Give the Lawyer his Cut

The latest issue of Forbes (Oct. 3) has an article by myself on contingent fees.  (It’s based on a short AEI book, Two Cheers for Contingent Fees with Eric Helland). 

Contrary to popular argument, contingent fees serve a social purpose.  A lawyer paid by contingent fee will only take those cases that have a decent probability of winning – thus contingent-fee lawyers act as screeners, saving the court system and everyone else the trouble of examining frivolous cases.  That’s right, contingent-fee lawyers reduce the number of frivolous cases!  When contingent fees are restricted, lawyers naturally turn to alternatives such as charging by the hour.  But a lawyer paid by the hour has little incentive to screen.  Helland and I find evidence consistent with the screening function of contingent fees.

In states that restrict contingent fees,
plaintiffs dropped 18% of cases before trial without getting a
settlement. In states where lawyers were free to take their usual 33%
cut, they dropped only 5% of cases. This tells us that lawyers had
already screened out the junk suits and were pursuing those with merit.

Our study also shows that the time to
settlement in medical malpractice cases is 22% longer in states that
restrict contingent fees. In Florida, in the 300 days after contingent
fees were restricted in 1985, settlement time increased by 13%. Why?
When lawyers are paid by the hour, they have little incentive to settle
quickly.

By the way, one of the fun things about doing an article for Forbes is that they always send out a professional photographer – which for an academic like me can be quite a thrill as they really do primp and preen over you.

Turn to the right, oh yes, that’s it, hold it, hold it, Great!  The camera loves you!  Now lean back a little, good, good, good.  Be like a Cheetah, a Cheetah.  No a Lion, yes, a Lion.  Hold it, Hold it.  Yes.  Wonderful!  Wonderful!

I exaggerate, but it was fun.  Unfortunately, the photo is not online so you will have to go to the newsstand to see the result. It’s arty, but I’d say they captured the lion.  Yeah, baby.

Google is using prediction markets within the firm

The markets were designed to forecast product launch dates, new office openings, and many other things of strategic importance to Google. So far, more than a thousand Googlers have bid on 146 events in 43 different subject areas (no payment is required to play).

We designed the market so that the price of an event should, in theory, reflect a consensus probability that the event will occur. To determine accuracy of the market, we looked at the connection between prices of events and the frequency with which they actually occurred. If prices are correct, events priced at 10 cents should occur about 10 percent of the time.

In the graph below, the X-axis indicates the price ranges for the
group. The orange line represents the average price, which is how often
outcomes in that group should actually happen according to market
prices. The purple line is how often they did happen. Ideally these
would be equal, and as you can see they’re pretty close. So our prices
really do represent probabilities – very exciting!

The image

Here is the story, and thanks to several of you who sent in the link.

Who are the world’s top intellectuals?

Cast your five votes here, plus you can see how old each candidate is and how many of these names you have read or heard of.  Several economists, such as Krugman, Becker, Sen, Summers, and Bhagwati, are included in the polling; Hernando de Soto and Richard Posner make the list as well.  For other nominees, how about Derek Parfit and Milton Friedman?  Philip Roth?  The politically incorrect Michel Houllebecq?  Bruno Latour?  Marvin Minsky or Hans Moravec?  I am glad to see Pramoedya Toer on the list.  How about the Google people?  An early blogger?

Is the Singularity Near?

The first half of the twenty-first century will be characterized by three overlapping revolutions — in Genetics, Nanotechnology, and Robotics.  These will usher in what I referred to earlier as Epoch Five, the beginning of the Singularity.

So writes Ray Kurzweil.  In other words, we will reverse engineer the human brain and turn people into computer uploads, all within the next century.  At the very least you will be an advanced cyborg.  In the meantime buy the book (p.s.: you can stop worrying about the Medicare fiscal train wreck, although you should exercise more to reach immortality).

No, I won’t dispute the science on any single point, but nonetheless I feel confident in my skepticism.  I am still waiting for an Internet Explorer that doesn’t crash, and for an NBA with the common sense to move out the three-point line.  More generally, Kurzweil has thirty-four good arguments why his scenario will happen, but only one of those has to fail.

