Wrong, wrong, wrong

Looks like I got thoroughly schooled by the University of Canterbury econ-blogging team in picking Nobels.

On the plus side, apparently Elinor Ostrom is the first woman to win the economics Nobel, which is cool.

Fama for the Nobel?

Greg Mankiw reports that Eugene Fama is, according to a betting agency, the favourite to win the Nobel Prize for economics this year.

If this were a prediction market rather than an old-school betting agency, I would be heavily short on this contract - I just don't think this is likely. Not because I don't think Fama is an excellent candidate and thoroughly deserving of a Nobel - he is basically the father of modern finance. However, Nobels measure largely the influence someone has had on their profession - and since the financial crisis I think it's safe to say that Fama's Efficient-Market Hypothesis is not at the peak of its popularity (although I am still a fan). For that reason, Fama would be a pretty controversial pick.

The same reasoning applies to Kenneth French, who is also quite high up.

Who will win it then? I don't know. I'm also sceptical of Paul Romer (who is just behind Fama on the odds), so my bet would be with Ernst Fehr, whose work on behavioural finance and neuroeconomics is looking pretty good about now.

That said, I hope to be proven wrong and see Fama win, I think he's awesome. Here's an interesting video interview with him about his life.

Quote of the Day, supporting VSM edition

From Stuff:

Weltec students association association president Therese Keil agreed that it would cause financial issues.

"We will have to cut back on services like stationery, coffee and tea facilities and perhaps we would just look at offering only advocacy services," said Ms Keil.

Sounds good to me.

Emissions Hand-Out Scheme

Via The Standard it seems that the Government have released some details on New Zealand's emissions trading scheme. There's some pretty weird details in it.



My first thought though is that for people that should be all too aware of the negative effects of rapid structural changes in the economy (eg), many on the left are pretty quick to criticise policies designed to ease the transition. We pollute a lot, and it's not something you can painlessly change over night.

In terms of the actual plan however, it's a little bizarre. Firstly, it's not really a true cap and trade scheme, because it has a cap on marginal emissions rather than an overall cap (if I understand it correctly) - it's kind of a cross between C&T and a carbon tax. The actual effects of this are a little hard for me to intuit - if any of my micro-economics-loving readers (eg paging Matt Nolan) are able to explain how this is going to work I would be most grateful. It feels like it should be distortionary but I can't quite get my head around it.

Secondly, they have a 'transitional fixed price' - apparently to ease businesses into the scheme. For an allegedly market-oriented party, price fixing is an odd tack to take, and I don't know any good justification for it in this case. Were I very cynical, I would suggest that National expect the market price would be lower than their cap - enabling them to increase the price paid to the firms they choose to hand out credits to, thus rewarding the favoured firms.

I am cynical enough to entertain this as a serious possibility, and the justification they give that it will help businesses 'limit costs' and thus 'enhance stability' is not all that encouraging. Surely the whole point of a scheme like this is to increase business' costs to adequately reflect the costs of carbon emissions to society. That brings me to another point, which is the scheme, when compared to previous efforts, will

... halve the price impact on households for fuel and electricity to 3.5c/l and 1c/kWh.

Forgive me if I sound a little heartless, but the whole point of emissions trading schemes is to increase the costs of things like electricity! It's because of the externalities associated with these things that the market over-produces them in the first place. People that want to reduce carbon while keeping the cost of actually emitting it nice and cheap are simply deluding themselves, and a Government which thinks it can do so is destined to fail.

So I am pretty unimpressed with this scheme. Transitional effects are important - but if you want to reduce them you don't need to do so by giving away credits for free, or engaging in amateurish price-fixing. Simply make the cap start low and gradually increase it. Unfortunately it looks like Greg Mankiw's 'fundamental theorem of carbon taxation' is sinisterly accurate, that is,

cap and trade = carbon tax + corporate welfare.

'Eye-popping' Indeed

Via Kiwiblog, I see that the ever-astute John Minto has recycled the old idea of a salary cap of 10x the minimum wage.

I am sure that all my readers are familiar with standard discussions of price ceilings (as would any high school economics student be), so I won't rehash them here, except to note that that would probably halve the incomes of most of our senior doctors (or close to it) - presumably they are also the disgusting corporate types Minto despises so much. Obviously being a perennially-incensed pundit is far more noble and civic-minded.

The more interesting point (to me) whenever someone proposes something like this is how they intuitively decide what's too much. Very few people suggest salary caps that would ever be likely to affect them. John Minto's proposed salary cap is just enough to be comfortably above what a journalist and/or author could reasonably expect to earn at the peak of his/her career in New Zealand (including speaking fees, etc). I suspect that this is not a coincidence.

Choice and VSM

A persistent meme about the proposed Voluntary Student Membership Bill currently before the NZ parliament is that the current situation allows for quantitatively more choice than the proposed bill. Basically, it goes like this.

At the moment, students can have binding referenda on VSM. The bill would force VSM upon them, abrogating them of that choice. Therefore, if you support choice, you should oppose the bill. Often thrown in are some corollaries along the lines that ACT or National are 'forcing' VSM on a probably unwilling student populace.

This brings out an important difference in how people see politics generally. To me this argument is absurd, but to many it rings so clearly true that it needs no more justification. The difference (I think) lies in your conception of the relationship between the individual and society. If (like me) you think that individual rights are the only true rights, then VSM provides more choice - because it devolves it to the level of the individual. On the other hand, if you think collectives and groups can make meaningful decisions that are broadly representative of their constituents, then of course you should let the group 'choose' whether or not they want VSM.

Ultimately this distinction is unlikely to be resolved with respect to VSM, because (as with many political issues), both sides are steadfastly unwilling to acknowledge that the other might have a point, or to admit that their basic principles are even up for debate. But here are a few brief specific reasons which will hopefully be persuasive.

1) The group of university students is wildly heterogeneous, that is, individual students are huge different from each other. There are jocks, nerds, goths, anarchists, conservatives, apathetics, and all sorts of people that don't fit into silly stereotypes and definitions. How can you really say that this group 'chooses' something by simply aggregating their votes? Even calling them a group is stretching it.

2) VSM allows people to 'decide' on universal membership every year. It's like having a (nearly) free referendum! How? Well if everyone supports student unions, then everyone will join. So VSM allows people to make the same choice a referendum would, but every year! If we are interested in 'choice arithmetic' - it seems like VSM is the way to go.

3) Compulsory student membership, properly understood, is the anthesis of choice - and even voting on it is. This is because what you are voting on is whether or not you should stop your fellow students from choosing to leave. So you are choosing whether or not you should be allowed to choose. This isn't like voting in an election, it's like voting as to whether you should have elections at all, or whether everyone's vote should just be the same as yours.

The obvious response is to say that choice isn't that important, and that there are considerations at play. Obviously there are, and you can expect some posts on them in the future. But if you say that, you've conceded to me more or less the point of this blog post, which I am happy with for now.

Update: BK Drinkwater does a much more comprehensive post.

Meritocracy - Neither Descriptive nor Desirable

A guest poster at Kiwiblog informs us that full equality of opportunity exists - the only reason why you might be unsuccessful in life is because you're lazy.

This is of course silly, not even the most ardent meritocrat would argue that there is a 0% correlation between your parents' wealth and your own (for example), even correcting for other factors like IQ. Hard work just isn't all the story. But underlying it is the common concept that wealth in society is and ought to be distributed according to merit.

Morally, this is the wrong way of looking at things. As Robert Nozick showed a while back, if you want a society where wealth is strictly patterned according to a particular variable you like (hard work, intelligence, number of posts read on Defective Equilibrium), you are going to have to continually interfere in voluntary (and often mutually beneficial) transactions to maintain this distribution. To take the merit-based argument, if you really want wealth to be distributed according to merit, once you had a meritocracy, you would have to forbid people giving gifts to people less meritorious than themselves, lazy people from accidentally making new discoveries and getting rich off them, etc. To actually maintain the pattern would require a state that intrudes in things most people think it probably shouldn't.

