Perversity of preferences

10/04/2014 § 2 Comments

I’ve been watching the roll-out of the Affordable Care Act (ACA) in the US. I understand why the Rube Goldberg apparatus was set up the way it was. Doesn’t make me happy about it, but it does mean that more people are better insured.

The Supreme Court ruling that cleared the final roadblock was exactly the sort of split-the-baby decision we should have expected. As sometimes happens with rulings, the implications weren’t immediately clear. In particular, the provision that states could opt out of the Medicare expansion turned out to be more important than was first thought. The implications were recently discussed in an interview with Prof Jonathan Gruber, MIT, Director of the health care program at NBER:

[T]he single thing we probably need to keep the most focus on is the tragedy of the lack of Medicaid expansions. I know you’ve written about this. … I think we cannot talk enough about the absolute tragedy that’s taken place. Really, a life-costing tragedy has taken place in America as a result of that Supreme Court decision. You know, half the states in America are denying their poorest citizens health insurance paid for by the federal government.

(N.B.: ‘half the states’ does not mean half the people — the states in question are less populous than the ones that expanded Medicare.)

Why do I point this out? Because the economist Gruber was surprised by the politics:

if you’d told me, when the Supreme Court decision came down, I said, “It’s not a big deal. What state would turn down free money from the federal government to cover their poorest citizens?” The fact that half the states are is such a massive rejection of any sensible model of political economy, it’s sort of offensive to me as an academic. And I think it’s nothing short of political malpractice that we are seeing in these states and we’ve got to emphasize that.

‘What state’ is an incorrect way to think about the issue. It wasn’t ‘states’ that decided. It was people, specifically politicians and the voters who support them. What politicians-and-the-voters-who-support-them would turn down free money? People who believe — who prefer, let us say — that poor people should not be helped. That poverty is just desserts. That poverty is just the flip side of positive incentives for hard work and sober decisions. These people prefer a certain set of incentives aligned with a specific view of how the world works (Weltanschauung, if you don’t mind me saying).

This ACA situation is the Ultimatum Game writ large. We just played the game in class. When the offer was 50:50 or 60:40, it was accepted. When it was 90:10, it was rejected. Person A turned down free money because Person B else wasn’t ‘playing fair’, wasn’t acting according to Person A’s preferences.

Politics is a way for people to express their preferences and try to foist them on other people. It is also a bloodsport, as Dr Thompson would remind his readers. That’s my way of saying, of course these people rejected Medicare for the poor, even at a cost to themselves. They are using the issue to Make A Statement about how the world should be, and if people get hurt, well, omelettes and eggs.

It’s an important lesson for economists working in policy. People’s preferences are wild and woolly, and when expressed through political process can lead to seemingly perverse results.

Magic asterisks

27/03/2014 § 3 Comments

I’ve been fighting magic asterisks lately.

Unfortunately, I’ve been doing it secretly — anonymous reviewer, confidential client work — so I can’t share the details. I can’t even show you the costume. But I can rant a bit.

The original Magic Asterisk (TM) was a Reagan-era budget device from David Stockman. To make the net budget come out right, he resorted to adding asterisks that indicated unspecified spending cuts. The cuts didn’t happen, of course, but the budgets balanced. The books might not have, but the budgets did.

I am starting a collection of terms that people use in economics as magic asterisks. These are devices — rhetorical, mainly — to get them from what they can prove to what they wish to be true. They are little bridges from reality to ideology.

Here is the start of my collection, and why [note heavy use of sarcasm]:

  • Lock-in, path dependence — sure, the decision you face looks straightforward, but the unspecified opportunities that you are destroying in the fractal future are amazingly valuable! If you make the wrong choice, you will be forever condemned to a life of regret and penury.
  • Non-linear — oh, man, it’s gonna go boom! Don’t you see, it’s non-linear. Just a little push, and you’ll be smiling it’s all over! Like, y’know, compounding interest and discount rates and the parabolic effect of gravity on a tossed ball.
  • Uncertainty — you don’t really know, do you? The future is uncertain. Anything could happen. Oh, and maybe some evil demon is just dreaming all this.
  • Chaos theory — classical mechanics doesn’t really understand cause and effect. Butterfly wings and hurricanes, that’s all I’m saying. It may look unimportant, but it could have really big consequences.
  • Bounded rationality — you can’t know everything! and people make mistakes! That means you don’t really know anything and you’re probably even wrong about that.

