Results for “solve for equilibrium” 136 found
Jean Tirole and Intrinsic and Extrinsic Motiviation
Although not central to his work, one of my favorite papers of today’s Nobel prize winner, Jean Tirole, is Extrinsic and Intrinsic Motivation (written with Roland Benabou). In this paper, Tirole and Benabou try to resolve the economist’s intuition that incentives motivate with the idea from psychology that incentive schemes can sometimes demotivate. The psychologists argue that extrinsic motivation can reduce intrinsic motivation (but they are not at all clear on why this should be the case). Tirole and Benabou try to produce a similar finding by arguing that in addition to providing motivation an incentive scheme gives the agent, the one being incentivized, some information and the information may undermine the motivation.
For example, if I tell my son. “If you get an A in math, I will give you $1000.” What does my son conclude?
- My father must think math is very important for my future to offer me $1000. My father is smart. I will work hard.
This is the message that I hope to send. But my son knows that I know something about math and also that I know something about him and he may use this knowledge to make a very different inference.
- If my father thinks I need $1000 to get an A, math must be very hard or I must lack talent. I will work for an A this year but next year I should probably not sign up for advanced math classes.
Or perhaps he infers
- If my father is offering me $1000 to do the right thing , he must not trust my judgment.
Or perhaps
- My father is trying to use his money to control me. I rebel!
Thus reward has two effects a pure incentive effect (holding information constant) and an inference effect. Notice that the inference effect depends on the context. Thus, without knowing the context–how the father gets along with the son and their history of interaction–we can’t know what the effect of the “incentive” will be. Thus I have argued that “an incentive is not an objective fact but a subjective interpretation.”
I’m not convinced that Tirole and Benabou have the right answer on intrinsic and extrinsic motivation but thus and other papers indicate Tirole’s broadness of thought and his characteristic approach to issues.
By the way, working out the equilibrium in these games is not at all easy because the principal knows the agent will infer information about the characteristic from the reward structure and the agent knows the principal knows that the agent will infer information about the characteristic from the reward structure and so on – thus we have a Moriarty problem and must look for conditions such that there can be an equilibrium in which everything is common knowledge. But heh, if these problem were easy you wouldn’t get a Nobel prize for solving them!
See Tyler’s post and my other posts below for much more on Tirole.
Assorted links
1. Maps of cultural centers, a new research tool, fun too.
3. “Scientists reconstruct speech through soundproof glass by watching a bag of potato chips.”
4. Marathon finishing times have reference-dependent outcomes. And bumble bee cognitive individuality.
5. Good review of the excellent David Eimer book on Chinese minorities. And the strike that is Hong Kong. And who will end up owning New Zealand farms?
6. Early Mediterranean containerization.
7. Chefs, critics, solve for the equilibrium with four-letter words.
8. Serenading the cattle with my trombone (music video).
Piketty v. Solow
Krusell and Smith lay out the Solow and Piketty growth models very nicely but perhaps not in a way that is immediately transparent if you are not already familiar with growth models. Thus, in this note I want to lay out the differences using the Super Simple Solow model that Tyler and I developed in our textbook. The Super Simple Solow model has no labor growth and no technological growth. Investment, I, is equal to a constant fraction of output, Y, written I=sY.
Capital depreciates–machines break, tools rust, roads develop potholes. We write D(epreciation)=dK where d is the rate of depreciation and K is the capital stock.
Now the model is very simple. If I>D then capital accumulates and the economy grows. If I<D then the economy shrinks. Steady state is when I=D, i.e. when we are investing just enough each period to repair and maintain the existing capital stock.
Steady state is thus when sY=dK so we can solve for the steady state ratio of capital to output as K/Y=s/d. I told you it was simple.
Now let’s go to Piketty’s model which defines output and savings in a non-standard way (net of depreciation) but when written in the standard way Piketty’s saving assumption is that I=dK + s(Y-dK). What this means is that people look around and they see a bunch of potholes and before consuming or doing anything else they fill the potholes, that’s dK. (If you have driven around the United States recently you may already be questioning Piketty’s assumption.) After the potholes have been filled people save in addition a constant proportion of the remaining output, s(Y-dk), where s is now the Piketty savings rate.
Steady state is found exactly as before, when I=D, i.e. dK+s(Y-dK)=dK or sY=sdK which gives us the steady level of capital to output of K/Y=s/(s d).
Now we have two similar looking expressions for K/Y, namely s/d for Solow and s/(s d) for Piketty. We can’t yet test which is correct because nothing requires that the two savings rates be the same. To get further suppose that we now allow Y to grow at rate g holding K constant, that is over time because of better technology we get more Y per unit of K. Since Y will be larger the intuition is that the equilibrium K/Y ratio will be lower, holding all else the same. And indeed when you run through the math (hand waving here) you get expressions for the Solow and Piketty K/Y ratios of s/(g+d) and s/(g+sd) respectively, i.e. a simple addition of g to the denominator in both cases (again bear in mind that the two s’s are different.)
