they also care about keeping the overall economy functioning. If politicians respond to ideas, they're probably bad and wrongheaded, which is much more likely to crush our economic output.

Arguably, the best social role for political economists is advising the vested interests in how to rent-seek in the most inoffensive way possible. It's less noble-sounding, but a much more direct route to policy relevance. There is still a role for teaching good economic principles to students, but expecting that to trickle-up into better policy is optimistic in the extreme. Given the choice I'd rather speak to the captains of industry, rent-seekers though they might be.

Thursday, February 7, 2013

Chart of the day: (dis)trust in government

The Washington Post today reported on a Pew Research project which has tracked trust in government over the last fifty years. The results are surprising.

In the sixties, during the days of the counter-culture, trust in government was at a historic high of 73%. It began to fall with the aftermath of Vietnam and Watergate, rose slightly again under Reagan and Clinton, and now has bottomed out at 26% under Pres. Obama.

Source: Pew.
A libertarian interpretation of this graph: the steady expansion of government power and services is not a good representation of "the will of the people." If the public was genuinely happy with all the regulations and general largess being given out by the Federal Government, one would expect to see their trust increasing because they're getting more of what they want! Instead, the opposite has happened, and an increase in the government's power has made it steadily less trustworthy.

A psychology interpretation: blame the media. Maybe government has been basically the same over this time period, but journalists have gotten more and more tools to muck-rake on our leaders. So representativeness bias leads people to think government is less trustworthy than it really is, because that's what they see on the tube.

A political science interpretation: this is old news. People commonly say they distrust government in general, but when asked about their Congressperson specifically, they tend to have favorable impressions. This is why incumbents can keep winning even when Congress as a whole has a ~10% approval rating. It's always "the other guys" we don't trust, but of course our state would only send an angel into office.

A demonstrated preference interpretation: who cares what people say to a pollster about their opinions of government? Their voting decisions (and continued willingness to live in this country) show that they are generally pleased with what government is doing. If the median voter truly distrusted government this much, they wouldn't keep voting for it.

The Washington Post takes a lamenting tone, talking about the "death of trust in government." Frankly, I'm more optimistic. If distrust makes voters more watchful of our representatives, maybe they'll start doing more things that we want and less of the things we don't.

Rent dissipation and Greek food riots

Is food really "free" if you have to wait in a huge line and risk getting trampled by an unruly mob to get it? This must be what many Greeks are asking themselves right now. A farmer's protest which distributed free food ended in disorder and several people were seriously injured.

More generally, this illustrates a concept raised by Gordon Tullock: rent dissipation. If there is "free money" available, people will compete for it up until the costs of competing are equal to (or occasionally greater than) the value of the prize.

For example, when universities give out free tickets to basketball games, students stand in line for a week in advance to get them. People will be willing to stand in line until the value of the ticket is equal to the value of the time lost, which (not coincidentally) is probably very close to what the price would have been had the tickets been offered for sale. The same logic can be applied to political contests, online deal hunting, and many other activities.

So, some people in Greece received free food and were better off as a result of the giveaway, but a few people were hurt in the process. Gains equalize losses. Rents are dissipated. The lesson: there truly is no such thing as a free lunch.


Wednesday, February 6, 2013

Nietzschean Classical Liberals

This thought inspired by a conversation yesterday.

People with nihilistic or Nietzschean philosophical views probably reject the underpinnings of libertarianism; what is "freedom" but another empty value? However, such people have strong reason to support a classical liberal system of government, because it's one of the few which protects people with wildly unpopular philosophical beliefs (as Nietzscheans tend to be) from persecution by the masses. So the "practical" nihilist might advocate for libertarianism, even while thinking most of its ethical claims are baseless.

There is also an argument to be made, as presented by Edward Romar's 2009 paper, that Hayek's free markets and Nietzsche's disdain for slave morality are perfectly consistent, but I'll leave that interplay for the philosophers to sort out.

Can you know what you want when you know nothing?

Specifically, about politics. In the first chapter of Collective Preferences in Democratic Politics, Scott Althaus raises this dilemma:
Sampling problems and nonresponse error are well-known pitfalls to survey researchers, and the questions that are used in surveys may fail to capture the public's real concerns. While these problems are worthy of serious attention, there is an even greater problem about which few seem aware or concerned: the public's low level and uneven social distribution of political knowledge diminish the quality of political representation provided by opinion surveys... This problem is so pervasive as to call into question whether opinion surveys can tell us reliably what the people really want. 
In other words, if a tree falls in the forest but no one nearby can tell a tree from a bush or weed or flower, should we put any stock in their opinion about whether it makes a sound?

Tuesday, February 5, 2013

If you can't ban it, regulate it to death, Part 2: "Gun Insurance"

This just in. California Democrats propose that gun owners should purchase "violence insurance" to cover damage that it might cause. The idea is silly enough that it probably can't even pass in California, but just to beat a dead horse even further...