Equally important is that 'merit' is such a nebulous concept, it's more or less impossible to draw any moral conclusions from it. What attributes I think are good are likely to be highly different to the attributes you admire. Maybe I think that a lazy but brilliant person is of greater merit than a hard-working average person, or maybe vice versa. There's not an obvious set of independent standards by which we can judge this. Most people implicitly judge it by imagining what they want to be like, and assuming that everyone should also aspire to that, or something very similar. But that is not a very good way of doing it. It's easy to accept that different people can gain equal enjoyment from living vastly different lives, that is, theories of the good should be thin (at best). But people are for some reason reluctant to generalise this when thinking about desirable personal attributes.

There's also the important question of which of your attributes you deserve and which you do not (further reading: Rawls' Original Position). Surely I don't 'deserve' in any merit-based way the money my parents worked to earn (note that this is a different thing from saying I am entitled to it in a Nozickian sense). But then why should I deserve their work ethic, intelligence, or anything else I might (or might not) inherit from them? Surely I can't claim to be a better person for things I'm not responsible for in any meaningful way?

Conclusion: The meta-readers among you will notice that I've presented a kind of right-wing and a kind of left-wing argument here. My hope is that no matter where on the political spectrum you fall, you will reject meritocracy. There are just simply way better alternatives out there.

Economic History Question

Who was the first person to discuss externalities and how they affect markets? The sources I've read seem to strongly imply Pigou but I am not sure if that is just because of the tax.

Does anyone know?

Theological Paranoia

Say you're God and you want to kill of all of humanity, but in such a way that no-one will know that it's you (as is your want). How would you do it? You might consider what humans' weaknesses are, in order to exploit them.

Addictive behaviour? Doesn't seem to be universal enough, even if you try to compensate with substantial negative externalities. Eg. Smoking.
Risk Management and Natural Disasters? It seems like people aren't very good at anticipating rare, catastrophic events. But humans would be on to you with this one, they've already labelled these 'acts of God'.

There are plenty of others, but I think your best bet would be a lethal collective action problem dispersed across the entire world. Humans are broadly self-interested, and at the very best can only consistently be altruistic in quite a limited way. So if you set things up in such a way that heaps of their actions have costs which they themselves don't have to bear, they will by and large do little about it, while collectively making themselves slowly worse off, to the point of self-extermination, if you set it up right. It would be more effective if it was dispersed across the whole world, because that makes it harder for people to bargain with each other and come to better outcomes that way.

That sounds pretty effective, but here's how you could make it even more deadly. You would make the costs so dispersed and hard to see that it would take the smartest people in the world to notice that they actually existed. Secondly, you would notice that academics aren't very good at collaborating across genres, so you make it a massive cross-disciplinary project to determine the costs precisely.

Finally, you set up a lot of the industries that produce the most cost with high fixed costs, and economies of scale. This makes them naturally fairly uncompetitive, that is, you have a small number of big companies producing in those areas. So there will be strong incentives on very powerful interests to resist pricing in the costs appropriately.

So far, so hypothetical. It's lucky for us that God loves us and... wait. Uh oh.

We are screwed.

Thought Experiment: Printing Money

Here's another thought experiment - still public policy stuff but as I have just received the latest Philosophical Review hopefully I will have some more eclectic ones shortly. This one is decidedly less abstract, I'm not even sure if it classifies as a thought experiment, but there you go.

Say the Government decides to manage the money supply itself and take over the task of printing money from the central bank. Say then that there is an enterprising politician (call him William) that now thinks he can game the system to his own advantage. William has a sure-fire investment that is going to make him a millionaire, but he needs $10,000 to get in on it.

He figures that he can use the Government printing press to print the money. Sure, that devalues everyone's money, but what would be the inflationary effect of $10,000 more across the whole economy? Far less than would be even noticeable or measurable. How can you say your rights have been violated if you can't even notice the extent to which they have been? Is there even a rights violation at all? Or if you're not into rights, surely you would accept that this investment is going to make William much happier, without noticeable effect to the rest of us. By a utilitarian standard, wouldn't he be morally obligated to print himself money?

Question: Is what William does immoral? On what grounds? Assume that he doesn't get caught, and puts mechanisms in place so it can never be done again.

Brief Thought

If I support local action on climate change, but would defect in a Prisoner's Dilemma, am I being inconsistent?

It seems like I am.

Supply, Meet Demand

Jeanette Fitzsimons probably needs to become more acquainted with them both, unfortunately, as well as a bit more textbook micro.

Here she is on electricity:

With shoes or toothpaste, increased demand gives economies of scale and tends to bring prices down. With electricity ... increased demand raises prices. (my emphasis)

To be fair, I suspect she's just guilty of poor phrasing. What is interesting though is how she justifies the low level of competition in the electricity sector. Apparently there are diseconomies of scale there, according to Fitzsimons.

Hold up. What do diseconomies of scale mean for market structure? It means that the efficient number of firms is lots of small ones - which just so happens to be one of the conditions for a competitive market. This is because one big firm will produce stuff more expensively (per unit produced) than lots of little ones. It's when we see economies of scale that we start to see natural monopolies, or at least oligopolies. So by Fitzsimons' own reasoning, we should probably deregulate the electricity industry and let the market get to work. On the other hand, we should probably have state-run shoes and toothpaste factories.

To be fair on Fitzsimons, she does make other arguments that are somewhat more valid. However their proposal of staggered electricity rates (ie, increasing marginal cost) seems like a great way for the power companies to capture more surplus.

Related question: Should having taken first year Econ (at least) be a prerequisite for political service? Unfortunately then the New Zealand Green Party could cease to exist.

Note: I do think that the Green Party are great and a valuable addition to NZ politics - but they do have a habit of getting themselves confused about economic issues.

Update: Paul Walker does it a little more rigorously.

Upcoming Debating Goodness

If you live in Wellington and like argument, this Monday could be a good day for you.

At 10AM is the grand final of the New Zealand Schools' Debating Championships (the schoolkids are debating over this weekend to determine who makes it). It will be held in the legislative chamber of Parliament, on the topic "That citizens initiated referenda should be binding on government". All are welcome but if you want to go you have to RVSP for security reasons - check out the facebook event here for more info. New Zealand is currently the world champion for schools debating, and I've seen quite a few of the debaters debate before, they are all excellent.

Of more interest perhaps to those of us who's schedule doesn't let them take Monday morning off to watch a debate is the Victoria Uni DebSoc hosted Public Debate, on the 'smacking debate' currently very popular in New Zealand. Defective Equilibrium co-blogger Udayan Mukherjee will be debating, as well as Sue Bradford MP and a whole lot more interesting people. It is at 6:30PM at Rutherford House LT1, again check out the facebook event here. Again all are welcome, there might be a gold coin donation.

My Favourite Blog

My favourite blog at the moment (apart from yours of course, if you have one!) is My First Dictionary. If you like black humour, I recommend it.

Thought experiment of the day - Rights/Welfare Tradeoff

I know I don't do these every day or even every month, but perhaps if I say so it will make me do it - it could be a cool feature perhaps.

Say everyone earns the same wage, $100. The Government taxes income (and income only) at 20%, and has a choice of two policies - A and B.
Policy A lowers the income tax to zero with no other effects (I suppose the Government isn't doing much to start with). So people now earn $100 after tax (up from $80).
Policy B raises the national income level by 25%, meaning an after-tax wage of $100, however it violates people's rights slightly by doing so, perhaps by forcing them to work as slaves for 10 minutes every day.

Which policy would you prefer? In this case it's easy, as they both give the same income level but one has us working as slaves. So you would choose policy A.

But what if I change the numbers? What if policy B doubles the national income, at the cost of 20 minutes a day of slave labour?

The reason I ask this is that I think the majority of deontological theories of political justice (like that of Rawls) take into account consequences at some level (Nozick and Kant being the two obvious exceptions, and even Nozick allowed some ad hoc consequentialism). What is often less clear is how they determine the tradeoff - at what point do we bite the Kantian bullet and just say that rights are too important? At 3 hours of slavery per day? At 8? Or vice versa, at what point does welfare override basic freedoms? What if you could abolish scarcity by putting cameras in everyone's house (don't ask me how) without telling them?