We can now see what the models predict when g changes–this is a key question because Piketty argues that a fall in g (which he predicts) will greatly increase K/Y. Here is a table showing how K/Y changes with g in the two models. I assume for both models that d=.05, for Solow I have assumed s=.3 and for Piketty I have calibrated so that the two models produce the same K/Y ratio of 3.75 when g=.03 this gives us a Piketty s=.138.
As g falls Piketty predicts a much bigger increase in the K/Y ratio than does Solow. In Piketty’s model as g falls from .03 to .01 the capital to output ratio more than doubles! In the Solow model, in contrast, the capital to output ratio increases by only a third. Remember that in Piketty it’s the higher capital stock plus a more or less constant r that generates the massive increase in income inequality from capital that he is predicting. Thus, the savings assumption is critical.
I’ve already suggested one reason why Piketty’s saving assumption seems too strong–Piketty’s assumption amounts to a very strong belief that we will always replace depreciating capital first. Another way to see this is to ask where does the extra capital come from in the Piketty model compared to Solow? Well the flip side is that Solow predicts more consumption than Piketty does. In fact, as g falls in the Piketty model so does the consumption to output ratio. In short, to get Piketty’s behavior in the Solow model we would need the Solow savings rate to increase as growth falls.
Krusell and Smith take this analysis a few steps further by showing that Piketty’s assumptions about s are not consistent with standard maximizing behavior (i.e. in a model in which s is allowed to vary to maximize utility) nor do they appear consistent with US data over the last 50 years. Neither test is definitive but both indicate that to accept the Piketty model you have to abandon Solow and place some pretty big bets on a non-standard assumption about savings behavior.
High prices for broadband, contestability, and Google Fiber
Here is a potential new development:
Verizon is adding more antennas to its network, forming smaller wireless cells with stronger coverage and rolling out service on new segments of the wireless spectrum, the digital equivalent of opening new lanes for traffic. Sprint is introducing a service called Sprint Spark that increases access speeds if customers have devices that can use multiple wireless frequencies at once.
If pCell works as promised, Mr. Perlman’s technology could result in much bigger gains in wireless speeds. In traditional cellular networks, antennas placed around a city transmit wireless signals to all of the mobile devices within their area. As more people enter an area, they share the wireless network with everyone else there, resulting in slower speeds. Wireless carriers cannot simply solve the problem by putting antennas everywhere because their signals can be disrupted if they are too close together.
With a network of pCell antennas, someone with a mobile device will get access to the full wireless data speed in the area, regardless of how many other people are sharing that network, Mr. Perlman said.
There is also this:
The plan is to bring Google Fiber to 34 cities and see how that goes.
Here are various satellite video streaming services.
I do not feel I can judge the prospects for these developments. The point, however, is this. Improving connectivity is an extremely dynamic market sector. A high mark-up on cable internet connectivity, as might be applied by say a Comcast monopolist, is also creating a “prize” for further innovation in the sector. Admittedly one does not prefer to have this prize funded by deadweight loss (less broadband consumption) but virtually all prizes are funded by deadweight loss in some manner rather than by lump sum taxation.
When people claim “the current mark-up is too high,” that is an entirely reasonable stance. But when you rewrite it as “the current innovation prize, funded out of deadweight loss” is too high, that reframing brings some clarity, some moderation, and I think also induces some more agnosticism about the costs of the current semi-monopoly. For similar reasons I don’t worry about monopoly in the eBook market and the like and there the case for simply ignoring the problem is much stronger because the options and cheapness have exploded so radically and so quickly.
So I don’t see the current cable semi-monopoly as lasting that long. And its current cost cannot be that much higher than the cost of sending a disc in the mail, otherwise the disc would be sent. Alternatively, most communities have public libraries which offer pretty good and pretty free internet connections, including video streaming of course. If the argument is simply “this prize, for future connectivity innovation, cannot be funded from deadweight loss because it means that in the meantime some poorer people will have to wait to get their discs in the mail and make too many trips to the public library”…well, I guess I’m not that impressed this is a major public policy problem.
The longer and more you regulate cable prices, the longer it will take this sector to reach a more competitive equilibrium.
By the way, dear reader, I am not clever enough to use Netflix streaming, as I find the TV menu confusing. So I still get the discs in the mail.
*Her*
As I tend to find Jonze’s work contrived I didn’t expect much, but I was bowled over by what is a must-see movie for anyone interested in tech or the social sciences or for that matter cinema. Two of its starting premises are a) we as humans now face shadow prices which lead us to deemphasize the physical world of things and live in a world of information, and b) if we are going to have AI, which consumes real resources, which Darwinian principles will govern what kinds of personal assistants survive or do not? Will they enslave us, will they be our dogs, our friends, our trading partners, or something else altogether? This movie is the single best place to start on that question.