Don’t misunderstand me. All these terms have meanings. Actual, y’know, defined meanings that can help us understand economics better. Take bounded rationality. As Simon developed the idea, it focused on using rules of thumb in structured environments to achieve a ‘good enough’ outcome without optimising. Some people think it just means not optimising. Some people think it means optimising subject to cognitive constraints. It was something different — it was about the method that people used. Powerfully, it shows how using rules of thumb is useful in predictable circumstances but possibly catastrophic in others.

Feel free to add your own.

Details of economic perceptions in US

24/03/2014 § Leave a comment

The Pew Research Centre reviewed some interesting results. They start off saying that there’s a puzzle:

One of the biggest political puzzles of 2014 is why the public remains so bearish about the economy, and in turn critical of Barack Obama’s stewardship of it, given clear signs that economic indicators are improving.

First, they have been finding for the last few presidential administrations that perceptions of the economy are linked to party affiliation. That trend still holds. What is curious is that Pew thinks it is curious. It makes perfect sense, really. If your guy is in power, you are probably going to be pleased with how he’s running the place. If the economy is strong, it’s because of him. If it’s weak, he’s doing the right thing to make it better. So, the partisan gap isn’t surprising.

Secondly, they report a gap in perceptions of personal finances that correlates with education:

For example, college grads now size up their finances roughly as well as they did before the Great Recession took a toll on their outlook. In contrast, personal financial assessments of the less well-educated Americans have not improved as the economy has recovered after the Great Recession.

But again, this roughly reflects what’s happened. People with college degrees have tended to do better, both before the recession and after. The assessment of the non-college graduates is probably realistic: more unemployment, longer unemployment, lower wages, etc.

I’d be really interested in similar surveying for New Zealand and Australia. UMR Research, for example, has the Mood of the Nation survey. The reports on their site don’t break down results by demographics, though.

I’m an idiot

03/03/2014 § 3 Comments

I was looking at per-capita GDP today. Turns out I hadn’t realised how bad it’s been. I mean, I knew things had been moving a bit sideways and that the recovery, such as it has been, hasn’t been flash. But I hadn’t realised the full extent. So, from Stats NZ:

Real gross national disposable income per capita ($ 1995/1996 prices) SG09RAC00B06NZ

2008 — 32,247

2013 — 32,869

That’s growth of 1.9% in five years.

No wonder we’re grumpy.

Teaching vampire squid economics

26/02/2014 § 6 Comments

I’ll be doing a little teaching this term. As those of you who teach know, there isn’t really anything that’s ‘a little’ teaching. With a new prep, there’s a lot of worrying and wondering and researching.

And then Matt Taibbi (old place, new place) comes along and makes it even harder.

I’m a little late coming to this, because I wanted to say more about it but the clock has run out, but Taibbi had some frightening reporting a couple of weeks back about the concentration of economic power:

Today, banks like Morgan Stanley, JPMorgan Chase and Goldman Sachs own oil tankers, run airports and control huge quantities of coal, natural gas, heating oil, electric power and precious metals. They likewise can now be found exerting direct control over the supply of a whole galaxy of raw materials crucial to world industry and to society in general, including everything from food products to metals like zinc, copper, tin, nickel and, most infamously thanks to a recent high-profile scandal, aluminum.

How should I teach this?

Because a) this is going on so students are hearing/reading about it and should have tools to understand it, and b) I believe that it is economically important.  I’m just a humble microeconomist mostly interested in decision making by individuals, so these sorts of corporate organisations aren’t really my bailiwick, especially when they start getting crossed with macroeconomics like fiscal policy. But the main theories of micro are mostly about not having control over markets. I’m just preparing a lecturing on supply and demand, and looking at using the Pit Game (pdf). These vampire squid schemes — and other major events like Enron, which cost California something like US$40 billion, around 80% of the entire New Zealand economy at the time — lead me to wonder about the balance of time spent on theoretical market efficiency versus actual commercial behaviour.