This seems like an obvious question but it is one I think that is rarely spoken to. In particular, most people tend to believe in the fortunate coincidence that their favoured policy is both welfare-maximising and non-rights violating, at least to a certain degree. But if that is not the case, how much welfare is worth one rights-violation?

Notice that I am defining considerations of redistributive justice out of my thought experiment, I think that would overly complicate things.

Update: BK Drinkwater shares his thoughts. He promises he will talk less in the abstract in the future - I make no such promise.

The Length of Human History

Today someone pointed out to me that civilisation has (arguably) existed for about 7000 years - since the Sumerians. So if you live to 70, you have been alive for 1% of the length of civilisation. That seems quite substantial, and perhaps a remedy for those that feel insignificant in the scheme of things. 1% is quite a substantial chance to make a difference.

That said, the earliest historical figure I can think of is Thales (can you do better?), and he was only about 600BC - which is less than half the length of civilisation ago. So perhaps our prospects for being remembered aren't all that good after all.

Of course, scientifically-inclined readers will note that if you live to 70, you have been alive for about 0.00000005% of the history of the universe so far...

The Poverty of the Politics of Poverty

Udayan complained the other day that my writing is too 'vanilla'. Luckily for him, I have been a little unimpressed with the NZ blogosphere of late, and so here is something a little more strongly worded than usual. Normal posting will resume shortly; I have a few thought experiments on the morality of tax which will be coming soon.

Like many, I am little worried that the social development minister Paula Bennett thinks it's appropriate (read that link because I will assume you know what I'm talking about!) to chuck private information into the public domain to win some cheap debate points. But unlike some local commentators, I don't think it's worth hyperventilating about. It's clearly inappropriate, but saying that it is 'about the right to free speech without fear of reprisal' is way off-base. It's also a little hypocritical for those who are provoked into a righteous rage whenever someone even mentions that the 'more Government' isn't the answer to every political question to tell us to 'beware of unbridled Government'. But it's pretty apparent that many people are only opposed to Government power when it's wielded by the 'bad guys', and are quite happy for themselves or their friends to have it - witness Obama's somewhat limp redaction of Bush-era civil-rights abuses.

Let's be quite clear here - these two ladies are certainly criticising the Government. But they are also making empirical claims about the amount of welfare they receive, which appear to have been misleading, to make their case for more welfare sound stronger than it actually was. That puts them in a very different situation than your average National-hating blogger, some of whom are now ridiculously suggesting that they could be the next target. Get over yourselves. More importantly though, you should realise that National's reponse, while bad, isn't straight out of Mussolini's playbook. There's a world of difference between abusing your power to embarrass your critics and abusing it to correct them when they lie about their means. Both are bad, but only one is really a threat to the fabric of democracy. The former discourages criticism full stop, the latter discourages lying about yourself in the public sphere to try to get more money.

I think that in any healthy debate, both actors should as a general rule be able to correct factual inaccuracies in the other side's case. In this specific situation, the error related to private information, so the Government should have definitely proceeded more carefully (read: not given out the information). The appropriate response would be to defend their programs with averages and hypotheticals.

I guess a large part of the reason I am annoyed here is my views are coloured by my own situation - I am a student and (if Paula Bennett's figures are right) have an income (including weekly student allowance, not including course fees) of less than half what those women receive. In terms of Government transfers, I get less than a quarter, and I have to pay that back when I graduate (or more accurately, when I start working full-time :) ) I appreciate that it's difficult to raise a child and study at the same, but with student loans and subsidised child care on top of what they already get, I'm very sceptical that these two women can't afford to study.

Yay! I guess.

From the NZ Herald:

Finance Minister Bill English yesterday said the Government was dropping criteria preventing the sale of "strategically important assets" into foreign hands as part of a raft of changes aimed at encouraging greater foreign investment. ...
The Government will introduce a new right to veto on the grounds of "national interest" - but Mr English expected it to be used so rarely that he could not think of a case which might require it to be invoked.

The latter is obviously a political move to look more centrist (median voter theorem anyone?), but probably the most disappointing part. They say that they won't use it, but given their previous actions I am very sceptical. And I think we can be pretty sure that if they don't, Labour will. The fact that they still couch their announcement in the misleading language of 'protecting national assets' is unfortunate. Are we supposed to believe that the evil foreigners will abscond our airports off to their home countries and do who knows what with them? Well perhaps not all of us, but politicians are still playing very much to those that do.

So it's good news, but not great news.

I thank The Standard for the tip.

Moral and Political Psychology

In the last few days we've been exploring a putative evolutionary basis for political groupishness. Tom suggested it was due to group selection, I suggested that it wasn't, but I think that we both agree that there must be some psychological trait which underpins our political choices. Jonathan Haidt is a pscyhologist who explores precisely these issues. In this interesting lecture, he explores five dimensions of morality and how they are differently emphasised in the minds of liberals and conservatives.

This is exactly the kind of work which will hopefully help us to stop being so tribalistic, and seriously look beyond partisanship.

Rock, Hard Place, etc

The popular narrative of the financial crisis is that banks got greedy, took on too much risk and subsequently got into trouble. In particular, they lent money to people for mortgages that realistically they would never have been able to pay back, and then fooled themselves into thinking they were not at risk. This is (we are told) doubly bad, because the people who took out the mortgages paid out heaps of money in mortgage payments only to be thrown out of their homes.

Obviously reality is far more complex, but if you accept something like this narrative (which a lot of people do, including many in Government) you would think that you would support banks being more conservative in their lending.

Unfortunately this looks to be one of those ideas that people like more in theory than in practice. For example, Stuff reports that a Nelson man was so upset that the bank refused his application for a mortgage (because he had no regular income) that he withdrew all his life savings from the bank in $20 notes, just to be ornery (bizarrely to the teller, who obviously has no responsibility for bank lending policy).

It seems to me that most people would like banks to be conservative about their lending and not lend too much money, except to themselves, people they identify with, or their constituents. This is an attitude that we can only hope has no effect on public policy in the short term.

Note: I don't mean to pick on this gentleman - he may not himself believe that the crisis was caused by loose lending practices, and thus be quite consistent intellectually. But it provides a good explanation of what I think is quite a widespread cognitive dissonance.

A Challenge for Political Group Selection

Below, Tom argues that a dogged commitment to a political party might be well understood in terms of the dynamics of group selection. My intuitions generally agree. However, although the conclusion might be alluring, the mechanism proposed to get there seems like an all too crude application of evolutionary theory, and exactly the sort of just-so story that Darwinists should strive to avoid.

Here's why. Tom proposes that group selection produces pressures for individuals to engage in elaborate forms of signalling so that they can secure themselves as a member of that group. Crucially, this needs to be irrational, so that groups maintain their stability over evolutionary time-scales and are allowed to be selected for. The premise, of course, is that human social groups are a good way for individuals (or gene-lineages) to propagate themselves downstream.

This premise is the one which doesn't stack up, and is generally regarded with skepticism in evolutionary biology. Why? Because from the perspective of an individual (or their genes), adaptive fitness would be much higher if you exploited a group, than if you did your best to be a co-operative member of a group. This point is most vivid if we consider a possible proto-human social group: the hunting party.

It seems to make sense for a collective of cavemen to co-ordinate hunting activity, since it reduces the costs to any individual hunter, while allowing them to track bigger game (woolly mammoth et al) and thus maximise their payoff. But consider any individual hunter. They could do even better than the others, if they simply slacked off their hunting duties but still had access to the spoils. Of course, this kind of reasoning is symmetric, so every individual will think the same way and try to free-ride off the group. Obviously, this will destroy the stability of the group in favour of individual fitness.

The simple way to think of it is this. If the group is thought to be the unit of selection, then the challenge is to show that successful groups don't simply grow in number, but actually spawn new groups which are similar to themselves - groups that are their offspring. Otherwise, the best explanation for human groupish tendencies isn't group selection, but simply a cascade of individual selective pressure. Pace Tom, but I don't think his account paints the correct picture of the evolutionary architecture of political commitment, because it doesn't establish how these groups get going in the first place.

