Category: Economics

Brad DeLong has an excellent post on the prisoner’s dilemma, the symmetry argument and Newcomb’s problem.  He hits the nail on the head with this:

I am a dominant-strategy guy. If you find the Symmetry Argument
convincing–well, Grasshopper, you have once again failed to snatch the pebble
from my hand. But I feel the force of the other side: If you find the Symmetry
Argument an obvious fallacy–well, Grasshopper, you have once again failed to
snatch the pebble from my hand.

Let me again cite Alex’s strong arguments against the importance of adverse selection in insurance markets.  Here is Paul Krugman, and here is Brad DeLong, both of whom see adverse selection as the central health care problem.

How can we square these differing points of view?

When I argue that adverse selection is not the key, I hear a common response: "*You* try getting insurance after you have been diagnosed with an advanced brain tumor," or something along those lines. 

To be sure, this is a real point but it is not adverse selection.  Adverse selection requires asymmetric information, namely that I know more about my brain tumor than does my potential insurance company.  The more likely problem is that the tumor is common knowledge, or would be if I applied for insurance, and the company won’t sell a policy for any price cheaper than the costs of treatment.  There is no asymmetry of information, rather insurance simply is no longer possible.  In the limiting case, imagine that a predictor-demon could forecast your lifetime medical expenditures with certainty, and then blog them by your social security number.  Such a person, no matter how healthy, couldn’t buy insurance either.

Scream all you want, but that is not inefficient per se (don’t complain in the comments about the limits of the efficiency concept, and the cruelness of economists, I’m already on that one, scroll down to #7 under "microeconomics", alternatively you might make a complicated Rawlsian argument.)  Covering these people, by the use of government policy, is a transfer, not an efficiency improvement, with an added caveat for imperfect capital markets.

Defenders of the adverse selection argument in reality believe the following: if someone is going to face death, or a very bad medical outcome, and can’t buy their way out of it, government should put up the money, at least within limits.

Maybe yes, maybe no, but now we are comparing competing investments and which will bring the greatest utilitarian good and the greatest moral good.  I’m far from convinced health care access wins that race or even comes in second.

And that is a general point, it is not about the United States and whether we pay more to get less compared to Europe, and so on.  Please don’t bring up that comparison to distract yourself from the logical force of this point or to think you can get a free lunch.  If you wish, think of it as whether the Netherlands should subsidize as much health care as it does. 

The point is this: defenders of the single-payer system, by invoking adverse selection, wish to claim efficiency on their side.  If the single-payer system were more efficient, we would not have to worry about competing investments, in fact we could make more of such investments by moving to a single payer.

But what looks like adverse selection is in reality something just a wee bit different.  That wee bit, however, is an important bit.  The desirability of the supposed remedy follows from an ethical judgment, not the prospect of a Pareto improvement.  And then we are back to comparing alternative investments for scarce resources.

I see the big marginal gains in lifestyle and in pharmaceuticals, not in access to health care per se.  And that is another reason why I am skeptical of the single-payer arguments.  That is without even considering the possible secondary consequences of so much government involvement.

I haven’t dealt with the Rawlsian approach, which attempts to transform the ex post disaster into a case for ex ante insurance and thus returns us to the realm of efficiency.  But if you reread the paragraph immediately above, that Rawlsian move, even if it succeeds on philosophical grounds (I am skeptical), still won’t save the case for a single-payer system.

Tim Harford, writing in Saturday’s FT, allows us, as benevolent utilitarians, to ask ten bums one common question, and upon hearing their answers we give a donation to one of them.

I am never one to believe that cheap talk has zero value, if so why would I write (or you read) a blog?  So what questions might be asked?  The bums know the game, so of course they are tempted to lie.  Alex, Tim and I pondered this one over lunch.

1. Alex’s idea: ask each bum "who deserves the money the most?"  If they have repeated dealings with each other, the folk theorem might kick in and the group will nominate the wealth-maximizing recipient and institute side payments.  This may or may not maximize group utility as well.

2. Ask each bum "what are you doing here?", with a provocative tone of voice.  Give the money to the bum with the rudest, least polite answer.  He is least likely to get funds from elsewhere, plus the polite bum is probably a drug addict or otherwise totally dysfunctional.