The rest is, as they say, solve for the equilibrium. I found the dialogue, performances, and cinematography very strong. The skyline blends Los Angeles and Shanghai. The movie toys with the viewer in a clever manner as to whether it is about the future, the present, or both. Several of the scenes (reluctance to spoil prevents further specificity) were some of the best and most creative and most conceptual movie-making I have seen, ever.
The “sources” for this movie, whether Spike Jonze is aware of them all or not, include Cyrano de Bergerac, various Mermaid legends, Blade Runner, Spielberg’s AI, 2001, Lubitsch’s The Shop Around the Corner, Philip Pullman, Bewitched and I Dream of Jeannie, Pinocchio, Girard and indeed Shakespeare on the triangulation and intermediation of desire, Electric Dreams, Battlestar Galactica, Annie Hall, and even the Mormon doctrine of the Holy Ghost, as well as Jonze’s previous movies. This is perhaps the most accurate review (some spoilers) I have seen. This too is an insightful review, but the spoilers there are massive. Best is not to read either but just to go see it.
Definitely recommended, for me this was one of the cultural events of the year.
Some dangers in estimating signaling and human capital premia
Let’s say you signal your way into a first job, then learn a lot from holding that perch, and enjoy a persistently higher income for the rest of your life. Is that a return to signaling or a return to learning? Or both?
Maybe it matters that “the signaling came first.” Well, try this thought experiment.
Let’s say you have to learn to read and write to signal effectively. Can we run a causal analysis on “learning how to read and write”? Take away that learning and you take away the return to signaling. Should we thus conclude that the return to signaling is zero, once we take learning into account? After all, the learning came first. No, not really.
The trick is this: when there are non-additive, value-enhancing relationships across inputs, single-cause causal experiments can serve up misleading results. In fact, by cherry-picking your counterfactual you can get the return to signaling, or to human capital, to be much higher or lower. Usually one is working in a model where the implicit marginal causal returns to learning, IQ, signaling, and so on sum up to much more than 100%, at least if you measure them in this “naive” fashion. If you think of a career in narrative terms, IQ, learning, and signaling are boosting each others’ value with positive and often non-linear feedback. And insofar as these labor market processes have “gatekeepers,” it is easy for the marginal product of any one of these to run very high, again if you set up the right thought experiment.
Along related lines, many people use hypothetical examples to back out the return to signaling, learning, IQ, or whatever. “Let’s say they make you drop out of Harvard and finish at Podunk U.” “Let’s say you forge a degree.” “Let’s say you are suddenly a genius but living in the backwoods.” And so on. These are fun to talk and think about, but like the above constructions they will give you a wide range of answers for marginal returns, again depending which counterfactual you choose. A separate point is that many of these are non-representative examples, or they involve out of equilibrium behavior.
I call the methods discussed in the above few paragraphs the single-cause causal measures, because we are trying to estimate the causal impact of but a single cause in a broader non-additive, multi-causal process.
There is another way to analyze the return to signaling, and that is to leave historical causal chains intact and ask what if a degree is removed. Let’s say I’ve held a job for ten years and my team is very productive. But the boss can’t figure out who is the real contributor. I get an especially large share of the pay because, from my undergraduate basket weaving major, the boss figures I am smarter than those team members who did not finish college at all. If I didn’t have the degree, I would receive $1000 less. So that year the return to signaling is $1000. I call this the modal measure. It is modal rather than causal because we take my degree away in an imaginary sense, without taking away my job (which perhaps I would not have, earlier on, received without the degree).
There are also the measures (not easy to do) based in notions from bargaining theory. Consider IQ, learning, and signaling as coming together to form “coalitions.” One-by-one, remove different marginal elements of the coalition in thought experiments, estimate the various marginal products, and then average up those marginal products as suggested by various bargaining axioms. You could call those the multi-cause causal measures. They are more theoretically correct than the single-cause causal measures, but difficult to do and also less fun to talk about.
Yet another method is to pick out a single counterfactual on the basis of which policy change is being proposed. I’ll call these the policy measures. Let’s say the proposal is to subsidize student transfer from community colleges to four-year institutions. You can then ask causal questions about the group likely to be affected by this. (It is possible to estimate the private return to education for this kind of policy, but hard to break that down into signaling and learning components.) In any case the answers to these questions will not resolve broader debates about the relative importance of signaling, learning, IQ, and so on and how we should understand education more generally.
Usually when people argue about the return to signaling, they are conflating the single-cause causal measures, the modal measures, the bargaining theory measures, and the policy measures. The single-cause causal measures are actually the least justified of this lot, but they exercise the most powerful sway over most of our imaginations.
The single-cause causal measures are especially influential in the blogosphere, where they make for snappy posts with vivid narrative examples and counterexamples. But they are misleading, so do not be led astray by them.