However, all is not lost for the conscientious Darwinist. I still agree with Tom's conclusion, but with a slightly different flavour. The answer, I think, is a question of cultural rather than biological evolution. And not just in a metaphorical sense, but in the literal application of natural selection to the propagation of social information. This is a big topic in itself, and hopefully one which I will explore shortly.

Evolutionary Irrationality

I've been intending to write about political ideology and group selection for a while now, but a good example last night has spurred me into action.

NZ's top left wing blog The Standard has a post in which the author argues:

One of the great strengths of the Right is that the rank and file supporters are such slavish followers of their leaders. ... Simply doesn’t happen with the Left’s support base. You can’t get the buggers to agree on anything. They care about detail. They argue over it. The educated ones, especially, see simple slogans and shallow arguments as anathema. They don’t tend to go in for blind adherence to their leaders either. They see leaders as tools. Servants for furthering their shared ideals. They critically assess what their leaders say. If they do agree with it when they repeat it to others it will be in their own words. Not a simple repetition of a carefully crafted slogan*. The Left will never have our version of ‘PC’. It’s just not the way we think.

Certainly there are often cognitive differences between people on difference parts of the ideological spectrum, but I think any reasonable non-partisan would think that this far overstates any possible case.

But we shouldn't be dismissive - there is a potential evolutionary explanation for why people do things like this.

In group selection, the necessary (and most problematic) part is getting people to irrationally commit to a group - that is, so they stop considering the relative merits of other groups. A group that people left as soon as they found a better one wouldn't be very stable, and would be selected against. Of course, this is hard to do - even if you assign people to monitor defection, they are also incentivised to defect, and if you set up people to monitor the monitors, the problem just regresses! Some have proposed religion as possible solution (God is impossible to defect from if you believe in Him), but another potential one is simply costly signalling (although obviously this is part of the religion story as well).

Costly signalling is essentially just telling people that you are in the group. It has to be costly so it's difficult to fake (and therefore you are less likely to tell people you're committed to the group when you aren't). I think we can look at posts like the one discussed (and in fact a lot of political behaviour in general) as part of a scheme of costly signalling - the author is just telling his/her left-wing friends that they are part of the group, and he/she would never consider joining the other group because they are so deplorable.

Too simplistic? Of course. But I am fairly sure that it is a substantial part of why political behaviour is so irrational.

Best of the Rest

Via Marginal Revolution I learn that the cool new journal Rejecta Mathematica has published its first copy. The idea of the journal is to publish interesting papers that have been rejected several times from academic publication. There's no way I have enough maths to really understand all of what's going on, but each paper includes a brief rejection history (or a link to one); they make fun reading.

Some are a little petulant:

Mathematics my foot! ... Programming is much much harder than doing mathematics. I bet that the referee will never ever be able to write such a program.

Some more forlorn:

With high optimism, we submitted a paper to a top-tier image processing journal. ... But alas, our enthusiasm was deflated due to the following review points...

And some kind of funny:

Our obsession with these simple matrices has generated a great deal of criticism. Lubos Motl, the string theorist, called us F–ing Crackpots on my blog ...

and

Where did I go wrong? Perhaps I should not have called professional mathematicians, in the first paragraph, “meaning-imposers” who generate “inconsistencies and confusions”. Perhaps I should not have asked “Where did I go wrong?” on page 61; or, “Have I made another blunder?” on page 62. ... Maybe I used too many exclamation marks.

It's hard to do them justice as a whole, so I suggest you read them for yourself!

Rawls' Approach to Philosophy

Although from time to time I get mild criticism from some on the left for my economic views, astute readers of this blog (which is all of you of course!) might have ascertained from the name 'defective equilibrium' (c.f. this) that I am a bit of a fan of John Rawls, the great modern political philosopher.

John Rawls' most famous idea is what he calls the 'second principle of justice' (the first being a scheme of appropriate liberties, although he engaged in quite a bit of semantics about this later in his career), also known as the 'maximin principle'. The idea is that the goal of society should be to maximise the wellbeing of the worst off members. This means that inequality is permitted, but only if it makes the worst off better than the counterfactual.

As it is with a lot of influential political philosophy, a large amount of subsequent literature has been devoted to trying to read Rawls' mind, and divine what he was really advocating. Some have claimed him a defender of modern welfare capitalism (Hayek even approvingly cited his earlier work), while many on the left have portrayed him as pretty much a hard core socialist that was maybe willing to tolerate radically altered forms of capitalism (this is basically the approach of Samuel Freeman's book, for example).

I think that both these approaches are wrong, and they are show how people take different approaches to political philosophy. It seems to me that Rawls is at heart a political philosopher, and his book is a contribution to the field of political philosophy, not a political advocacy tract. The difference is subtle, and not, I feel, appreciated by a lot of philosophers. When you think something is unjust, it's very tempting to want to try to correct it, or provide a means by which others might. But trying to correct an injustice is not the same thing as rigorously proving it is actually unjust. It's not necessarily impossible to do both decently (I think Thomas Pogge would be a good example of a mixed approach), but Rawls, I think, only ever saw the task of political philosophers to be the former, not the latter. He essentially never advocated his views in a way that was even vaguely interesting to anyone without a deep interest in moral philosophy - his books are fairly long, exhaustively reasoned and create a lot of jargon. He rarely gave interviews, and certainly not in popular forums.

One way of bringing out this difference a little more sharply is to compare Rawls' work to Noam Chomsky's political writings. Chomsky writes for the most part with a general audience in mind - his goal is to change the world to make it more just. To do so, you have to persuade people, but that is essentially a tool to achieve positive change, not an end in itself. To Rawls (in my interpretation), persuasion and presenting the best possible argument are the ultimate end of political philosophy. In the preface to Theory of Justice, he essentially says that his goal is (only) to provide a more intutionally satisfying alternative to utilitarianism (my insertion).

That's not to say that Rawls was aloof and uninterested in the justice of the real world. I am sure he would have been delighted if modern states had adopted justice as fairness. But that would have been a pleasant side-effect of his writing only.

Whether or not this is the best approach (morally) is something I am not sure of.

Why the Government should lie to us

One under-appreciated aspect (in my opinion) of fully 'socialised' medicine is the effect it has on Government ad campaigns and the general goal of public health.

Why is this? Socialised medicine essentially means that people pay for health insurance through tax. The amount of tax they pay is in no way related to their health needs, or perhaps even inversely related, as chronically unhealthy people may earn less money on average. Because the direct relation is missing, health insurance becomes essentially a sunk cost. It is unrecoverable, and irrelevant to rational decision making.

This means that the monetary cost of most health procedures doesn't factor in to individuals' behaviour. There are certainly other costs to unhealthy behaviour (so costs don't go down to zero) but this will mean that people will consume more healthcare and behave generally less healthily than they would if they bore the full costs of their behaviour. It is kind of like a Government-created externality. This problem exists in private markets based on insurance also, but private insurance companies can adjust premiums, etc. This of course brings in moral hazard, but I will leave this issue aside for now.

How can the Government counteract this? One thing it can do is to try to provide misinformation. If people over-estimate the health cost of smoking or other similar behaviour, then this might cancel out their under-estimation of the monetary cost. For most people, Government ad campaigns are percieved to be a credible source of information, and the cost of fact-checking usually too high. The New Zealand Government appears to have taken particular advantage of this. From a cost-benefit perspective lying to the public, while it might be annoying, may actually make (economic) sense.

Of course, the Government is hardly a unitary, cost-minimising rational actor. It's likely that this sort of misinformation is encouraged by rent-seeking lobby groups, or politicians and elites assuming other people should share their preferences. Nonetheless, it may be a way to curb healthcare spending in a socialised system, and shouldn't be immediately derided.

The Law and Justice

I don't know much about law in academia, but a lot of what I see seems quite a lot like moral philosophy. That makes sense, because if we are considering new laws, the morality of them is obviously important.

In that vein, the Legal Theory Lexicon has this excellent new entry on justice, including brief primers on consequentialism, deontologicalism and virtue ethics. I suspect most of our readers already know what these are, but it is interesting to see them (and other ideas) explained from a legal perspective, as opposed to a purely philosophical one.