3. Take advantage of the human proclivity to boast about knowledge.  Ask each bum what is the best way to find or to drink cheap alcohol, and give the money to the bum who shows the least expertise.  This was also an Alex idea.

4. Find the single question best correlated with the results of an IQ test.  Give the money to the stupidest bum, who is likely to be unlucky more than self-destructive.

Alternatively, say you had to tax one of ten rich men, and had one question to ask the group to determine who should pay the tax.  What should the question be, and why is this a harder problem?

Your thoughts on either problem?

GMU people study prizes, sponsor prizes and we win some also!  Must be something in the water.

A George Mason University chemistry professor has won a $1 million
engineering prize for developing a simple and inexpensive means of
filtering arsenic from well water, an advance that is already
preventing serious health problems in hundreds of thousands of people
in his native Bangladesh and could help millions of others around the
world.

The 2007 Grainger Challenge Prize for Sustainability,
administered by the National Academy of Engineering, will go to Abul
Hussam of Centreville, academy officials announced yesterday…

His final creation — an easy-to-make, maintenance-free, two-tiered
system that uses sand, charcoal, bits of brick and shards of a widely
available kind of cast iron — removes virtually every trace of arsenic
from well water. It wowed an independent panel of engineering academy
judges who, under the rules of the prize, were looking for an
affordable, reliable, socially acceptable and environmentally friendly
solution to the arsenic problem that did not require electricity.

Prize
rules also required that the product be proven in field conditions, not
just in a lab….The 2007 sustainability prize is the first in a series to be funded by
the Grainger Foundation of Lake Forest, Ill., created in 1949 by an
electrical engineer.

Thanks to Nitpicker for the pointer.

The ever-interesting ApeMan writes:

If you grant that overregulation, excessive lawsuits, and complex tax codes all present problems that increase the demand for high I.Q people, then the price for the labor of high I.Q actors should rise until demand and supply stabilize.  Therefore, it follows that if you grant that regulations, the rate of lawsuits, and the complexity of the tax codes are not optimal, then you must admit that the pay rate for high I.Q people is not optimal either.

A good point, but I am not convinced that a highly regulated society boosts income inequality.  On the flip side, the regulators themselves earn government salaries, and that favors greater equality.  Either they are the dregs pulled up a bit, or some otherwise high-salaried lawyers move to the greater security of the public sector.

How about inefficient regulation itself? 

Lots of smart people earn a mint finding creative ways around complexities in the tax code and in regulations.  But I still believe that those complexities tax smart people more than they benefit them.  The smart lawyer is paid so much only because some other smart guy wants to walk through that loophole and is otherwise suffering under the regulatory lash.

Imagine that a regulation chokes off an entrepreneurial opportunity worth $100 million.  Without regulation, one entrepreneur would have earned that much.  With regulation, a bunch of smart lawyers rake off, say, $20 million of the total but that is still a more equal distribution than the former scenario (which is not to say it is better).  An alternative scenario is that such large gains are usually spread across many shareholders, and lawyers walk in as the big winners, thereby boosting inequality, but I do not think that is the primary case.

Furthermore inequality tends to rise with wealth (imagine the Gini coefficient for Bel-Air), so inefficiencies which destroy wealth tend to lower inequality, albeit not for the better.

The Mexico or Indonesia scenario is different.  Government creates some monopolies and a small number of people get very rich from them.  That is unlike the case where smart lawyers get smart people through hurdles. 

The bottom line: To the extent income inequality is higher, I don’t view government as a fundamental cause, at least not in the United States.

Here from Business Week is a very cool story on a prize I had not heard of before.

A few years back, Toronto-based gold mining company Goldcorp (GG)
was in trouble. Besieged by strikes, lingering debts, and an
exceedingly high cost of production, the company had terminated mining
operations….Chief Executive Officer Rob McEwen needed a miracle. Frustrated that
his in-house geologists couldn’t reliably estimate the value and
location of the gold on his property, McEwen did something unheard of
in his industry: He published his geological data on the Web for all to
see and challenged the world to do the prospecting. The "Goldcorp
Challenge" made a total of $575,000 in prize money available to
participants who submitted the best methods and estimates…

Within weeks, submissions from around the world were flooding into
Goldcorp headquarters. There were entries from graduate students,
management consultants, mathematicians, military officers, and a
virtual army of geologists….