Digitalization and the value of various tourist locales
Miles, a loyal MR reader, writes to me:
I’ve spent a fair amount of time today at my desk in California looking at this, and it got me thinking about an interesting interplay between the tourism industry and the “digital revolution”:
https://s3.amazonaws.com/Gigapans/EBC_Pumori_050112_8bit_FLAT/EBC_Pumori_050112_8bit_FLAT.html
(use the +/- buttons to zoom and drag to shift the view)
After finding people and understanding the scale of those mountains, I am in awe of Everest and the Himalayas, but feel absolutely no need to travel there. A digital representation has given me an amazing experience of a place on the other side of the world, and at least for this particular occasion, has convinced me never to go there (try to find the people climbing the upper portion of the glacier and you’ll understand why). So maybe some amazing (non deadly) location would convince me that I need to visit in person, but at some point, the digital experience gets so good that it’s a better, cheaper alternative to travelling. If in a few hundred years we can create digital experiences far more immersive than physical visits to locations, what experiences/amenities/etc will induce people to travel? Where will tourism die off (Himalayas), where will it increase (Paris)? As you say, solve for the equilibrium.
Thought it might make for an interesting discussion.
I predict that bustling, interactive locations — such as Guatemala — will do fine, and it is the static nature settings which will face a bit more competition. That said, while I have never visited the Himalayas, I suspect the trip there involves a lot of bustling interaction with local cultures and that the final destination is in part an excuse for the process. Keep also in mind that most of us do not in fact enjoy travel but enjoy only the memories of travel, with our minds playing a fairly active role as editor. I doubt if the memory of visiting the digital image will ever compare, even if the image itself is more beautiful and more convenient than the reality of an actual physical site. Finally, there is marketing to consider. The digital image may market the original, just as the rather vivid LOTR movies have boosted tourism to New Zealand rather than replacing it. So overall I still see tourism as a continuing growth industry.
Offshoring and Directed Technical Change
That will have been one of the most important papers of this year and it is by Daron Acemoglu, Gino Gancia, and Fabrizio Zilibotti. Read every sentence of the abstract carefully because each one matters!:
To study the short-run and long-run implications on wage inequality, we introduce directed technical change into a Ricardian model of offshoring. A unique final good is produced by combining a skilled and an unskilled product, each produced from a continuum of intermediates (tasks). Some of these tasks can be transferred from a skill-abundant West to a skill-scarce East. Profit maximization determines both the extent of offshoring and technological progress. Offshoring induces skill-biased technical change because it increases the relative price of skill intensive products and induces technical change favoring unskilled workers because it expands the market size for technologies complementing unskilled labor. In the empirically more relevant case, starting from low levels, an increase in offshoring opportunities triggers a transition with falling real wages for unskilled workers in the West, skill-biased technical change and rising skill premia worldwide. However, when the extent of offshoring becomes sufficiently large, further increases in offshoring induce technical change now biased in favor of unskilled labor because offshoring closes the gap between unskilled wages in the West and the East, thus limiting the power of the price effect fueling skill-biased technical change. The unequalizing impact of offshoring is thus greatest at the beginning. Transitional dynamics reveal that offshoring and technical change are substitutes in the short run but complements in the long run. Finally, though offshoring improves the welfare of workers in the East, it may benefit or harm unskilled workers in the West depending on elasticities and the equilibrium growth rate.
In this paper you will find a ray of hope, namely “…when the extent of offshoring becomes sufficiently large, further increases in offshoring induce technical change now biased in favor of unskilled labor because offshoring closes the gap between unskilled wages in the West and the East, thus limiting the power of the price effect fueling skill-biased technical change.”
And this:
The unequalizing impact of offshoring is thus greatest at the beginning. Transitional dynamics reveal that offshoring and technical change are substitutes in the short run but complements in the long run.
Of course we will see, but if you wish to be ahead of the game, spend your time pondering those propositions. Ungated copies are here.
The truly clever will solve this model for some analogous propositions about robots.
Would abolishing cash help cure AD problems?
Miles asks about this on Twitter. Earlier in the year, Matt wrote:
Stop for a moment and ask yourself why the interest rate can’t be reduced much below 1 percent. The trouble is cash. At any given time, relatively little paper currency circulates in the United States. Instead, most of the American money supply consists of bank accounts and other electronic stores of value. People prefer to keep money in bank accounts because it’s convenient and because you get interest on it. If the rates were driven below zero—in effect a tax on holding cash in the bank—people would just withdraw money and store it in shoeboxes instead. But what if you couldn’t withdraw cash? What if all transactions were electronic, so the only way to avoid keeping money in a negative-rate account was to go out and buy something with the money? Well, then, we would have solved our depression problem. Too much unemployment? Lower interest rates below zero, Americans will start spending and investing again, the economic will grow, and unemployment will go back down to its “natural rate.”