It also leads me back to Galbraith, who discussed the attitudes of the men running corporations in his day. They believed it was their function, not the market’s, to allocate returns to shareholders, management and labour. Other centres of power, such as labour unions, were therefore not anti-competitive, but a necessary countervailing power for an economy that was already far from a market solution.

I propose a new class: Vampire Squid Economics (Econ 20X). Each lecture centres on a case study: Enron, Goldman Sachs I and II, AIG 2008, etc. Prereqs are intro micro and macro. Heck, we could even develop a common syllabus and offer it across the country. Then I can park all this messy reality somewhere and get back to teaching theory.

TPP — can’t get something for nothing

12/02/2014 § Leave a comment

I have avoided discussing the Trans-Pacific Partnership (TPP) trade negotiations, because it’s complex and secret and yet to be decided. But a statement from Tariana Turia, Associate Minister of Health, leads me to comment. Turia’s plain packaging for cigarettes bill just passed its first vote. The bill is intended to reduce the sale of cigarettes by making the packaging less attractive. A challenge to a similar Australian law is before the WTO, and the bill raises questions about the TPP.

The question is whether New Zealand will have the latitude to pass such laws should it sign the TPP. Just to stress, until the language is finalised, it’s all speculation. This legal post on investor-state arbitration is an example. But, Turia’s statement suggests a certain naivete about the negotiations. She said:

While the tobacco industry may have laid down a threat that if this legislation is passed [it will be challenged] my message to them is that our country has a sovereign right and a legal right to protect its citizens.

The point of these sorts of negotiations, though, is the give-and-take. New Zealand gives up a bit of its sovereignty to make laws within its own borders in exchange for consistency across borders.

One lesson from the analysis of international trade — the one that gets trumpeted — is that free trade makes countries better off. It lowers prices, increases the amount of products, increases product variety, leads to greater uptake of technology, and promotes innovation. Another lesson from exactly the same analysis is that there are distributional impacts from free trade. Some people within a country can be made worse off. This result arises either from the supply or demand side — either individuals’ resources fall in value or their consumption bundles become more expensive. The now-richer country can moderate the distributional impacts, but it isn’t a requirement of the models.

So back to New Zealand. Let’s stipulate that TPP will lead to economic benefits for the country as a whole. The same analysis would also tell us that there are likely to be winners and losers. Given that much of the negotiation has happened out of sight of the public, and that the Government won’t even let the people’s representatives see the text, one does have to wonder who those winners and losers will be.

Also, the cigarette companies have a very good legal argument on their side. The products are legal and their brand image is valuable. Quoting ACT MP John Banks:

I don’t believe the State should seize property rights from legitimate companies selling legitimate products.

So we have two opposing legal rights — the country’s right to protect its citizens, and the property right of companies. In the future, TPP will end up being a thumb on the scales. Turia may find that the balance has shifted.

Adjunctivitis — a choice, not a condition

10/02/2014 § 13 Comments

Universities in the United States run on adjunct faculty. Adjuncts are part-time, temporary, untenured faculty paid per course to teach. They have little time for research or administrative duties, and they are finding it hard.

Paid a few thousand dollars per course, they apparently now make up around half of US university faculty. There is concern about what it means for the quality of education and the future of universities. If teaching staff don’t have time to research, how do they stay current? If they can’t contribute to administration, how will all the curriculum and ethics committees get their work done?

The neologism ‘adjunctivitis’ is revealing. The suffix ‘-itis’ suggests a medical condition that has befallen the faculty — think appendicitis, bronchitis, etc. But what we have here is a choice. These faculty haven’t suddenly come down with adjunctivitis. They have been building towards it for years, making a series of choices, continuing on this particular path despite the difficulties.

It is a hard choice, yes, but a choice nonetheless. Maybe they feel driven to teach. Maybe they really like their specific area of research. Maybe they like where they live, or their partners are settled into their own jobs. But let’s not forget that these are people with options. They are clever people with good work ethics who know how to communicate. They are choosing to continue being adjunct faculty because they feel it is better than the alternatives.

Hey, sorry, it’s not my problem if you can’t land your dream job. Wouldn’t it be lovely to be Prof Reg Chronotis – a little office, a little sinecure, no teaching load? But such positions are works of fiction.