The contestants identified 110 targets on the Red Lake property,
more than 80% of which yielded substantial quantities of gold. In fact,
since the challenge was initiated, an astounding 8 million ounces of
gold have been found–worth well over $3 billion. Not a bad return on a
half million dollar investment.

Frank Lichtenberg uses a novel strategy to estimate the effect of price controls on innovation.  Simplifying (see the paper for details) Lichtenberg argues that the profit from a pharmaceutical is essentially P*Q-FC where P is price, Q is quantity and FC is fixed cost.  Most of the fixed cost is due to research and development and getting through FDA hurdles.

The key to Lichtenberg’s strategy is to note that changes in Q have the same effect on profit and thus on the incentive to innovate as changes in P (this is not really true since changes in P also influence Q but Lichtenberg adjusts for the elasticity of demand).  Moreover we can estimate the effect of changes in Q on innovation by looking at how the incidence of a disease influences innovation.  Lichtenberg finds, for example, that pharmaceutical innovation is higher among cancers with greater incidence (e.g. lung versus pancreatic cancer).  Using the Q to innovation relationship he estimates that a 10% reduction in price would reduce pharmaceutical innovation by 5%.

We know that pharmaceutical innovation saves lives and has a very high benefit to cost ratio.  Thus, price controls or other restrictions that reduce prices are almost certainly a bad idea.

Indeed, as I have argued before, health care spending on the margin has very low value.  We know, for example, that Medicare regions that spend twice as much on patients have no better outcomes.  Spending on health care research and development, however, has very high value.  Thus price controls would be a disaster – reducing high value R&D and replacing it with low value current spending.

I fear that short-term thinking by politicians and the public will destroy the US pharmaceutical industry. 

Ed Glaeser writes:

Manhattan, not suburbia, is the real friend of the environment.  Those
alleged nature lovers who live on multiacre estates surrounded by trees
and lawn consume vast amounts of space and energy.  If the environmental
footprint of the average suburban home is a size 15 hiking boot, the
environmental footprint of a New York apartment is a stiletto-heeled
Jimmy Choo.  Eight million New Yorkers use only 301 square miles, which
comes to less than one-fortieth of an acre a person.  Even supposedly
green Portland, Ore., is using up more than six times as much land a
person than New York.

New York’s biggest environmental
contribution lies in the fact that less than one-third of New Yorkers
drive to work.  Nationwide, more than seven out of eight commuters drive.

I get the point but I don’t quite buy this.  Manhattan sells services, most notably finance and entertainment, to the rest of America, and in turns draws upon industrial outputs, which of course include steel and glass.  It is also no accident that Gary, Indiana is near Chicago and those rather aesthetically thrilling factories off the New Jersey Turnpike are right outside New York City.  Try the other boroughs as well, they don’t call Staten Island a big garbage dump for nothing.  Praising Manhattan is a bit like looking only at the roof of a car and concluding it doesn’t burn much gas.  Manhattan supports its density only by being surrounded by a broader load of crud.

Perhaps a better question concerns the margin.  If we tax Peoria and subsidize Manhattan an extra bit, and induce some migration, does the total environment footprint of mankind go up or down?  For instance building up rather than out saves space but it also costs more construction energy and attracts more commuters and leads to more surrounding crud. 

If you think the big problem is humans grabbing more and more space, you might prefer to tax suburbs and subsidize cities.  If you think the big problem is humans using more and more energy, the opposite conclusion might follow.  Suburbs are bad for burning gas, but they are an especially efficient place to work, buy things, and raise children. 

A subsidy to 5th Avenue is also a subsidy to Port Newark.  Think of Manhattan as a place which outsources its pollution, simply because land there is so valuable.

1. We weave a thread of self-reliance into a sturdy fabric of interdependence. By respecting the law, we reinforce impersonal justice. By competing intensely and fairly in an impersonal global market, we raise our standard of living through specialization and innovation. By upholding Constitutional principles for limited government, we sustain our individual freedom.