Still, Ray Kurzweil must be the most important thinker today, if only in expected value terms, putting the complexities of Pascal’s Wager aside.  It is no longer intellectually acceptable not to know his major arguments.  Here is the book’s web site.  Glenn Reynolds offers useful commentary and linksArnold Kling is a fanAddendum: Read James Miller’s TCS review as well.

Equity shares in everything

If the new Internet venture succeeds, it will be a whole new ballgame for the gambling-driven pastime of fantasy sports, which already has up to 20 million players.
    ProTrade, which opened for business yesterday, will treat professional athletes like stocks to be bought and sold, initially in a theoretical currency. Cash prizes will be awarded to the most successful investors.
    The value of a blue-chip quarterback such as Peyton Manning of the Indianapolis Colts will be determined by a community of traders competing to identify players most likely to contribute to the success of their real-life teams.
    In this bottom-line approach to sports, teams are known as investment portfolios and the real-life athletes get their own ticker symbols. Manning’s symbol is PMANN…
    ProTrade initially will be confined to trading NFL players, but the San Mateo, Calif., company expects to add the NBA and Major League Baseball after working out licensing agreements.

Is it real money?

At the outset, basically for the first half of the NFL season, no actual money will be exchanged in ProTrade’s market; each participant will get a virtual stake of 25,000 coins to invest.
    But capitalism will fuel the market’s activity, with weekly prizes awarded to the portfolios with the best investment returns. Later this year, traders will be allowed to create their own competitive leagues and set their own entry fees, with a $5 minimum per entrant.
    ProTrade will hold all the entry fees in escrow and then distribute jackpots, minus a 2 percent to 3 percent commission, to league participants who generate the best investment return. ProTrade hopes to make money from those commissions and advertising on the site.

Here is the story.  Comments are open, in case you know more about this than I do.  I like this part of the story:

Former San Francisco 49ers tight end Brent Jones, a member of ProTrade’s advisory board, believes most players will stay away from the site.
    "There are a lot of guys out there who aren’t going to want to see what they’re really worth," he said.

I guess I still do care about this guy…

A collaboration of titans, Bob Dylan – No Direction Home, directed by Martin Scorsese.  I’ve just started watching, but it is hard to recommend this too highly.  The quality of the music clips — most of which are not Dylan — simply defies belief.  And did you know that Dylan wanted to attend West Point and his favorite politician is Barry Goldwater?  Fifteen years ago I thought this guy would go into the dustbin of musical history, but I was so so wrong.  The DVD was released today, and the show will be on PBS soon.  And when it comes to CDs, Entertainment Weekly outlines the essential Bob Dylan.

The Vioxx Hex

It’s a real thrill when the editorial page of the Washington Post starts to sound like, well, me (e.g. here and here).

Politicians and regulators should be asking themselves whether a system of
massive cash awards to people who may or may not have been adversely affected by
Vioxx is a logical, fair or efficient way to run a drug regulatory system. They
should also be asking whether juries that scorn medical evidence are the right
judges of what information should or should not have been on a prescription
label. After all, Vioxx was produced and sold legally. The drug was approved by
the Food and Drug Administration, and its label did warn of coronary side
effects. It is possible, even probable, that Merck was negligent in its decision
to ignore early warnings of the cardiovascular risks of Vioxx. But the company
has already paid a price for that negligence, in the losses it has suffered
after abruptly taking Vioxx off the market. Fair compensation for the injured
needn’t entail disproportionate financial punishment as well.

In the long term, using the courts to "send a message" to Merck isn’t going
to help consumers. If the result is an even more cautious FDA approval system
and a more cautious pharmaceutical industry, that will keep innovative drugs off
the market for much longer. More people will die waiting for new treatments. The
cost of producing new drugs will rise dramatically. Already, there are whole
areas of medicine — women’s health during pregnancy, for example — that are
made so risky by liability issues that companies may stop doing research in
them.