1. Most gun crimes aren't committed by licensed gun-owners. According to the Bureau of Justice Statistics, 80% of criminals acquire guns illegally. In Texas (2009) there were 65,651 gun-related violent crime convictions, only 101 of which were committed by people with licensed concealed carry permits. In other words 0.15% of crimes were committed by legally carried guns - approximately one in a thousand. Obviously a gun-toting criminal won't care about insurance requirements any more than (s)he cares about concealed carry laws.

Premiums for gun insurance will either be negligible and thus irrelevant, or they will inaccurately count illegally committed crimes against legal gun owners, causing insurance-buyers to effectively cross-subsidize damage caused by criminals.

2. Personal liability should be enough to deter carelessness with guns; being bankrupted due to misuse of a firearm is a pretty serious consequence. And, if that doesn't stop someone, why would purchasing insurance be any more of a deterrent? If anything, the economic prediction would be that insurance encourages less care by gun-owners, because the costs of their mistake will be borne by the insurance company (as well as the unlucky victim). Of course, maybe insurance companies refuse to insure people who seem like a "bad risk" but this is effectively circumventing the second amendment right to bear arms.

3. Such insurance basically functions as a tax on guns, which will only help keep them out of the hands of low-income individuals who might live in dangerous neighborhoods and want personal protection.

Beyond the immediate consequence of more crime, the implications of taxing a right protected by the Constitution are staggering. Should every YouTube contributor have "free speech insurance" in case they post an inflammatory video that causes riots overseas? Should every voter carry insurance in case their ignorance brings war-mongering, deficit-raising politicians to office? Oh wait, that is called a "poll tax" and we had a Constitutional amendment to get rid of them.

I hope I'll look back at this blog entry and laugh at myself in a few weeks for even thinking there's a chance that this law might pass, but stranger things have happened in politics.

Counter-signaling and Crayon Resumes

Taking as a starting point that most education and credential-seeking is in fact signaling good traits to employers (rather than productivity enhancing) one has to wonder what sorts of strategies an informed job-seeker might use to take advantage of this system.

One aspect of signaling is that it has a negative externality on other job-seekers; every new degree I get makes others look comparatively worse, so they need more degrees and so on. It's an academic arms race. Only one person can be the "best" candidate, and as more and more degrees are acquired, the marginal value of each continues to fall.

So what about counter-signaling, i.e. intentionally refusing the signaling game or sending the opposite of a positive signal in order to distinguish oneself from others? This phenomenon certainly exists in some areas; think of brilliant Berkeley mathematicians who dress like homeless people. They're simply so good that they can actively disregard social convention, and the fact that they can afford to disregard convention is further evidence that they are that good.

So when might it be advantageous to do something outlandish when applying for a job, like submit a resume written in crayon? It would certainly stand out, but to work I think these other three conditions also have to be met:

1. Other observable traits already show you are highly competent;

2. The signaling market is fully saturated;

3.. Value placed on conformity is low.

What sort of jobs might fit these conditions? I think the third is least likely to be satisfied, because people in general (and employers especially) tend to value conformity. However, being a nonconformist in polite and non-threatening ways can sometimes pay off, as this intern's application to Wall Street which went viral demonstrates.

If you're a demonstrated mathematical genius applying for a hedge fund position along with 10,000 other mathematical geniuses, maybe a crayon resume would pay off. Unfortunately,I suspect for the rest of us the conformity test would lead that resume straight to the trash bin.

Conservatism: wisdom of ages vs. path dependence

I think one of the better arguments for conservatism (historically speaking, not necessarily the modern-GOP variety) is the classical one raised by Edmund Burke. To paraphrase, the institutions we have now were chosen over time because they worked well and served some purpose that people valued. It is all very well and good to question those institutions, but before making radical changes, we should understand why things are the way they are.

Put bluntly: give presumption to the status quo, and put the burden of proof on those who would change it.

This argument is persuasive against radical revolutionaries, but it is vulnerable to a simple counter-argument: times change, and institutions often do not continue to serve the purpose they were originally designed for. Uncritical acceptance of what is can lead us to path dependence, where we repeat the same mistakes over and over again.

How to resolve this dilemma? I'm reading Robust Political Economy by Mark Pennington, and I found his take on this to be fairly compelling. In defending the classical liberal tradition, he says:
Social evolution depends on the battle between competing ideas and can be halted or reversed owing to human error. There is, therefore, no implication that 'whatever is must be efficient.' For much of human history, the prevailing assumption has been that social order can only be maintained by the exercise of deliberate authority. It has been the contribution of the classical liberal tradition to argue that this is not so... Looking for ways to expose institutions to competitive trial and error may be a more robust method...
Recognising the benefits of competitive processes is not to deny a role for institutional design. Rather, the central concern is to create a framework within which evolutionary processes can be harnessed to beneficial effect. (p. 43)
From this perspective, a limited government is best because it allows maximal experimentation. The wisdom of ages will thus be preserved, while path dependence will fail the competitive test. I'm not sure that's the end of the story for Burke, but it's a good advancement in the classical conservatism vs. classical liberalism debate.

