Prospect Theory

A loyal Marginal Revolution reader asks about prospect theory [an extension of expected utility theory where local utility is based on a perceived expected outcome]. I have never had occasion to apply it. My gut reaction is that it is a tasteful exercise in numerology: people demonstrably do not maximize expected utility, so let's add another unobservable parameter to increase the flexibility of our theory. On the plus side, though, it provides a good explanation parametrization of the very real endowment effect.

Since I am following Mr. Cowen's agenda, let me also follow his example and slip into dispensing advice. To wit, your utility function is probably flatter than you might imagine, and you are better off acting to maximize expected utility even when it seems counterintuitive. In short, don't spend much effort avoiding small risks.

[Mr. Cowen's comments are here.]

Kindness

Via Q&O, we see some evidence of internal unhappiness with the Iranian regime:

An Iranian MP who supports summoning Iranian President Mahmoud Ahmadinejad for a discussion on his administration’s economic and foreign policy has told the conservative Iranian news agency Aftab that eight more MP signatures are needed.

He said that despite pressure by Ahmadinejad’s supporters, he and his colleagues have succeeded in obtaining signatures from 64 MPs.

This is promising, and Mr. McQuain conjectures that continuing American sanctions will further strengthen these dissidents.

Some few readers may recall that last year I argued in favor of immediate military action against the Iranian regime. This did not occur, and the world has not yet ended; thus I suppose I was in error.

Now consider the possibility that sanctions have, as some suggest, served to keep the Cuban and North Korean regimes in power -- just as Japan's isolation before 1850 preserved the ancient Shogunate. I have discussed before how open trade can be used by oppressive regimes to bribe potential rivals. Is there a middle ground, of trade which is open to Iranians but not completely controlled by their regime, which would permit us to open up the country?

Naturally Iran's rulers will seek to avoid exactly this outcome. In addition, we still wish to reward cooperation rather than intransigence. Thus I propose the following:

Continue the program of sanctions until some sign of progress, however specious, is achieved. Offer to "reward" the Iranians for this, not be completely relaxing sanctions, but by opening up a new "managed trading presence" which would putatively ensure that trading was in some broad spectrum of "approved" goods. In fact, the approved list would be a sham: the point is to create a managed trading presence in such a way that the profits from trade cannot be steered by the regime to its supporters. (It is not at all necessary that America or its allies capture these profits.) This offer would be made in a highly public manner to make it difficult for Iran's rulers to refuse; we would hope then to maintain and increase a presence in this enemy territory.

Perhaps kindness can kill. It's worth a try, though I confess I am happier with carrier groups waiting in the wings.

We'll Fish There

"Beyond the Zero" is the first two hundred pages of the greatest novel ever written. Alas, Gravity's Rainbow is not that novel. Thomas Pynchon's genius operates only at short wavelengths: half a page can change your heart, but a whole novel is a chaotic heap of glories, like the ruins of Atlantis.

Fluent and brilliant users of language -- Martin Amis, William Gibson, or the incomparable Nabokov -- are praised for their "sparkling" or "crystalline" clarity. This metaphor is deserved, but its implied passivity is also apt. Mr. Pynchon's stroboscopic, obfuscatory, blazing prose is of a different kind.

Here is his description of wartime English carolers, from Gravity's Rainbow:

So this pickup group, these exiles and horny kids, sullen civilians called up in their middle age, men fattening despite their hunger, flatulent because of it, pre-ulcerous, hoarse, runny-nosed, red-eyed, sore-throated, piss-swollen men suffering from acute lower backs and all-day hangovers, wishing death on officers they truly hate, men you have seen on foot and smileless in the cities but forgot, men who don't remember you either, knowing they ought to be grabbing a little sleep, not out here performing for strangers, give you this evensong, climaxing now with its rising fragment of some ancient scale, voices overlapping three- and fourfold, up, echoing, filling the entire hollow of the church -- no counterfeit baby, no announcement of the Kingdom, not even a try at warming or lighting this terrible night, only, damn us, our scruffy obligatory little cry, our maximum reach outward -- praise be to God! -- for you to take back...