Spontaneous (Dis)Order

Today William Easterly at his great blog Aid Watch argues that the Pope, like many, is suffering from what he calls the 'Man in Charge Fallacy' - a false assumption that the economy is or can be centrally run.

This fallacy is related to something Udayan discussed a while back on this blog; the way people like to assume design when there is none. Economist readers will no doubt recognise the links to Hayek's 'spontaneous order' theory of the economy (or perhaps Adam Smith's Invisible Hand), but an perhaps even more fundamental application of it is in our own evolution, where amazingly complex order arises without any design at all.

It is not surprising that the head of a major religion has a tendency to see design in non-designed processes. But the rest of us should be wary of making the same mistake.

Free Book

They say there's no such thing as a free lunch, but you can always get someone else to pay for you. Become a fan of Sir Roger Douglas on facebook (which you can do here) and he will send you a copy of his latest book. I have no idea what the book is about (although the title is suggestive), but something in me can never say no to a free book. I have therefore become a fan, and my book is apparently on its way.

Depending on your politics and friend circles, you might argue that publicly becoming his fan is the cost, which you bear to your reputation. That's probably true; I probably wouldn't, for example, become a fan of Hitler to get a free copy of Mein Kampf. Still, if you have non-judgemental friends, it looks win-win.

No word on whether he does overseas shipping. If he doesn't, is that protectionism?

Amateur Philosophers at BERL

I assume that most people who read this blog also read the excellent Offsetting Behaviour, which is why I haven't really commented on Eric Crampton's devastating critique of the BERL report on the social costs of alcohol. If you're not up on it, economic consultancy group BERL wrote a report on the costs of alcohol with (som say) some poorly defended assumptions, and some heavily misleading conclusions. It got some play through high-up lobby groups, so Crampton and Matt Burgess wrote a heavily critical response. Recently though, one of the authors defended the report in a particularly interesting way:

So for example someone who murders someone, from the individual’s point of view, Eric would be, I presume, quite comfortable with that. The person who decides to murder someone else makes an evaluation of what are the benefits and costs to me of this action? Society says ‘well some people do murder other people’, but society says ‘that’s not good.

If BERL's report was on whether or not society thought people should drink alcohol regardless of the costs, Mr. Slack (who's quote this is) would have a point. But it wasn't a x-phi survey on folk morality, it was an economic analysis. That Mr. Slack has the two confused is perhaps revealing to the approach BERL took to the analysis. Moral philosophy has an important role to play in analysis of public policy. But:

a) It should be done explicitly, rather than hiding it in leading assumptions.
b) Economists aren't generally the best people to do it.

You would think economists out of anyone would understand the benefits of division of labour.

In any case, the only (secular) case I can see for opposing consumption of alcohol prima facie in the same way we oppose murder would be a cost benefit analysis. It would be good if BERL defended their report on these grounds, and left the poorly-considered analogies out of it.

Follow-up on Pay Equity

In a previous post I argued that at least part of the difference in pay between men and women (for the same job) would be attributable to social attitudes about pregnancy (and the physical realities of it).

Obviously it's given that women are in modern societies paid less than men. But are they paid less after correcting for all the other factors that affect income? My hypothesis suggests that they would be, but not by much. Unfortunately cross-sectional data with all the necessary variables is really hard to find, presumably because of privacy laws, etc. So my question is, does anyone know of any good data? It would be interesting to run a multiple regression on it to see what effect gender actually has on income, ceterus paribus.

The other thing I alluded to briefly is that I think 'pay equity laws' (currently popular with the New Zealand Left, and unpopular with the Right) are kind of like minimum wages, with the same sorts of costs and benefits. On the benefit side, obviously many women would receive higher wages. On the cost side, the number of women employed is likely to drop, as the proposal will not change the shape of the demand function for labour (and there will be an oversupply of labour). Whether or not the total amount of money paid to women increases will depend on the elasticities. There is some evidence that shows that small increases in the minimum wage don't lead to redundancies at all, but I suspect a 'pay equity' law would be a substantial enough increase.

On these grounds, perhaps a pay equity law is a good idea, particularly if you are a woman with a secure job. But like in my last post, I think it would be a better idea to try to correct the fundamentals which cause the inequity. This can be done through affirmative action scholarships for higher education, attempts to change societal prejudices (such as they exist), and so forth. To me, compared to these things, pay equity law seems crude and post-hoc. Perhaps it is intended to be a short-term solution. But I see no indication of this from its supporters.

Gender-Based Pay Discrimination and Pregnancy

It is a commonly-cited fact that in New Zealand (and around the world), men and women have different incomes; with women usually, if not always, receiving lower pay. Whether women receive lower pay for doing an identical job or are simply less present in 'high powered' jobs is unclear; I think it is likely a mix of the two. However, simply citing this fact doesn't prove the existence of residual sexism (although this may also exist). There are important (but not irremediable) differences between women and men in the current labour market which at least partially account for this difference in pay.

The one I want to focus on is pregnancy and childcare, which is an interesting problem of asymmetric information. Suppose that at a particular company, a woman and a man both work, and both add the same amount of value to the workplace. Their employer knows this, and so hasn't discriminated based on gender so far. The employer however knows that both the employees are young, and likely to have children at some point. Moreover, the employee cannot know estimate the exact probability of a person having a child; marriage is no longer a good guide, as many children are born out of wedlock. The only guide (that I can think of) would be age, which I will discuss later. So the employer, to maximise expected return from the employees, has to guess, using averages.

On average, women spend more time off work during pregnancy (because they physically have to), and (I suspect) spend more time off after pregnancy as well to look after newborn babies. This means that even if they are equally good at their job, a women's expected value to their employer is lower, even if they don't plan on getting pregnant (because the employer probably doesn't know this). This means that even in a world free of sexism and any other reason to discriminate through pay, women will be paid somewhat less than men (After some basic algebra and wild guesses I very provisionally estimate this to be by about 5%).

What should we do? A popular solution is so-called 'pay equity laws', which force employers to pay women the same as men. This seems intuitive if you think the problem is sexism, but if you (like me) think there are at least some other factors involved, what you are essentially doing is placing quite an onerous minimum wage, which is likely to result in less women being employed, and probably perpetuate differences in earning power. We obviously can't make men give birth, and we can't stop people having babies. What might be a better solution (to the problem I have outlined here) is that we try to encourage more men to take on equal (or to cancel out pre-pregnancy inequalities, slightly more) responsibility for newborns post childbirth. Maybe this goes against biology, I don't know. But I suspect that if this did happen, women's pay would start to close the gap.

Note: Obviously this shouldn't be the case with older women, as after a certain age they are unable to give birth. In fact we might expect to see the effect reversed, as men can still impregnate women up to a very old age! In reality I doubt we would however, as inequalities are likely to be entrenched by late-middle-age, and older people are probably less likely to have babies at all, making the numbers relatively insignificant.

X-Phi and Distributive Justice

On Public Reason they report an interesting experimental philosophy paper which tested people's intuitions on distributive justice in two cases.

In the first, they were told:

Suppose that some people make more money than others solely because they have genetic advantages.

The second group was told:

Suppose that Amy and Beth both want to be professional jazz singers. They both practice singing equally hard. Although jazz singing is the greatest natural talent of both Amy and Beth, Beth’s vocal range and articulation is naturally better than Amy’s because of differences in their genetics. Solely as a result of this genetic advantage, Beth’s singing is much more impressive. As a result, Beth attracts bigger audiences and hence gets more money than Amy.

Interestingly, but perhaps not surprisingly, people told only the abstract were far more likely to consider the situation unfair.

The question obviously has implications for Rawls' theory of distributive justice, which is fairly heavily reliant on

a) Reflective Equilibrium as a process for moral decision making
b) The unfairness of situations described above

The authors argue that:

Rawls, by his own lights, has reason to favor the judgments rendered in the more familiar concrete condition that deny the brute luck constraint over the judgments rendered in the less familiar abstract condition that affirm the constraint. A tension therefore looms between Rawls’s acceptance of the brute luck constraint and his methodology.