Ryan Avent comments. A few points from me:
1. Even pure cash can be taxed, if we are willing to go the goofy route. A stochastic declaration of “counterfeit,” based on serial numbers and scans, is one way to go.
2. Technologically speaking, it is possible to run virtually all transactions without cash, or it will be quite soon. That said, for this to work as stated, you would need to run all transactions without cash or the option of cash. How many millions of Americans do not even have bank accounts much less smart phones? This is more likely to work in Singapore or Denmark, at least for the foreseeable future.
3. You could have currency or some currency equivalent continue to exist in the black market economy, with penalties for ordinary citizens caught holding currency. (Which would probably not be popular on Fox News, and furthermore in Tennessee imagine all that talk of Book of Revelation, “Mark of the Beast,” etc.) Even so, you still end up with a currency-bonds margin and most likely with lower nominal interest rates in that equilibrium; if the law taxes currency holdings there is less need for equilibrium to require a high nominal interest rate. I am not sure why this should be so desirable for monetary policy.
Furthermore, under some views, this proposal would in essence put monetary policy in the hands of the drug trade. Cracking down on drug lords, or easing up on them, would become major monetary policy instruments, at least if you take the Fama-Sumner view that currency has special potency over the price level.
4. I do not myself believe that currency per se has such extreme power over aggregate demand, at least not in such a credit-intensive economy as ours. That means this proposal doesn’t get at the heart of the AD problem, which is closely linked to credit creation. But if you disagree with me on this one, you end up back at #3.
5. What do we really know about money demand anyway? Cooley and Leroy (1981) is still worth reading. Under one plausible view, you get sustainable increases in velocity, aggregate demand and investment when people feel safer and wealthier, not when you tax them more. It’s fine to say “we don’t know,” but I get nervous when macro stabilization policy is relying so directly and so relentlessly on money demand effects.
6. I don’t see how this proposal could work unless it is applied globally, which seems implausible. If your dollars are being taxed some extra amount, just put them in a foreign bank to earn zero or do some kind of funny quasi-repurchase agreement, with a foreign bank, to avoid having formal ownership of the dollars on the days of the tax.
On net, it is an interesting idea, but I wouldn’t actually do it.
Addendum: Scott Sumner comments (I don’t myself think the monetary base is so special, and if pre-2008 wasn’t a problem, that is why).
My eurozone podcast with Russ Roberts
You will find it here, I was happy with how it turned out.
Wolfgang Münchau has a nice update:
Contrary to what is being reported, Ms Merkel is not proposing a fiscal union. She is proposing an austerity club, a stability pact on steroids. The goal is to enforce life-long austerity, with balanced budget rules enshrined in every national constitution. She also proposes automatic sanctions with a judicially administered regime of compliance. She rejects eurobonds on the grounds that they reduce pressure on fiscal discipline.
That is another absurd “solution” that has no chance of working, unless of course the critical countries simply recover on their own. (Why does it remind me of “Don’t mistreat the Abos! (if anybody’s watching)”? Don’t forget this:
Andrew Duff, a member of the European Parliament, last week provided a very useful guide to the distance the eurozone is from where it would have to be if it were a proper fiscal union. He drew up a list of all the changes in the European Treaties that would need to be amended to achieve that. It includes changes to 23 articles and five protocols.
And this is from MR comments, Ryan Cooper:
Thinking in the short term, obviously the solution involving the least collective misery for everyone is for Germany to bite the bullet and backstop the whole continent’s debt in one way or another. But just past the immediate crisis I don’t see any reason for optimism. If recession really does hit, how are the SPIIG crowd going to get out of the “debt -> austerity -> crap growth -> more debt (or at least not much extra money to pay down the principal) -> more austerity” cycle? It seems like a 1918-style suicide pact.
The SPIIG governments have to be weighing the costs of cutting their losses and getting out. (Right?) People seem to agree that would be another devastating financial crisis, and thinking selfishly that would be bad, but if I were Spain and it’s a choice between 2-3 years of total chaos and 20-30 years of grinding hopeless misery, I think I’d go with the first option.
Solve for the equilibrium…
Addendum: Ezra Klein offers observations from Germany; they focus on the real side of the economies!
Barsky and Summers and Krugman on Gibson’s Paradox
From Barsky and Summers:
This paper contributes a new element to the explanations of the Gibson paradox, the puzzling correlation between interest rates and the price level seen during the gold-standard period. A shock that raises the underlying real rate of return in the economy reduces the equilibrium relative price of gold and, with the nominal price of gold pegged by the authorities, must raise the price level. The mechanism involves the allocation of gold between monetary and nonmonetary uses. The authors’ explanation helps to resolve some important anomalies in previous work and is supported by empirical evidence along a number of dimensions.