I am not sure I have grasped what it all means.

2. We are creative and pro-active in helping one another. We do not have the patience to wait for government, nor do we want to be lulled into passivity by the promise of government. Instead, to solve those problems that require collective action, we form voluntary associations, including civic groups, corporations, clubs, standards-setting bodies, consumer information services, and charitable foundations.

Agree fully.

3. Government must be kept in its place. We hold government officials to high standards of competence, honesty, and fairness. However, we do not confuse government with family. We do not confuse government with religion. We do not confuse government with business. We are conscious that any expansion of government responsibility, however well-intended, crowds out those institutions that are the true bulwark of our society.

I disagree with the last sentence.  Many expansions of government, for instance tax incentives and foundation law, boost civil society.  Relative to current political debates, however, I am on Arnold’s side.

4. We celebrate the successes of others. We are glad when an entrepreneur becomes wealthy by finding a way to fill a customer need. We are glad when an immigrant family climbs the ladder of success. We are glad when people living in other countries make economic progress and spur us to innovate and improve.

Fully agree.

Ethical Principles

5. Government cannot legislate morality, but it does mess with the incentives. Those incentives should never be tilted against the institution of the family whose mission is to raise children to be fine, upstanding citizens.

I don’t think all incentives should favor families, for instance higher education should be priced, unlike in much of Europe, and divorce should be fairly easy.

6. We maintain an ongoing conversation about morality and ethics. This conversation is informed by the Ten Commandments and Biblical scripture. It is informed by the Declaration of Independence, the Gettysburg Address, and Dr. Martin Luther King’s "I have a dream" speech. It is vital to continue the conversation, even when consensus is difficult.

The Ten Commandments are pretty tricky, first there are eleven of them presented in the Bible, second they are presented in three different versions, third I would consider worshipping graven idols.

7. Like new businesses, new moral ideals can revitalize our society, even though many of them fail. For example, we recognize that we are a better people without racial segregation or barriers to the education and career opportunities for women. However, we judge some social experiments to be failures, including eugenics, Communism, and nihilistic cultural relativism.

A mouthful.  What about non-nihilistic cultural relativism?  Does that have a place?  Do arranged Indian marriages count as eugenics?

International Principles

8. Our ideology does not have to be sustained by military suppression. Although it can inspire people to fight against tyranny, ultimately our ideology allows us to live in peace.

What is "military suppression"?  The U.S. military should not have to suppress American citizens but it should try to prevent China from taking over Taiwan.  I doubt if permanent peace is possible, though I wish it were.

9. We believe that people all over the world yearn for liberty, and for them we stand as a beacon and a champion. But we recognize that freedom is not ours to give when community leaders are not ready to seize the opportunity that it offers.

I am never sure how many people really yearn for liberty.  I wish more of them did.

10. When foreign leaders issue threats against us, we take them at their word and act accordingly.

I am not sure words are the best way of reading true intentions.  Many threats are issued for domestic consumption, or are best ignored.  Some real villains stay pretty silent.

This is Tyler answering, by the way, not Tyrone.  I feel what is missing is a more explicit platform about the importance of long-run economic growth, plus there should be greater consideration given to dealing with catastrophic events such as pandemics, natural disasters, nuclear terrorism, and so on.

Mr. Velde, in a Chicago Fed Letter
issued in February, has come up with a solution that would abolish the
penny, solve the excess costs of making nickels, help the poor, keep
the Lincoln buffs happy and save hundreds of millions of dollars for
taxpayers.

As Mr. Velde explained in an interview, “We face a
very medieval problem so I took inspiration from the medieval practice
of rebasing.”

He would rebase the penny by having the government declare it to be worth 5 cents.

We would then stop coining nickels at a loss.  Here is more, from Austan Goolsbee.  I am reminded of Neil Wallace’s work from the 1980s on the indeterminacy of equilibrium exchange rates in the absence of legal restrictions.  If we take away government acceptance at par for taxes and the like, is there not an equilibrium where each penny is worth a million dollars?  More ambitiously, if the U.S. government declared that each $20 bill is now worth $100, or each $100 worth $500, would the real exchange rate adjust immediately?
 