Any of Pynchon's novels is filled with smaller-scale creations, overwhelming works that lack even canonical names: the Angel of Lubeck, the Disgusting English Candy Drill, the Lightbulb's Monologue, and innumerably more.

Mr. Pynchon is also an electrical engineer, and scientifically literate. Who else would write an ode to the Poisson distribution:

There do exist levels were chance is hardly recognized at all. But to the likes of employees such as Roger Mexico it is music, not without its majesty, this power series

Ne-m

æ è

1+m+

m2 2!

+

m3 3!

+¼+

mn-1 (n-1)!

ö ø

,

terms numbered according to rocketfalls per square, the Poisson dispensation ruling not only these annihilations no man can run from, but also cavalry accidents, blood counts, radioactive decay, number of wars per year....

Mr. Pynchon's failure to scale up has two major sources, beyond the inscrutability of his plots. The first is his mythmaker's reliance on suggestion, indirection, and ellipsis, which is effective in any given instance but cumulatively irritating.

The second, and more important, is his and his characters' tendency -- none the weaker for being self-aware -- to paranoia. Paranoia cannot be made plausible, and the novel must remain frustratingly vague or else become risible. The vague "levels" in the passage above show a light touch of this, but it is laid down more and more heavily as Gravity's Rainbow progresses.

In case even that is too subtle, Mr. Pynchon's next novel Vineland is a blunt, ill-tempered, hectoring reprise of the same themes -- though its fleshed-out villian, the overly competent Brock Vond, is the one character worthy of respect in the whole sorry show.

Paranoia is also a distinguishing feature of the earlier novella The Crying of Lot 49. Here it is less of a problem; in fact, it provides the only interest or novelty in a book utterly lacking in competing merits. This is widely assigned to college classes, presumably on account of its brevity. It would be much better to follow Mr. Cowen's suggestion and read the first fifty pages of Gravity's Rainbow; it would even be better to read fifty pages torn out at random.

I have not read Against the Day, and cannot say anything of value about it.

V. is less brilliant, and less incoherent, than Gravity's Rainbow -- but still past the redline in both categories. Mr. Pynchon's vignettes (the Nose Job, MG Love, the Siege Party) are more extended but equally distinctive. These larger building blocks are not arranged into any recognizable overall structure, but the poetic and somewhat melancholy novel is still a wonder to read:

Do they even see the wandering bums,
The boys with no place to go,
Or the drifter who cried for an ugly girl
That he left in Buffalo?
Dead as the leaves on Union Square,
Dead as the graveyard sea,
The eyes of a New York woman
Are never going to cry for me.

Finally, Mason and Dixon takes an energetically anachronistic writing style, applies it to a series of implausible or impossible incidents loosely strung along a flat and unsurprising plot, and somehow emerges as a worthwhile and (a first for Mr. Pynchon) moving tale.

[Mr. Cowen's own reply is here.]

Name That Tune

In the previous post, I promised a more concrete proposal for improving Africa's fate. To understand this, we consider mounting an active counter-corruption campaign, analogous to the counter-insurgency campaigns now underway in various parts of the world. Let us accept the "oil spot" analogy, i.e., the premise that we should proceed by creating limited areas of good conditions, and then attempt to cause those areas to gradually spread.

There are at least two other options: the present status quo, or a policy of detachment (also known as "Let Africa Sink"). The preponderance of evidence indicates that these are the only other options. Remember that the object is to help Africans, not their nations.

Who will undertake such a counter-corruption operation? No national interests are at stake, except possibly for resource acquisition. This is why China has begun offering friendship to some African governments; but this is also the exception that proves the rule, showing that resource acquisition is more efficiently accomplished through corrupt governments than despite them. Altruism might be a motive, but in the whole course of history altruism has not accomplished anything of this scale; and, as we will shortly see, the process will involve violence or at least the credible threat of violence, which are hard to reconcile with pure altruism. Thus we must posit a counter-corruption campaign propelled by the prospect of profit.