This is interesting stuff, but I think more depth into the psychology is needed (in the field, not in this specific paper necessarily). If we understand more fully the psychological processes which generate our moral intuitions, then we are better placed to how we should accord them value. This is really the area I see experimental philosophy making big headway in the future, as philosophers have been reticent to rely on psychological evidence in argument, and vice versa. In many ways, experimental philosophy is the behavioural economics of philosophy, and papers like this show why it is so promising, but also why it has still quite far to go.

Competition

Click here and then click play to watch Australia and NZ battle it out for higher income per capita and better infant mortality rates, since last century.

Very cool website.

Loan Sharks

A guest post by NZ Labour MP Chris Chauvel on the No Right Turn blog brings up the issue of loan sharks, and in particular, whether the Government should legislate them out of existence. Chauvel is of the opinion that they should be and has a members' bill in the ballot to do just that. He says:

Loan sharks prey on the vulnerable with unscrupulous rates of interest and this includes many of our Pacific people. They are the scourge of our community and instead of lending a helping hand keep borrowers in poverty.

And:

Market forces are clearly not an appropriate determinant of interest rates at this low end of the socio-economic spectrum. It's all very well to guarantee bank deposits and slowly roll out a nine-day fortnight. But this is something that would help those in real financial trouble. I call on the Government to do the right thing and take action in this area now.

Some of Chauvel's proposals have merit, in particular allowing loan sharks to charge fees, although I don't know why they should need to be registered to do this. However, I think the bill is a bad idea.

Why do these people take out loans at all, if the rates are so high? This sentence of Chauvel's is revealing:

Increasing numbers of people are pawning items like bikes and children's toys just to meet essential expenses like their power bill. I saw an elderly man taking his weed eater into a loan shark outfit in Wellington, and it was distressing to watch first hand.

It is certainly tragic for someone to have to sell their bikes to pay for their power bill. But why are they doing this? It is because they don't have enough money to pay their power bill at all, and they consider it a good trade to sell these things. Chauvel proposes no remedy for this situation (also known as relative poverty), so it seems he would prefer people sit in unpowered houses full of bikes and toys. I suspect the people in question may disagree.

In this vein, I would argue against the implicit assumption that taking out these loans is always irrational. Chauvel engages in a little evocative rhetoric with "loan sharks prey on the vulnerable" and gives some dubious examples but doesn't really argue for this at all. It's the classic prohibitionist fallacy - to assume that anything with high costs is necessarily irrational. But this isn't a useful approach. I think these loans can often be rationally entered into; if you are starving and need money for food, and you aren't getting paid for a while, it is quite plausibly rational that you might sacrifice some pay in the future so that you can eat now. Perhaps the stigma among your bogan friends of not owning a car is bad enough that you would be willing to pay extra to own it right now.

These sorts of situations are hard for our highly-paid politicians and moderately paid pundits to understand, no matter where they sit on the political spectrum. I think it is easy once you are in power and engaged in high-level discussions and important decisions, it is easy to run together an admirable concern for the poorest members of our society with an unfortunate paternalism with regards to their intelligence and ability to make decisions. If you think that poor people are inherently stupid, this sort of legislation intrinsically looks more useful. If you do not, then it looks highly patronising.

Even if you don't agree with what I've just said, you should of course still worry about the black market. As Chauvel observes, loan sharks already engage in activities of dubious legality, so it is not much of a step for them to move to the all-out illegal trading. Legislation will not stop high-risk borrowers needing short-term credit, nor, without quite substantial levels of surveillance of transactions, even stop loan sharks from operating. I predict that if this law passes, we will still see loans being given out to poor people, but with the loan sharks resorting much more quickly to violence and intimidation. Then we will see actual loan sharks, and it will not be good news for the poorer citizens of New Zealand.

Two somewhat unrelated asides:
Firstly, it is interesting that with respect to the credit crisis, we criticise lenders for underpricing the risk of loans. But here, we slam them for correctly pricing risk!
Secondly, does anyone know why they are called sharks? I suppose if they stop lending they die, much like sharks can't stop swimming. But if you generalise it, that applies to any job. Is it because sharks hunt and eat smaller fish? Surely then a more accurate metaphor would be 'loan humans'. Hm...

Assumptions

This is from my microeconomics textbook.

For simplicity, suppose that medieval England was a single, large, price-taking firm that produced one type of output with a constant-returns-to-scale Cobb-Douglas production function Q=L^αK^1-α, everyone works and all capital is used.

On the face of it, this looks like an absurd assumption. You might be tempted to say that while it might have teaching value, as an actual approximation it would be a waste of time.

However, as the question goes on to show, it actually provides a decent approximation to reality. Obviously it is too simple to make too specific predictions, but if you calculate the effect of a halving in the labour supply (which is what happened in the Black Death, apparently), the results you get are a pretty good approximation of what actually happened (wages increased substantially as the marginal product of labour went up). You wouldn't want to stake your reputation on it perhaps, but it serves as a good illustrative lesson of how you can actually derive fairly useful results from very simple models. Oversimplification is something that economics is often criticised for (although it's interesting that the critics rarely extend this to physics, which has similar levels of abstraction. Perhaps this is because physics is harder to use as an ideological tool, creationism notwithstanding). So perhaps examples like this are useful for those of us who wish to defend it.

Active and Passive Investing

In a previous post I argued that the debate over the New Zealand Super Fund was leading to a recurrence of popular misunderstandings about financial markets, particularly with respect to 'timing' or 'beating' the market.

A fallacy I didn't address, but perhaps should have, was the (related) idea that now is somehow a 'good' time for active investing - that by picking stocks that you suspect are going to rebound in terms of price, there is an opportunity to make a lot of money, rather than just riding up the market by buying indices or something similar. A lot of people seem to believe this is the case with the New Zealand Super Fund.

Here, Kenneth French explains why this is wrong. Consider two types of investment strategies - active investment and passive investment. Active investors try to time the market, pick under-priced stocks, etc. Passive investors just have portfolios that represent the market, so when the market as a whole goes up so does their portfolio, and when it goes down their portfolio goes down. When you phrase it like this, it is clear that both groups have to have the same returns on average. Passive investors' returns obviously average out at market levels. The market is only made up of active and passive investors, so active investors have to average out the same as well! However they usually charge higher fees. So in fact now, like every year, is a bad time for active investing.

Public Goods and City Councils

This article raises interesting questions about the role of local bodies, but it made me particularly think about how they collect our rubbish.

(Rodney Hide) listed these (core functions) as transport and water services and public health and safety, such as rubbish collection.

As it stands, I don't think the current setup is ideal.

Why do they provide rubbish collection at all? Presumably there is a public good argument - an untidy town is detrimental to all, but there is an incentive to free-ride on the cleanliness of one's neighbours. However, at least in Wellington they make you voluntarily pay for rubbish collection through buying rubbish bags. So it seems like they put the incentives right back there, which kind of defies the point of centralised bodies providing public goods.

However I suspect there is a greater complication - they also clean the streets, parks and pavements. If private firms collected your rubbish, you could just get the same thing for free by dumping it in the park and getting the council to pick it up. So the private firms would go out of business, and the council would have a whole lot more work to do cleaning the parks. If you don't think people would do that, you haven't seen the streets around the student flats in Otago University.
However, we should note that these incentives still exist as long as the council makes us pay for rubbish bags.

If rubbish-collection is a public good, it should probably be free. Otherwise it should be privatised. I can't really see the benefits of having a user-pays, centrally provided system like this.

Luck, Size, and the NZ Super

In light of recent substantial budget deficits and worsening outlooks, the NZ Government has cancelled contributions to the NZ Super fund in the medium term. The Super Fund is an investment fund whose board of directors reports to the Government, and up until the financial crisis it had made above-market returns, but now is (I believe) slightly below par. It was intended to cover some of the cost of superannuation in the future.

Unfortunately, the debate around the cessation of payments has caused some recurrent fallacies about financial investment to, uh, recur. Unsurprisingly this is most common at the moment among those who support the parties in opposition, but I suspect that the same fallacies are broadly shared irrespective of political affiliation.