The paper is here. Paul Krugman offers a very good explanation of a related hypothesis. It’s one useful way of thinking about why the price of gold is rising in a deflationary time (without requiring one to deny the potential relevance of other factors). The presentation also explains the behavior of gold prices in a TGS era, namely with low real rates of return.
I very much enjoy this puzzle. It requires a working knowledge of many different parts of economics, not just a few.
The ECB bond-buying plan
“The ECB is once again intervening as the last line of defense,” said Jacques Cailloux, chief European economist at Royal Bank of Scotland in London. “The intervention will put a halt to the bond market crash that some member states faced. However, the ECB is now in for the long haul and will potentially have to buy up to half of the Italian and Spanish traded debt, the biggest risk-pulling effort ever engineered in Europe.”
Here is the article. This analysis by Paul Krugman probably won’t be beaten, and more here.
Arguably it’s now a question of who stares down whom. If you do not doubt German resolve, bet on the ECB and lend money to Italy fairly cheaply. If you fear that Italy suffers from its own version of the great stagnation, and doesn’t have good enough political institutions to make decent reforms (and now the hammer of the private capital markets is partially removed), maybe the ECB will cry uncle at some point and give up. Knowing that, confidence will not return and the speculators will continue to pounce. We’ll see soon enough what the markets think.
As I am posting this, Dow futures are off about 250 points, although that bad news could be traced to numerous causes.
Speculative attack games can be hard to predict for the marginal cases (personally I am skeptical), but the general uncertainty resulting from the U.S. debt fight, and the resultant “flight to safety” isn’t helping matters. It’s another way in which our fiscal nonsense brings some very real costs, and quickly. Have you seen that France might suffer a downgrade from AAA? In the abstract, that makes sense. Why should they be safer than the US? Again, our stupidity makes the European mess harder to resolve by shifting the focal equilibrium from a good outcome to a bad, scary outcome.
*On What Matters, vol. I*, review of Derek Parfit
Derek Parfit is one of my favorite philosophers, and favorite writers at that, so for many years I have been looking forward to his next book, which is now out. The main argument is that rule consequentialism, properly understood Kantianism, and contractualism all can be understood as a broadly consistent moral theory, all climbing up the same mountain from different sides.
The text is recognizably Parfit, but I am not convinced by its major arguments, and I also believe the Parfitian method — any reader of him will understand this reference — does not succeed in all of the new areas under consideration.
The philosophical patron saints of the book are Kant and Sidgwick, and I would suggest also Bloomsbury. Parfit is an extreme rationalist and he thinks (hopes?) we can find, and agree upon, the right answers to moral questions. (At the same time he deeply fears that we cannot, and he is a philosophic conservative as Keynes was.) What’s missing is Hume, not the Hume of is-ought worries but the Hume who came to terms with the tensions between the arguments of philosophy and the experience of everyday human life.
My favorite features of the Parfit book include the early comparison of Kant and Sidgwick and the general concern with the frequency and intensity of moral disagreement.
Parfit at great length discusses optimific principles, namely which specifications of rule consequentialism and Kantian obligations can succeed, given strategic behavior, collective action problems, non-linearities, and other tricks of the trade. The Kantian might feel that the turf is already making too many concessions to the consequentialists, but my concern differs. I am frustrated with this very long and very central part of the book, which cries out for formalization or at the very least citations to formalized game theory.
If you’re analyzing a claim such as — “It is wrong to act in some way unless everyone could rationally will it to be true that everyone believes such acts to be morally permitted” (p.20) — words cannot bring you very far, and I write this as a not-very-mathematically-formal economist.
Parfit is operating in the territory of solution concepts and game-theoretic equilibrium refinements, but with nary a nod in their direction. By the end of his lengthy and indeed exhausting discussions, I do not feel I am up to where game theory was in 1990.
I read the standard game-theoretic results as implying that ethics is a far more indeterminate enterprise than Parfit might like to see. Any particular specification of rule consequentialism tends to require increasingly baroque refinements to cover all the different possible kinds of situations. At the end we’re not left with much in the way of a rule at all, other than a general injunction to tell people to do something good and then to rejigger the rule itself, or complicate it with more contingencies, to cover the required ground.
To pose a simple example: “maximize your marginal impact” won’t as an injunction address a lot of environmental problems. “Maximize your average impact” fails in cases where you are truly decisive. What might other more complex rules be, and what are the expectations those rules are making about the behavior of others, what you infer from their behavior, what they infer from your inference, and so on. The path out of these boxes takes us very far away from a rules concept that say Sidgwick might have found intuitive.
Hume has been locked out of the room and he is not allowed to re-enter in the form of Parfit having a dialogue with Cho and Kreps.