What if a bunch of them said no? What if they just decided, y’know what, selling real estate or writing computer code or being in middle management is less stress and more money? I don’t know what would happen, but it would be interesting to find out. A new cohort of adjuncts might appear, ready to do the same work at the same pay. Or, universities might have to do something about pay and conditions.

Universities are under pressure to offer students luxury facilities at reasonable prices (air conditioning?! private bathrooms?! hah!). Universities are also affected by governments cutting spending:

In 1980, states provided 46 percent of the operating support for public colleges and universities, according to the Association of Public and Land Grant Universities. By 2005, average support had fallen to 27 percent.

Something’s got to give. In this case, it’s the cost of producing the lectures and assessments. A big variable cost with them is the teaching staff. If there’s no countervailing pressure from people, oh I don’t know, refusing to work for peanuts, then that’s where the universities will cut the costs.

Finally, there’s a revealed preference here about the attributes in the bundled good ‘university education’. This adjunct trend has been going on for years, and the complaints about impacts on teaching quality are nothing new. And yet, people keep shelling out more money for poorer teaching. Why? It does suggest that going to university is about getting that certification, or building networks, or being socialised, or buying the name brand if you can. People — students, parents, employers — seem less worried about the quality of the education.

Until they do — can I interest you in a little fixer-upper bungalow with nice harbour views?

Why inequality? A reply

07/02/2014 § 4 Comments

Paul Walker asked a question recently — why are some of us focusing on inequality? That started a discussion on the Dismal Science feed at Sciblogs. Since I’ve been implicated by link, I figured I should say something.

Why inequality?

Well, first, other people are talking about inequality, but they are getting it wrong. One thing I’m trying to do is establish a sort of factual basis for the discussion. For example, people like to point to The Spirit Level as somehow the final word in the evils of inequality. So I’ve read the  book and pointed out its faults, which I think are serious enough that the book doesn’t prove its thesis. Or, alternatively, I’ve calculated that mobility of income quantile doesn’t tell you as much as you think it might. I’m doing this work 500 words at a time, so it takes a while.

Secondly, I’m interested in the economy as a human construction. We’ve designed it, and we can re-design it. Note that I’m not suggesting something like a New Socialist Man. I’m not advocating that we re-make people. But if as economists we believe that (a) incentives matter and (b) institutions matter, then changing incentives and institutions produces different results. So, I’m interested in exploring how we make changes to meet different goals.

Finally, I’m acting according to my preferences. I like fairness. I like symmetry and order. There’s something about equity that appeals to my sense of order. Now, perhaps you think the economy is fair, in the sense that people get what they deserve and actions lead to appropriate consequences.  Or, perhaps you think that life is not fair and that’s enough of an explanation. Me? I look around and see more than just the background cussedness of it all. I see people using power and privilege to maintain their own positions, and then saying that it’s just The Way Things Are. Or, more academically, that we shouldn’t turn away from the fraud that accompanied the global financial crisis, for example.

That’s why I’ve been writing about inequality. It’s just my tiny little effort to make the world a better place.

Summary theories of the firm

05/02/2014 § 4 Comments

Paul Walker over at antidismal mentioned that he has a new article in the Journal of Economic Surveys on theories of the firm. There’s a pre-publication version on his University of Canterbury website. It’s highly recommended reading if you have any interest in why firms exist and what they do.

Titled ‘Contracts, entrepreneurs, market creation and judgement: the contemporary mainstream theory of the firm in perspective’, it reviews the standard theories and provides a bit of history and context for how they fit (or don’t) into mainstream economics theory. Essentially, if you assume perfect information and foresight, why do we need firms when we could all be individuals contracting amongst ourselves? The two reasons usually offered are principal-agent problems as a result of asymmetric information, and the incompleteness of contracts, which leads to the need for post-contract flexibility.

Walker also goes on to look at a few recent developments. One is the idea that firms are institutions whose objectives differ from those of the owners — a type of owner/management split that will be familiar to financial types. The other is a focus on the entrepreneur, familiar to Austrians (and Schumpeterians, if IIRC).