Who will oppose this operation? The obvious answer is: those who profit from the corruption. Since that includes the structures of the presently constituted governments of Africa, up to their highest levels, the "oil spots" cannot be under their control; and they will resist this loss of control (and loss of the spoils a region might otherwise generate). Even neighboring governments will be adversely affected by the example of a more prosperous region, which would increase their own subjects' dissatisfaction. Thus the campaign must of necessity face governmental enemies, which will have the means and the will to forcibly disrupt any progress it shows.

The administration of oil spots thus requires defenses against armed aggression. In addition, it requires a very particular kind of freedom for the residents: their freedoms must be aligned with the incentives that will make them productive members of a productive society. They must be free to own, to work, to learn, and to innovate; and they must not be free to extort bribes, to give patronage, or to evade debts. Their work will be hard and poorly paid, for they are unskilled and remote from the rich world; thus their incentives to dishonesty, reinforced by a lifetime in a dysfunctional society, will be great. The punishments available must therefore be correspondingly great, or the whole counter-corruption strategy will fail. Expulsion from the administered region might be sufficient, but this is not guaranteed.

Thus we will need externally imposed authorities with the powers of government, answerable to no African nation, holding great power over the lives of the native residents, attempting to profit from their labor. Readers will by now have recognized this scheme well enough to call it by its true name: colonialism.

Show Your Tongue

A loyal MR reader asks about Africa:

What are your long term predictions? Which policies should rich countries adopt? Which will they adopt? What can I do?

As before, let me address the last question first. What you should do depends on whether you wish to help Africans, or to keep their plight in the Western eye. The latter cause is admirably well served by donating to any of the highly advertised charities which claim to be helping Africans; what your money will really be used for is to pay Westerners to persist in informing us of Africa's plight. If this is not what you want, I think the best course is to donate through a long-established and lightly advertised charity; Catholic Relief Services and possibly Christian Children's Fund come to mind. I do not know whether secular equivalents exist.

Rich countries should desist from agricultural subsidies. This is a good idea in all kinds of ways. Obeying the rule, "First, do no harm," we should stop spending money to further immiserate the world's poorest. Note that undermining the livelihood of African farmers inevitably sends them to the already swollen and hellish cities.

This outcome does not seem likely. In America, the Senate (which I generally admire -- the institution, not its members) ensures overrepresentation of rural areas, and this power imbalance enables them to extract subsidies. The case in Europe may be still worse: Spain, in particular, garnishes 8 billion Euros annually from the EU CAP, and any attempt to push them away from the trough could well lead to their abandonment of Europe.

But the biggest problem for Africa is governance. As Tim Harford writes of Cameroon in The Undercover Economist:

The rot starts with government but it afflicts the entire society. There's no point investing in a business because the government will not protect you against thieves. (So, you might as well become a thief.) There's no point in paying your phone bill because nobody can successfully take you to court (so there's no point in being a phone company). There's no point in getting an education because jobs are not handed out on merit (and in any case, you can't borrow money for school fees because the bank cannot collect on the loan, and the government doesn't provide good schools). There's no point setting up an export business because the customs officers will be the ones to benefit (and so there is little trade, and so the customs office is under-funded and looks even harder for bribes).

No amount of aid from individuals or governments can correct this. I will offer a solution, less unsavory than Kim du Toit's, in a future post.

[Mr. Cowen's answers are here.]

Unpleasantries

Short, unpleasant comments, now at

http://un-pleasantries.blogspot.com

Loose Cannons

Loyal Marginal Revolution reader Johan Richter asked for:

Your preferred policy towards unions.

I am sympathetic to the idea that the asymmetry of size between a corporation and an individual employee should be redressed somehow. Unions as we have experienced them are a blunt and dangerous instrument with which to attempt this. Unions tend to overstep their ideal role in several ways:

Work rules are clearly wealth-destroying, and tend to outlive their usefulness.

Flying pickets and sympathetic strikes attempt to hold all of society hostage to union demands.

Henry Hazlitt, in Economics in One Lesson, phrased this well:

But the moment workers have to use intimidation or violence to enforce their demands—the moment they use mass picketing to prevent any of the old workers from continuing at their jobs, or to prevent the employer from hiring new permanent workers to take their places—their case becomes suspect. For the pickets are really being used, not primarily against the employer, but against other workers. These other workers are willing to take the jobs that the old employees have vacated, and at the wages that the old employees now reject.