Now maybe, just maybe, that game-theoretic messiness does not have to be fatal for rule-consequentialism. Still, I propose a rewrite. Cut or severely limit the hundreds of pages on this topic, start with what game theory already is showing, describe that mess in philosophic, conceptual terms, and then consider whether that mess is compatible with the analogous messes found in Kantianism and contractualism, Maybe it can be shown that they are (broadly) the same mess. Nonetheless, such a collection of messes may be surrounding the same mountain but they will not scale it and Parfit would have to gaze once again into the abyss of, what is to him, ethical nihilism. (Cut back to David Hume for a different attitude. Perhaps Parfit’s very strong philosophic and personal desire to succeed and solve the whole problem draws him from the path that will get us up the mountain some small degree.)
For these reasons I see the biggest and most central part of the book as a failure, possibly wrong but more worryingly “not even wrong” and simply missing the questions defined by where the frontier — choice theory and not just philosophic ethics — has been for some time.
On other points, the criticisms of subjective and desire-based theories are good, but I view Parfit’s conclusions as already having been established.
The talk of Kantian dignity, and of “treating people as a mere means” I do not think can be well-defined. I kept on wanting to see the Marginal Revolution (the real one, the 1871 one) inform this discussion.
I very much agree with Parfit’s argument that no one — not even evil people — should deserve to suffer. I also agree with Parfit’s notion of the irreducibly normative.
Until the material on consequentialism is nailed, I don’t think the integration with contractualism can work.
I would describe the Parfitian method as “the postulation of bold, minimalist claims, explored by the use of brilliant hypotheticals and counterexamples.” In Reasons and Persons the Parfitian method works because the potential for philosophic vagueness is limited by the vividness of the counterfactual (or real world) examples. Most readers of that book are still thinking about split brains, the Repugnant Conclusion, and Future Tuesday Indifference, among numerous other examples. You could question whether all of the terms were pinned down rigorously, but you still knew that the thought experiment was making you rethink some of your priors. In the subject areas of On What Matters the semantics are too slack, too open to multiple interpretation, and too many of the central concepts cry out for formalization. There are not compelling new metaphors and examples to pin down the discourse. Parfit’s greatest strength is as an imaginer, often outside of traditional philosophic dimensions, and yet here he is so concerned with justifying his disagreements with his peers and colleagues. Their ghosts and comments and discourses are shackling him, and if you visit the best pages of Reasons and Persons you will see they hardly mention the names of other philosophers at all, much less current philosophers.
I do not wish to put you off Parfit. He is a philosopher of major importance and, non-trivially, one of the most philosophical philosophers, perhaps ever. He lives, thinks, feels, breathes, and exudes philosophy in a way which is, in and of itself, a major contribution to human thought and being. Reading him is an unforgettable and illuminating experience. His best arguments have great real world import.
It is stunning to read the last three pages of the preface, which list everybody who gave him comments. It’s a long list, but I’m not sure it was the right list to have chosen.
Addendum: Here is Peter Singer’s review. Here is a review from Constantine Sandis.
Unemployment, Recessions and Barter: A Test
Nick Rowe explains that the essence of New Keynesian/Monetarist theories of recessions is the excess demand for money (Paul Krugman’s classic babysitting coop story has the same lesson). Here’s Rowe:
The unemployed hairdresser wants her nails done. The unemployed manicurist wants a massage. The unemployed masseuse wants a haircut. If a 3-way barter deal were easy to arrange, they would do it, and would not be unemployed. There is a mutually advantageous exchange that is not happening. Keynesian unemployment assumes a short-run equilibrium with haircuts, massages, and manicures lying on the sidewalk going to waste. Why don’t they pick them up? It’s not that the unemployed don’t know where to buy what they want to buy.
If barter were easy, this couldn’t happen. All three would agree to the mutually-improving 3-way barter deal. Even sticky prices couldn’t stop this happening. If all three women have set their prices 10% too high, their relative prices are still exactly right for the barter deal. Each sells her overpriced services in exchange for the other’s overpriced services….
The unemployed hairdresser is more than willing to give up her labour in exchange for a manicure, at the set prices, but is not willing to give up her money in exchange for a manicure. Same for the other two unemployed women. That’s why they are unemployed. They won’t spend their money.
Keynesian unemployment makes sense in a monetary exchange economy…it makes no sense whatsoever in a barter economy, or where money is inessential.
Rowe’s explanation put me in mind of a test. Barter is a solution to Keynesian unemployment but not to “RBC unemployment” which, since it is based on real factors, would also occur in a barter economy. So does barter increase during recessions?
There was a huge increase in barter and exchange associations during the Great Depression with hundreds of spontaneously formed groups across the country such as California’s Unemployed Exchange Association (U.X.A.). These barter groups covered perhaps as many as a million workers at their peak.
In addition, I include with barter the growth of alternative currencies or local currencies such as Ithaca Hours or LETS systems. The monetization of non-traditional assets can alleviate demand shocks which is one reason why it’s good to have flexibility in the definition of and free entry into the field of money (a theme taken up by Cowen and Kroszner in Explorations in New Monetary Economics and also in the free banking literature.)