This is material I have to deal with reasonably often, but I know only bits and pieces of it. We are often thinking about why specific institutional arrangements have arisen, or what kind of information asymmetry or transaction cost we are facing and how to resolve it. Having a well-structured framework of the literature with commentary is really helpful.

I will gin up my Opinion-Inator for one point. I’m less convinced about entrepreneur-led theories of the firm. First, they fit with the same world-view (Weltanschauung) that focuses on great-man explanations of history, which I find insufficient. Secondly, entrepreneurs in the flesh are not as heroic as they are in theory. It is possible to rescue the Entrepreneur from this observation, but only by making a distinction between Entrepreneurs and ordinary business owners. That just seems like a ‘no true Scotsman‘ fallacy. And finally, even if the above criticisms didn’t hold, lots of firms in the current economy aren’t entrepreneur-led. They are massive bureaucracies. That needs explaining, which other theories do.

It is important to remember the legal fiction/arrangement that produces modern firms, the Limited Liability Company/Corporation. It is a device to limit the liability of individuals; it separates individuals from the full consequences of their actions. In a micro sense, it allows entrepreneurs and investors to take advantage of the upside of economic activity while protecting them from the downside. In a macro sense, the arrangement has fostered a good deal of investment and risk-taking and economic activity with widespread benefits. That protection is an important reason for people choosing to organise into legally distinct organisations.

Walker’s article includes this ‘nexus of contracts/legal fiction’ view of firms, as well as lots of others. It is a concise and readable survey that I’ll be using myself and recommending to others.

Poverty: plus ca change…

03/02/2014 § Leave a comment

While it is in vogue to talk about inequality, it would be better to focus on poverty. The inequality strategy is intended to reduce the ‘othering’ effect of poverty: the poor are those other people over there, who are different from us. However, it lets all of us non-poor, non-elite assume the stance of victim. We get to say that we, too, are suffering. In our heated houses and comfortable clothes, wondering what to eat from our full pantries.

The biggest mistake with the inequality strategy is that it activates our demands for fairness, which prompts people to make judgements about whether the poor are ‘deserving’. On the one hand are people arguing that it is inequitable for lots of children not to have enough to eat and two pairs of shoes, while on the other hand are people arguing that it is inequitable to take money from people who work hard and scrimp and save and give it to people who don’t. Two sets of judgements, two set of preferences, and no clear solution.

Barbara Ehrenreich had a column in The Atlantic last month, ‘It is expensive to be poor‘:

I was also dismayed to find that in some ways, it is actually more expensive to be poor than not poor. If you can’t afford the first month’s rent and security deposit you need in order to rent an apartment, you may get stuck in an overpriced residential motel. If you don’t have a kitchen or even a refrigerator and microwave, you will find yourself falling back on convenience store food, which—in addition to its nutritional deficits—is also alarmingly overpriced.

She also traced the development of attitudes towards poor people. The US War on Poverty started by President Johnson arose from the idea that government should do something to help the disadvantaged. The conservative backlash argued, instead, that people were not ‘disadvantaged’ — which is a social condition, and speaks of what is done to someone – but that ‘poverty arises from the twisted psychology of the poor themselves’. She continued,

pundits and politicians have bemoaned the character failings and bad habits of the poor for at least the past 50 years.

Of course, it has been going on much longer than that. I’m currently reading Emile Zola’s Germinal, a story about miners in a company town in the 1860s. The life of the miners is juxtaposed with that of the bourgeois investors, the Gregoires. Zola captures the attitude of the comfortable bourgeois towards the miners (source):

One must be charitable. They said themselves that their house was the house of God. Besides, they flattered themselves that they performed their charity with intelligence, and they were exercised by a constant fear lest they should be deceived, and so encourage vice. So they never gave money, never! Not ten sous, not two sous, for it is a well-known fact that as soon as a poor man gets two sous he drinks them. Their alms were, therefore, always in kind, especially in warm clothing, distributed during the winter to needy children.

In the meanwhile, M. Grégoire repeated aloud the reflections inspired by the sight of these starving ones.

“There is evil in this world, it is quite true; but, my good woman, it must also be said that workpeople are never prudent. Thus, instead of putting aside a few sous like our peasants, miners drink, get into debt, and end by not having enough to support their families.”

We are still having the same argument.

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