The first principle of reforming this system should be that a company that
follows the FDA’s rather extensive guidelines should be protected from punitive,
if not compensatory, damages.

Growth fact of the day

…out of nineteen non-Western countries that belonged to the rich club in 1960, only four remained there (the Bahamas, Japan, Mauritius, and Slovenia) [in 2000].

Or perhaps you are wondering which countries, according to available statistics, appeared on the verge of crossing over into the "rich" category in 1960?  Here is the list:

Lithuania, Serbia and Montenegro, Hungary, Kazakhstan, Poland, Russia (addendum: no, I don’t believe the data), Ukraine, Croatia, Haiti (!), Guyana, Jamaica, Colombia, Panama, Nicaragua, the Congo (!), Senegal, Gabon, Ghana, Singapore, Iran, and Hong Kong.  At the time many of these countries lagged only slightly behind Portugal.

The lesson?  Don’t take your future prosperity for granted.

That is all from the very interesting Worlds Apart: Measuring International and Global Inequality, by Branko Milanovic.  Here is more information on the book.  Here are the author’s working papersThis paper argues for allowing the free movement of soccer players onto teams outside their nationality.

My view of the Chinese central bank

Brad DeLong has another useful post on whether we should be optimists or pessimists about the U.S. dollar.  Much hinges on whether we expect the Chinese central bank to continue buying U.S. Treasury securities.  As many MR readers will know, I am a cautious optimist.  I have never been to the Chinese central bank, or spoken with a Chinese central banker, but here is my implicit mental model of how they operate:

1. Intelligence and financial prowess aside, they grew up in an age of Communist terror, or if they are young they heard narrations of such from their parents.

2. They are deathly afraid of making mistakes and causing China to lose face on the global scene.

3. They know full well that the Chinese economy — especially the financial system — is a rickety house of cards.  If capital flows out of China were unrestricted, and the yuan allowed to float freely, a financial collapse would come within five years.  They see us as propping up their currency, rather than vice versa.  Most of all, they want to be holding safe assets, in case the worst should happen.  They are risk-averse bureaucrats.

4. They behave like many other non-profit institutions (e.g., Harvard) in accumulating an endowment of high-prestige, high-quality assets.  U.S. government securities are tops on this list.  Yes, it is a puzzle why Harvard accumulates such a considerable endowment, but no one expects them to stop anytime soon.

5. They don’t much care if they suffer capital losses on their dollar-based endowment, evaluated in terms of the relative exchange rate with the yuan.

6. Many Chinese have a highly conspiratorial view of the world.  They would expect — indeed "overexpect" U.S. "retaliation" if they suddenly stopped buying Treasury securities.

7. They are familiar with the old chess saying: "The threat is stronger than the execution."

The bottom line: We require a better theory of endowments to predict the future behavior of the Chinese central bank.  But what I do know — or at least imagine I know — does not give me cause to believe the U.S. dollar will soon plunge in value.

The cynic’s conundrum

The cynic’s conundrum is that while a cynic might prefer that others believe an idealistic theory of his cynical mood, his own cynical beliefs should lead him to believe a cynical theory of his own cynical mood. That is, a cynic should believe that complainers tends to be losers, rather than altruists.

Furthermore, the meta-cynical theory, that cynics tend to be losers, seems to better explain the patterns that people don’t like to be around cynics, and don’t want to their children trained in cynicism. If idealism indicates more attractive features, people and institutions would try to present themselves as idealistically as possible.

Of course both the idealistic and the cynical theory of cynicism seem to accept the claim that cynical beliefs tend to contain a lot of truth. And this fact in turn favors the cynical theory of cynicism. Thus while hypocrisy and low motives probably are in fact much more widespread than most people acknowledge, most people are well-advised to pretend that they believe otherwise.

That of course is Robin Hanson, here is the whole (short) essay.

A “Grand Coalition” in Germany?

The electoral deadlock in Germany may mean a "Grand Coalition" with its two major parties, the Social Democrats and the Christian Democrats.  This is the likely outcome if neither of the major parties can assemble a coalition with the minor parties; some minor/major alliances simply are not possible, for either political or ideological reasons.