Finally, unions in the public sector often have a too-cozy relationship with the government that is allegedly their employer. Here the issue of protecting workers from rapacious capitalism does not arise; yet, with no moral reason for their existence there, unions are omnipresent in government. Perhaps this is because only government can survive union work rules and constraints without being bankrupted.

Kevin Drum deserved particular opprobrium for his intellectually dishonest treatment of this issue. He is happy to gloss over the fundamentally undemocratic nature of the card check process, even after treating us to this egregious parody of reason:

I figure that if a country guarantees the following three rights, it's probably a pretty decent place:
The right to free speech
The right to a fair trial
The right to vote
.... So here's a question: Do you think convicted felons who have served their time should be prohibited from speaking freely? Do you think they should lose the right to a fair trial?
No? Then why do they lose the right to vote in 20 states?

This is perhaps the most laughable non sequitur I have ever seen in print.

Returning to the original question, my preferred policy would be to permit unionization whenever workers chose it by secret ballot; to protect union organizers from employer retaliation; to forbid government employees from unionizing; and to explicitly state that violence employed in a labor dispute is as criminally culpable as any other violence.

[Mr. Cowen's comments are here.]

Aversion Therapy

A loyal Marginal Revolution reader asks:

What is currency and what are the potential implications of a completely digital currency that could have unlimited meta information attached to it? [Some obvious implications would be tracking transactions and the government's ability to enforce taxes, etc., some more esoteric stuff would be attaching conditions much like covenants, say that a particular payment could only be used to buy products that were carbon neutral, possibly down the road having policy implications.]

This is a control fantasy. Here is what to do when you are tempted by ideas like this: imagine a team of wealthy, rude, and immensely cheerful investment bankers bantering with the masseuse in First Class on their way to explain to their client how to get around your regulation.

It works for me.

[Mr. Cowen's far more thoughful answer is here.]

Marvels of Automation

Even this blog is banned in China.

Hypothesis

Could Al Gore's exorbitant household electricity consumption, the target of so much analysis and satire over the past week, be due to electric vehicles? Recharging must be very energy-intensive, and this would also explain Mr. Gore's reluctance to offer a defense: it would be an embarrassment to the environmental cause to affirm this, if true.

Datum

A loyal Marginal Revolution reader asks:

What are your thoughts on the new dynamic optimal public finance policy models being built and simulated? Will they yield any new insights applicable for the real world, or are they a fad?

Fortunately for this reader, he did not ask me, since I possess no relevant information. I can, however, offer one true story.

Over the past few years, the UK government has sought to ensure the financial viability of pension funds, partly by imposing "duration matching" restrictions on the bonds held by these funds. The result has been substantially increased demand for long-dated bonds, to the extent that the GBP yield curve is now substantially inverted (as of this writing, 30-year swap yields are over a percent below 2-year).

The UK government, which is forcing pension funds to buy long-dated bonds, could then lower its own cost of funding by issuing more long-dated bonds; but they have not acted to do so. Perhaps in a few years' time that part of the government will notice the shape of the yield curve, and issue long-dated bonds, thus flooding the market and inflicting huge mark-to-market losses on the pension funds.

The point of this little story is that governments cannot be trusted to make even the most obvious decisions. This is not UK-specific: witness then-U.S. Treasury Secretary Lloyd Bentsen's persistent issuance of short-dated bonds before the 1994 rate hikes.

[Mr. Cowen's answer is here.]

Precious

A loyal Marginal Revolution reader asks for discussion of

china [sic]

I have not been to China since 1999, but I feel confident that the changes since then are the logical extension of those already underway at that time. I agree with the conventional wisdom that China is highly promising but highly unstable; and I think that, for the non-Chinese world, this is a good thing.

To a Western sensibility, China outside Hong Kong feels alien -- more so even than Tokyo. Perhaps I can express it best by saying that the Japanese, while serious and formal, seem young in their curiosity and perfectionism, while the Chinese seem old, old with weariness rather than with wisdom. Life is not precious in China, and death is not dreaded.