…On the global level, it is difficult to argue that inequality is one
of the world’s major political-economic problems. It is hard, at least
for me, to envision alternative political arrangements or economic
policies during the past 50 years that would have transferred any
significant portion of the wealth of today’s rich nations to today’s
poor nations. I can easily envision alternatives, such as Communist
victories in post-World War II elections in Italy and France that would
have impoverished nations now in the rich North.

I can also envision alternatives that would have enriched poor
nations: Deng Xiaoping becoming China’s leader in 1956 rather than 1976
would have done the job there. But alternatives that would have made
the South richer at the price of reducing the wealth of the North would
require a wholesale revolution in human psychology.

Nor should we worry a great deal that some people are richer than
others. Some people work harder, apply their intelligence more
skillfully or simply have been lucky enough to be in the right place at
the right time. But I don’t see how alternative political-economic
arrangements could make individuals’ relative wealth closely correspond
to their relative moral or other merit. The problems that can be
addressed are those of poverty and social insurance-of providing a
safety net — not of inequality.

But on the level of individual societies, I believe that inequality
does loom as a serious political-economic problem. In the United
States, the average earnings premium received by those with four-year
college degrees over those with no college has gone from 30 percent to
90 percent over the past three decades, as the economy’s skill
requirements have outstripped the educational system’s ability to meet
them. Because the required skills acquired through formal education
have become relatively scarcer, the education premium has risen,
underpinning a more uneven distribution of income and wealth.

Ceci Rouse and Orley Ashenfelter of Princeton University report that
they find no signs that those who receive little education do so
because education does not pay off for them: If anything, the returns
to an extra year of schooling appear greater for those who get little
education than for those who get a lot.

A greater effort to raise the average level of education in America
would have made the country richer and produced a more even
distribution of income and wealth by making educated workers more
abundant and less-skilled workers harder to find — and thus worth more
on the market.

Likewise, America’s corporate CEOs and their near-peers earn 10
times more today than they did a generation ago. This is not because a
CEO’s work effort and negotiation and management skills are 10 times
more valuable nowadays, but because other corporate stakeholders have
become less able to constrain top managers and financiers from
capturing more of the value-added.

Similar patterns are found elsewhere. Within each country, the
increase in inequality that we have seen in the past generation is
predominantly a result of failures of social investment and changes in
regulations and expectations. It has not been accompanied by any
acceleration in the overall rate of economic growth. For the most part,
it looks like these changes in economy and society have not resulted in
more wealth, but only in an upward redistribution of wealth — a
successful right-wing class war.

Here is Dave Leonhardt on prizes, including the work of Robin Hanson.  The pointer is from Chris Masse, don’t forget his blog www.midasoracle.org.

Here is Robin’s paper on prizes.

The Fed governors, and Dani Rodrik, both via Greg Mankiw.

His typist also worked for Agatha Christie and, during the time she was typing Schelling’s works on conflict resolution, she was also typing Christie’s classic play The Mousetrap.

That is from Robert Didge’s The Strategist: The Life and Times of Thomas Schelling.  This book is fun, fun, fun.  Rather than trying to signal his abilities as a "serious biographer," Didge gives the reader insight into Schelling and his times.  Yes it does cover both his career as a military advisor and his personal life.  The new Milton Friedman biography was a bore, this is a delight.

We evaluate whether the Renminbi (RMB) is misaligned, relying upon conventional statistical methods of inference.  A framework built around the relationship between relative price and relative output levels is used.  We find that, once sampling uncertainty and serial correlation are accounted for, there is little statistical evidence that the RMB is undervalued.  The result is robust to various choices of country samples and sample periods, as well as to the inclusion of control variables.

Here is the paper. 

My take: Even I don’t go quite that far.  The authors attach more weight to purchasing power parity than I would, and not enough weight to what I call the "newspaper protestations" of investors and capital market analysts, who all seem to want into China.  Nonetheless this paper has real arguments and real numbers.  I see the value of the Chinese currency as vulnerable over time, and this piece is a useful corrective to the many exaggerated claims made on the other side of the debate.