The first is that it is possible to consistently 'beat the market'. Share prices, we are told, are really low at the moment, and so if we buy them all now (or the Super Fund buys them on our behalf), when they go back up again we will all be rich. It would be fabulous if it were as simple as buying low, selling high. It supports our basic intuitions about trends - things usually carry on in the same direction if they have been doing so for a long time. Population increases, economic growth increases, so on. But this intuition fails us when it comes to financial markets.

To find out why, we have to turn to the Efficient-Market Hypothesis, in its weak-form incarnation (which is the most empirically supported one). As any financial prospectus will (or at least, should) tell you, past returns are no guarantee of future performance. It is impossible to predict what is going to happen in the market because if it were, people would. For example, if prices were going to rise at some point in the future and this was predictable, demand would increase. But then prices would rise already! What this means is that it is impossible to systematically make economic profit (or above market profit) from any given investment strategy, except by luck. For the most part share prices are like an old man at the supermarket, they follow an unpredictable, random walk.

This obviously precludes a lot of talk about how the NZ Super Fund managers are skilled, unskilled, or whatever. Kenneth French gives a good example of how it is easy to mistake luck for skill:

Consider, for example, a hedge fund with an annual volatility of 20%. (To be more precise, the standard deviation of the fund's excess return with respect to the appropriate benchmark is 20%.) If the fund's average abnormal return is 5% per year over a ten-year period, many investors and financial reporters would conclude that the manager is truly gifted, with a real knack for identifying under- and over-valued securities. But they would probably be wrong. Suppose the manager's true alpha is zero, so he really has no skill beyond that needed to recover his costs. If we pretend his returns are normally distributed, the probability that his average abnormal return exceeds 5% per year for a ten year period is more than 20%. In other words, in a group of hedge fund managers with standard deviations of 20%, we expect one in five to have a ten-year average annual abnormal return of at least 5%—even if none actually have any skill. We expect one in twenty of the unskilled managers to produce a ten-year average annual abnormal return of at least 10%.

French and Eugene Fama (the 'inventor' of the EMH) have an interesting paper on this here.

The second argument for why we need a super fund is that somehow it can make more money simply by virtue of being large. I cannot, to be honest, see how this could be true. But even if it were, the New Zealand Super Fund is hardly a massive player on the global stage. China, for example, has a fund (used for different purposes) of over $1t. If there were advantages to be made from having more money, other people would be getting them first. Some economies of scale are non-rival, it's true. But it seems unlikely that the NZ Super fund will somehow be able to buy stocks at below-market rates just because it has lots of capital.

As I've said before, the real test of someone's conviction that there is a lot of money to be made on the financial markets is their own financial position. If beating the market is so easy, do it yourself.

Won't somebody think of the opportunity cost?

A classic mistake in any public policy debate is to only point to the benefits and accounting costs. We are often told that such a policy will benefit New Zealanders in way X (such as providing them with warmer houses) and will only cost so much ($1.5b, for example). Comparison of these allegedly leads us to good public policy.

This seems reasonable, but to any economics student the mistake is obvious - it misses out opportunity cost, or what is foregone to pay for the policy. The reason it does this (and this is done all the time, at least here in New Zealand) is that often these arguments rely on a very blurred line between benefits and externalities.

One way to catch yourself from doing this, and to also explain the point I am trying to make, is to think to yourself - would people buy this if they were just given the equivalent amount of money? If they would, then your policy seems a little redundant. But few public policies are like this. The real issue comes when people would not buy the thing you would have the Government provide/subsidise, etc. You should then think to yourself, why not?

Perhaps there is a benefit or cost that goes to others when they buy it that they won't take into account. This is a decent reason, although it leads to other fallacies which I will hopefully discuss later. Perhaps people are cognitively biased in some sense that you are not (i.e. addicted to something), so their choices will not actually make them happier. Perhaps the spending serves some legitimate redistributive purpose.

However, if none of these options are true, it seems that you are left in a tricky place with policy. What you are doing is making people less happy than they could be! Surely this shouldn't be your goal. Sadly, this is the case with a lot of Government spending, but it is particularly evident in the recent decision to subsidise home insulation (and not even means-tested, at that). The supporters of the plan are happy to point to the many benefits we will see, and as someone who lives in a freezing student flat I can more than sympathise with this. However, why aren't people insulating their houses already? The answer is surely that there are other things they could buy that would make them much happier, like paying off their debts, or buying food.

It is an unfortunately masochistic political system where politicians must make society less well-off to stay in power.

A Moral Defence of Deficits

Government deficits are all the rage these days, and understandably this antagonises those on the far-ish right, who really, really wanted tax cuts (*). Common on both the linked blogs is a habit of calling deficits 'fiscal child abuse'. I think this overstates the issue, and I don't think that, morally speaking, the effect a deficit will have on future generations is a terribly bad thing. There may be other reasons to oppose a deficit. But concern for our children's welfare should not be one of them.

Firstly, child abuse a singularly monstrous thing. I think you strip it of meaning somewhat by comparing it to every policy which has a negative effect on future generations. Child abuse is child abuse, but nothing else is.

Secondly, we don't actually have child labour in New Zealand. So by the time they are paying taxes, they will be adults. So it is really, if anything, 'future adult abuse'. This sounds less dramatic, because it is.

Thirdly, provided the recession doesn't last forever (or the 'anti-growth people don't get into power), our children are going to be far richer than us. Because we get richer by such small percentages every year, we don't really notice it. But it compounds, and the reality is that we are far richer than our grandparents, and our children and grandchildren will live lives of luxury we can only dream of, drastic climate change notwithstanding. So perhaps we should worry a little less as to how they'll find the money to pay for it, and take some time to look after ourselves.

* The discerning reader will notice that tax cuts actually increase deficits. Of course advocates for far more limited Government want matching spending cuts. But it interests me that they appear to prefer tax cut advocacy over spending cut advocacy (what is the ratio of posts that complain about cancelled tax cuts in the budget to the posts that complain about spending levels?). Perhaps this is a more politically palatable strategy, or perhaps they simply don't care about future generations as much as they say. That's fine, they shouldn't.

Show Me the Magic!!

It's budget day, so naturally the macroeconomy is one of the big issues. For me, this means revisiting the fiction from my youth and drawing instructive analogies which can enrich ordinary discourse. Today, its Harry Potter.

On my 5th or 6th re-read of the series recently, I was struck by the basic incoherence of the principles which underpin the wizarding economy. Essentially, there is no scarcity. You need food? Gamp's law of transfiguration says that as long as you have some, you can increase its quantity as much as you want. Limited space an issue? Just build a room of requirement which can expand or contract with the wishes of the user. Issues like these bug me, somewhat destroying the realism of the novels.

But more relevant to budgetary concerns is this puzzling fact. Once students graduate Hogwarts (or Beauxbatons or even (heaven forbid) Durmstrang) there seems to be very few employment oppurtunities available. Either you join the Ministry of Magic, whose entire purpose is to keep the muggles oblivious. Or you become a teacher. Or you work on Diagon Alley in a retail store. There seems to be very little primary commerce going down in the wizarding economy.

Of course for wizards, this is not an issue, because they can just substitute magic for industry and everthing is sweet. But supporters of big government spending who believe that this can pump money into an economy and stimulate employment should learn from this. Maybe it would work if Dumbledore was the Minister of Finance. But for those of us tethered to the muggle realm, conjuring economic productivity is not so simple.

Thus ends my frivolous take on macroeconomics.

Old School

Give your mind a break from fiscal policy for a second.

"(Students gave the town) a typically 'Latin Quarter' atmosphere of rowdy, lawless, carefree, frivolous youths, who got into trouble with the police, wasted their time playing ball games, were mad on horse-racing and other shows, and had a weakness for feeble practical jokes ... and of course there was sexual immorality"

Marrou, H.I. A History of Education in Antiquity, 1956, page 215. On Athenian students.