During the Great Depression there was a marked increase in alternative currencies or scrip, now called depression scrip. In fact, Irving Fisher wrote a now forgotten book called Stamp Scrip. Consider this passage and note how similar it is to Nick’s explanation:
If proof were needed that overproduction is not the cause of the depression, barter is the proof – or some of the proof. It shows goods not over-produced but dead-locked for want of a circulating transfer-belt called “money.”
Many a dealer sits down in puzzled exasperation, as he sees about him a market wanting his goods, and well stocked with other goods which he wants and with able-bodied and willing workers, but without work and therefore without buying power. Says A, “I could use some of B’s goods; but I have no cash to pay for them until someone with cash walks in here!” Says B, “I could buy some of C’s goods, but I’ve no cash to do it with till someone with cash walks in here.” Says the job hunter, “I’d gladly take my wages in trade if I could work them out with A and B and C who among them sell the entire range of what my family must eat and wear and burn for fuel – but neither A nor B nor C has need of me – much less could the three of them divide me up.” Then D comes on the scene, and says, “I could use that man! – if he’d really take his pay in trade; but he says he can’t play a trombone and that’s all I’ve got for him.”
“Very well,” cries Chic or Marie, “A’s boy is looking for a trombone and that solves the whole problem, and solves it without the use of a dollar.
In the real life of the twentieth century, the handicaps to barter on a large scale are practically insurmountable….
Therefore Chic or somebody organizes an Exchange Association… in the real life of this depression, and culminating apparently in 1933, precisely what I have just described has been taking place.
What about today? Unfortunately, the IRS doesn’t keep statistics on barter (although barterers are supposed to report the value of barter exchanges). Google Trends shows an increase in searches for barter in 2008-2009 but the increase is small. Some reports say that barter is up but these are isolated, I don’t see the systematic increase we saw during the Great Depression. I find this somewhat surprising as the internet and barter algorithms have made barter easier.
In terms of alternative currencies, the best data that I can find shows that the growth of alternative currencies in the United States is small, sporadic and not obviously increasing with the recession. (Alternative currencies are better known in Germany and Argentina perhaps because of the lingering influence of Heinrich Rittershausen and Silvio Gesell).
In sum, the increase in barter and scrip during the Great Depression is supportive of the excess demand for cash explanation of that recession, even if these movements didn’t grow large enough, fast enough to solve the Great Depression. Today there seems to be less interest in barter and alternative currencies than expected, or at least than I expected, given an AD shock and the size of this recession. I don’t draw strong conclusions from this but look forward to further research on unemployment, recessions and barter.
Can vigilant creditors limit excess bank risk-taking?
I had promised to address that question. Ideally, enforceable bond covenants should limit bank risk-taking, and ensure major bank solvency, but is that feasible? I see a few problems with the idea:
1. It is very hard for a government or central bank to precommit to a "no bailout" policy. This is partly because of powerful special interests, but most of all because political time horizons are short. Most bailouts do patch things up in the short run, whether or not you like their longer-run consequences. Bondholders know this, and they are less vigilant ex ante.
2. Bondholders don't and can't have much idea what is going on inside the trading book of a bank. It doesn't matter how financially sophisticated the bondholders are; the point is that the trading book must remain fairly confidential and a lot of risk can be put in the trading book.
3. Some of the creditors — the short-term creditors — may be in on the deal. They lend money to the banks, under the premise that risky strategies will be executed. The short-term, collateralized creditors may not themselves be bearing much risk, given their superior "flight" capabilities and they also may be receiving a slight premium for such lending.
4. The net risk of a bank position is not determined solely by the bank's portfolio. Say a bank lends money to homeowners and then those homeowners increase their leverage. The bank is now in a riskier position, and de facto a more leveraged position, althoug it's measured leverage hasn't gone up a whit.
5. Experience with the ICE clearinghouse — one form of bank creditor — so far suggests that it serves bank interests, and indeed is largely controlled by the banks, rather than restraining them.
6. Let's say a no-bailout policy was credible, as indeed it was in the 19th century (there were no bailout facilities). What does the equilibrium look like? Is there less long-term lending to banks and more short-term lending? Would that make banks more or less stable? Few people think this is a positive development for countries. Would banks be more subject to "capital flight" risk?
We also could expect greater mutualization of banks, as was the case before deposit insurance, and we could expect experimentation with corporate forms other than limited liability. My view is this is what would be required to limit excess bank risk-taking. Yet I believe that, for better or worse, it is politically impossible. In a nutshell, big government needs big finance (or much higher taxes).
One reason that bailouts are so politically popular (not in rhetoric, but in their practice and in their effects) is that they make financial crises less common but, when they come, more severe because more leverage has built up. That change in the structure of returns is usually a political winner, call it "Ticking Time Bomb."