Monday, February 4, 2013

If you can't ban it, regulate it to death: abortion laws in Michigan

This from Bloomberg Businessweek, Jan. 21-27 edition:
On Dec. 28 last year, Michigan Republican governor Rick Snyder signed an omnibus bill combining multiple abortion-related measures... One stipulation requires abortion clinics to install special gooseneck scrub sinks. Another says recovery rooms must provide 80 square feet of floor space per bed, three feet between each, and one lavatory for every six patients. Corridors must have a minimum width of six feet...
These sorts of regulations should seem immediately silly to libertarians - regardless of the service being performed, shouldn't a business be free to decide on its own how wide the corridors are? - but they also expose some fundamental incoherence on both sides of the pro-life / pro-choice debate.

1. Liberals who are both pro-choice and pro-regulation face a contradiction. If the state is empowered to regulate as the populace sees fit, how to ensure it doesn't regulate away (arguably) core personal freedoms, like the decision not to carry a child to term? The result of increasingly onerous regulation on abortion clinics may be eventually the same as banning it altogether, effectively circumventing Roe v. Wade. But how do you fight such a strategy without admitting that regulations themselves are fundamental violations of human freedom?

2. Conservative politicians are presumably acting in response to strong constituent demands to stop abortion. But, if these regulations are couched in terms of safety and patient services, what are they supposed to tell the voters? "We've made abortion SO SAFE and with SUCH GOOD amenities that no one will be able to have one anymore." **wink wink, nudge nudge** Obviously, anti-abortion groups can read between the lines. but what happens if the Onion's "Abortionplex" moves from satire into reality? The end result might be that abortion clinics become so high tech and sophisticated that their use does not decline by much; higher quality service compensating for higher cost. What then?

I guess no one has accused political parties of philosophical coherence, but the convoluted and short-sighted politics of abortion regulation are now verging on self-satire.

Why are some societies rich and others poor?

Short answer: institutions + entrepreneurship.

Perhaps the most important question for modern economists, discovering why some societies have achieved great affluence while others remain in grinding poverty has spurred much important research. Obviously, under-developed societies lack the abundance of productive capital and labor which promotes growth in other parts of the world. However, this observation only scratches the surface; more than two trillion dollars has been given in foreign aid over the last fifty years so if capital investment alone were sufficient to end poverty, the problem would be solved already. In my view, there are two necessary elements for a society to prosper: a culture of entrepreneurship, and stable institutions which protect private property. If either alone were sufficient then poverty would be much easier to combat, but in reality both entrepreneurship and institutions are needed to create economic growth.

Entrepreneurship, defined broadly, is risk-taking aimed at exploiting previously untapped benefits from exchange. All humans almost certainly have some spark of entrepreneurship within them, but depending on the society they live in, that drive may be expressed along different margins. In cultures which promote group conformity, entrepreneurship which causes divergence from societal expectations may not be accepted. Individualistic culture, as is most often seen in Europe and the United States, has proven the most open to entrepreneurship, and led to more opportunities for economic growth. Entrepreneurs find new ways to use low valued resources and new ways to connect buyers and sellers, in ways that enrich both themselves and other members of society.

While by definition all freely chosen exchanges are mutually beneficial, not all exchange is voluntary. As Baumol (1990) famously observed, entrepreneurs can be either productive or destructive. The way entrepreneurial talents are deployed depends on another set of factors, referred to broadly as institutions. This encompasses the stability of the legal system, ability to enforce contracts, security of private property against state expropriation, and so on. Entrepreneurs operating in a weak institutional environment may exploit non-market methods to coerce others into involuntary exchanges. Coerced exchange transfers resources from higher-valued to lower-valued uses, causing society’s total wealth to shrink.

Institutions with consistent rules, applied impersonally, are best able to avoid destructive entrepreneurship. The Anglo-Saxon common law inherited by the United States from Britain is a good example of such an institutional structure. It is no coincidence that Hong Kong, which was also governed under British law for many years, outpaced the rest of East Asia in economic growth throughout the 20th century. The people of Hong Kong are presumably not very different from mainland Chinese, but because they acted under a different set of institutions their productivity was much higher, leading to rapid economic development.

To use a mechanical analogy, one can think of economic growth as a moving vehicle with entrepreneurship as the fuel and institutions as the engine. Without any fuel, even the best engine will not move forward; on the flip side, a badly constructed engine with lots of fuel will lose energy as waste and ultimately self-destruct. As almost any person is a potential entrepreneur to fuel economic growth, I think this second scenario is much more prevalent in poor parts of the world. There is nothing innately wrong with the people, except that the institutions they live under cause productive energies to be wasted and resources to be expended on rent-seeking rather than innovation.

 The reason that some societies are prosperous is that their people were free act entrepreneurially, and they were guided by strong institutions toward making mutually beneficial exchanges. In some under-developed societies entrepreneurship is hobbled by cultural attitudes which do not respect individual achievement, and by institutions which reward predation rather than creation (or both). This is why transferring capital from the rich to the poor alone is not enough to solve poverty; without the institutional and cultural preconditions for development in place, resources cannot be productively employed to bring lasting prosperity.

(Context: I wrote this essay for another purpose but I like it enough to recycle as a blog).