"The novitate... was set upon and badgered by the senior men about him. If he was very fresh, and inexperienced in repartee, they resorted to vulgar banter, but if he showed any quickness in retort, they tried upon him all the resources of their practised wit.... when the nerve of the freshman had been tested, they took him in and at last, the trials of novitate were over"

W.W. Capes, University Life in Ancient Athens, 1877, pages 100-101

Plus ça change, etc

NZ Budget 2009

Political detective/MP for Hutt South Trevor Mallard announces on the Labour Party Blog that he has some leaks as to the content of the NZ Budget to be released later this week:

1. Playcentres not to get the funding promised in Nats election policy for at least another year.
2. Modern apprenticeships abolished.
3. Polytechnic funding for trades courses slashed.
4. Sparc budget slashed.

It will be interesting to see if these are in there or if Mallard has been mislead (or is being misleading). These are all cuts - despite the risk of a credit downgrade I highly suspect that National will have a few radical new spending plans in there, mainly for PR reasons.
I personally would be happy with minimal spending cuts, and perhaps some tax cuts also. In times of hardship firms quite reasonably cut discretionary spending, but the Government does not and should not have this luxury. I like a balanced budget as much, if not more than, the next man, but most economists would accept that if it is to be done, budget-balancing should be counter-cyclical, as it is economically contractionary. This was done quite excellently by the previous administration, something I think is under-recognised by the its critics, who frequently focus too heavily on tax cuts as the sole metric of good policy.

As an aside, there appears to be very little comment on the NZ blogs that I read as to what people expect to see in this week's budget (aside from very good satire).

Depression Chic and the Philosophy of Fashion

The fashion industry irritates me. Designers and editors pontificate about 'it shoes' and 'statement handbags' and models preen and primp themselves before strutting around in whatever happens to be 'in' at the time. In response, we consumers collectively swoon and shell out the moneys. It has always seemed to me to be a vacuous circle, tapping into the crude social status circuitry in our heads in a vainglorious attempt at making our lives more fulfilling.

From the standpoint of human behaviour, I think fashion reveals two things. Firstly, I see it as an example of a cultural institution being moulded out of our genetic clay, and then misfiring spectactularly. Secondly, I think it can be used as a textbook example of monopolistic competition in a market traditionally thought of as quite competitive, and that might be illustrative of general anomalies in economic thinking. These are of course major theses in their own right, and deserve more thorough consideration which I will give them in due course.

But for now I have a different agenda. The Atlantic recently published a stimulating feature on fashion in the depression economy and the challenges the industry faces going forward. It is a great read, arguing that as we enter a winter of financial discontent, consumers will rethink their conspicuous consumption of fashion. However, the designers are ready for this, and will respond with a panoply of new trends which continue to push the envelope, assisted of course by Michelle Obama, that heraldic doyenne of all things glam. What can that family not do?

What particularly piqued my interest though was this:

Fashion’s singular ability to marry aesthetics and psychology, formalism and eroticism...consumers of fashion are undergoing a “values correction"

Sounds fascinating. But wait, there's more:

Fashion is both a form of self-expression and an outward means of defining and altering selfhood....It famously, complicatedly blends art and commerce, and perhaps the highest compliment one can pay a designer is to say that he or she understands the customer: a good part of the art lies in fathoming her mood, her desires, and her ambitions, and the ways these may shift from season to season and year to year and evolve as she ages.

The suggestion seems to be that self-identity, hopes and ambitions, emotional moods and personal narrative, nothing less than the fundaments of consciousness, can be manifest in fashion. Yes, this is a somewhat ponderous extrapolation. But to me it represents a fundamentally different way of looking at this industry and its values and purpose.

If aesthetic value can truly be ascribed such a weighty role, then we should spend more time celebrating this function, rather than allowing the rhetoric of fashion to descend into mindless platitudinous back-slapping. That would certainly stop me from so glibly dismissing the fashionistas.

Generational Racism

I recently read this very bizarre article in the New York Times on 'proms' in Georgia. Apparently many schools hold segregated proms - one for black people, and one for white people (although of course, white people are allowed to attend the 'black prom').

However, the article appears to want to argue that racism isn't the issue - it's just a desire to respect tradition. Several kids are interviewed. Typical quote:

“It’s awkward,” acknowledges JonPaul Edge, a senior who is white. “I have as many black friends as I do white friends. We do everything else together. We hang out. We play sports together. We go to class together. I don’t think anybody at our school is racist.”

The impression the author leaves us with is that none of the kids are in any way racist - the tradition is enforced by their domineering parents. None of the parents are interviewed.

We could draw from this that younger generations are more tolerant, less racist, etc. Before we get caught up, however, in our excitement at the coming tolerant utopia when today's youth are in power - a few cautionary notes.

Firstly, surely there is a bit of a Bradley effect. Small-town people, especially adolescents, when interviewed by an author for the New York Times, are going to want to seem more tolerant than they are.

But secondly, and perhaps more importantly, why are their parents apparently so racist? The majority of them would have been very young through the US Civil Rights movement, if they were even born(assuming they're about 40-50 years old). Institutionalised racism has essentially been abolished their whole lives! The obvious answer is that institutionalised racism is just a symptom of a culture of racism - which doesn't get abolished quite so quickly. But if their parents managed to learn to be racist from their parents, we should be sceptical that the current generation is somehow going to grow up racism-free.

Newton, Einstein and Behavioural Econ

In his recent post Udayan took me to task for my fairly conservative desire to treat neo-classical economics (and particularly the concept of homo economus) with serious respect, or at least, more respect than he thought it deserved. To clarify, I also think that behavioural economics is an exciting and fascinating new field. But I think that we should be careful, lest our excitement get the better of us, and we end up forgetting how useful our previous models were.

Uday used a useful analogy of Newtonian vs. Eisteinian physics. Newtonian physics gave us a good approximation of how the world worked for hundreds of years - but as Einstein showed, it turned out to be fundamentally misconceived. Einstein's insights gave us a deeper, more accurate understanding of how things actually work.

But have we since abandoned Newtonian physics? Of course not. In the vast majority of observable situations (that is, except for research physicists) Newton's laws still appear to hold. Engineers need not worry that people moving around in their buildings will increase in mass as they move and thus crash through the floor, for example.

I think the same applies in behavioural economics. We can use it to refine our explanations of markets, and to explain areas where the neo-classical model fails. But we should be very sure that the neo-classical model has actually failed, lest we get ironically caught up in our irrational exuberance to find more complex ways of explaining the easily explainable. In particular, there needs to be very clear and testable implications of our theory.

One very simple example is the phenomenon of hyperbolic discount rates, where people discount future payoffs inconsistently. This has clear, testable consequences for people's saving behaviour. Compare this to Udayan's post - which claims that a particular outcome is due to people not seeking to maximise utility. This may be true, but it is very vague and not susceptible to easy testing. In the comments Udayan provides a clearer and more useful explanation, but I think his post is indicative of a trend to revert to claiming cognitive biases without really exhausting other possibilities, which would be necessary to explain how your theory differs from standard predictions. This is classic scientific method, but in our rush to claim psychological experiments as the Einstein of economics it is sometimes sadly swept to the wayside.

The Behavioural Faultlines of Price Theory

In reply to my previous post, Tom was scpetical of the general approach I took to explaining the missing market. He said:

People aren't perfectly rational, but it shouldn't be our default explanation for every slightly perplexing feature of the market

Well...why not?

Of course this is a more general argument about why perfect competition doesn't exist. We can try and understand market failure by using the standard tools of the economist - assume homo economicus, look for transactions costs, point to an externality, find a public good problem and so on. All of these are valid to some extent. But if we know people are't rational in significant ways, then ignoring this fact trying to shoehorn human behaviour in some preordained way seems a bit odd.

This doesn't mean we have to argue that markets are always and everywhere a non-starter. It is merely an acknowledgment that the model proferred by neo-classical economics is not the final draft of economic explanation, but that it is akin to the Newtonian Physics awaiting its Einsteinian upheaval. For me this is tremendously exciting, as it opens up the study of economics and allows its foundations to be put under the experimental zoom lens. If people are predictably irrational, then it is something we need to be aware of as empirical scientists and integrate into our models of market behaviour.

I personally am quite enamoured with this approach, while Tom is less so I believe. This should make for much fruitful disagreement into the future, exactly what the discipline needs if we want to dispel the shrill pundits wailing about the death of capitalism and all that other nonsense.