Looking to public choice theory, how will a Grand Coalition operate?

Models of proportional representation typically allow for multiple equilibria, but a plausible outcome involves a trade between a major party and an allied minor party.  The minor party will promise to support the major party in forming a coalition, if the major party makes one or two key policy concessions.  The distribution of gains will depend on bargaining power.  Will the major party have other possible coalition allies?  Does the minor party crave power, or would it rather stake out a purist stance on policy, and risk being left outside the coalition?  Note that once the coalition is in place the minor party often has a difficult time defecting.  Minor party officials come to enjoy the perks of power.  Their threats to bring down the coalition often are not credible.  So the resulting government often holds power snugly and governs sluggishly.

When no minor party is available for the coalition, the terms of the bargain shift.

First, a Grand Coalition usually means that the two major parties have roughly equal electoral strength.  If the coalition collapses, and a government must re-form, and either party could come out on top in the new bargain.  Therefore the (slightly) weaker coalition member does not have a very strong incentive to hold the coalition together.

Second, the two major parties often have opposing platforms.  So the initial policy compromise might stop either party from doing much of anything.  That is one reason to expect stalemate.  It also means that the (slightly) stronger party doesn’t gain much from the coalition; it cannot promote its agenda.  There is also the danger of many minor parties proliferating at the fringes, given the centrism of the joint coalition.  This lowers the returns to holding power at the center, as these minor parties will cut into your future electoral support.

The bottom line: Two parties in a Grand Coalition will reap low gains from trade.  Neither party will much mind if the Grand Coalition collapses.  Stability is "knife-edge."  But the parties therefore might be willing to take more chances.  What do they have to lose?  A Grand Coalition does not mean certain policy gridlock (in contrast to this pessimistic view). 

And let us say that both parties recognize the need for reforms, but are held back by voters.  An arrangement where accountability is low and "each party can blame the other" might be exactly what is needed.

To cite reality for just a moment, Germany had a "Grand Coalition" from 1966 to 1969, and this was no obvious disaster.  Student revolts aside, many Germans consider these years a golden age. The earlier Grand Coalition passed important economic legislation in 1967 and restricted civil liberties in a controversial manner.  Modern German politics is often slow, but in relative terms this period was not a time of gridlock.

Addendum: Here is a longish piece I once wrote on proportional representation; note Alex’s contribution on referenda as well.

Rotting in FEMA City

The Bush administration and FEMA are planning to house Hurricane Katrina evacuees in some 300,000 trailers and "mobile" homes.  What an awful idea.  Mobile home cities are nothing but public housing built on the cheap – why must we revisit that disaster?

In Florida some 1,500 people left homeless by Hurricane Charley are still living in "FEMA City," a desolate subdivision of trailers and mobile homes built on 64 acres between a county jail and Interstate 75.  Located far from jobs, real schools and ordinary amenities like restaurants and grocery stores, FEMA City has become another public housing failure.

There are no trees, no shrubs, and only two small playgrounds for several hundred children.

Teenagers have been especially hard-hit – drug use, vandalism,
break-ins and fights are widespread. Young people regularly call FEMA
City a prison.

The troubles got so bad in the spring that the entire camp was
fenced in, a county police substation was set up, and armed security
guards were stationed at the one point where residents were allowed to
enter and exit. Even with that, the number of calls to the county
sheriff’s office was at an all-time high last month – 257 calls that
resulted in 78 police reports, many of them involving domestic
violence, fights, juvenile delinquency and vandalism. In January, there
were just 154 calls and 40 official actions.

FEMA City has only 1,500 residents.  Can you imagine how bad things will get if "vast towns of 25,000 or more mobile homes" are built, as is being planned?

Why are we interring people in government camps?  Housing vouchers are a much better policy.  Let evacuees use their vouchers in any city in the United States.  Let them begin to rebuild their lives with decent housing in places where they can find jobs, schools and community.