The overriding pragmatism of Chinese culture also appears to contribute to a greater vulnerability to tragedies of the commons. To a sufficiently imaginative viewer, almost any public good -- from an open stretch of roadside near a park entrance, to an honestly run business paying no kickbacks -- is a resource crying out to be exploited. The preservation of public goods through forbearance on the part of many is s significant part of "social capital", and there is little such forbearance in China. Perhaps this is an effect of crowding and poverty, rather than of anything specifically Chinese; I have no firsthand knowledge of India or of Africa beyond its northernmost reaches.

China is in a three-way race, where its economic growth must outpace both the aging of its population (projected into the future here) and the social time bomb of its gender imbalance. I expect that continued rapid growth is necessary for stability; stagnation or even slow (1-3% annual) growth will likely lead to unrest, violence and possibly collapse. Looking carefully at the aging chart above, it appears that China's apparent growth is partially due to favorable demographics, as many people enter the work force and few leave. This is reminiscent of Japan's apparent dominance in the 1980's, which was boosted by an extremely similar demographic profile.

Finally, throughout the world, what is precious? Many Americans and Europeans cast a very wide net here, proclaiming the sacred value (though they might not choose that word) of the quality of life of farm animals and lab rats. In China, where exotic animals are jammed into cages outside the more expensive restaurants, such a view seems implausible.

[Mr. Cowen's remarks are here and here.]

Spot the Constraint

A loyal Marginal Revolution reader asks for discussion of:

... the potential effects of not only making cable tv a la carte, but also requiring that television content providers allow choice in how the consumer pays for the service - either an advertisement based system or a fee that would eliminate the commercials. Additionally, require that the consumers be given a choice of types of advertisements they would be exposed to.

After all, if consumer choice is a good thing, wouldn't a mandatory increase in consumer choice be even better?

Snark aside, let me take these suggestions in reverse order. Giving consumers a choice of types of advertisement is a recipe for chaotic and intrusive intervention, as the definition of "type" is by no means obvious. Immediately obvious consequences include pressure groups seeking to create new types so that people can ask to not see them, and advertisers deliberately seeking to blur the boundary lines in order to minimize the relevance of the restrictions.

Next we come to the much more reasonable suggestion of forcing broadcasters to offer a choice between fee-based and advertising-based funding; for every channel we must also have a "premium" channel offering the same content (plus some filler to make up for all the time saved, I expect) without advertising.

Why doesn't such a thing already exist? The scarcest resource seems to be cable bandwidth, and it seems probably that premium ABC (or other major network) would be a more profitable use of bandwidth than an extra shopping channel. There are two possibilities.

First, perhaps a premium version of a major network would be the most valuable use of bandwidth, and the network operators are suppressing it for nefarious reasons of their own. In this case they could circumvent the proposed rule, for example by pricing the premium channel too high; cable operators would lose capacity and content providers would be unaffected.

Second, perhaps the market's apparent message is correct, and premium channels add so little value that they cannot justify this expense of setting them up. Then this would be just another mildly value-destroying government intervention.


There are two broad points to make. First, broadcast content providers may reasonably be subject to regulation based on their use of a public good (i.e., bandwidth on the relevant delivery mechanism), but regulations which oblige them to consume more of that good are difficult to justify.

Second, returning to my first reaction above, consumer choice generally cannot be manufactured by government regulation. Here the effect of duplicating major channels will be to drive marginal channels out of the spectrum.

[Mr. Cowen's discussion is here.]

Snobbery

Several loyal Marginal Revolution readers ask for discussion of IQ:

"There is something special about IQ. We must conserve IQ at very high cost, and gains in IQ will bring very high social returns."

Actions to improve average IQ are eugenics, or else they are not meaningful. This conclusion does not require that IQ be entirely, or even majority, genetic in origin. Any measures to improve the non-genetic portion of IQ are ephemeral as they are not propagated across generations, and are also tantamount to expending resources teaching people to take IQ tests. [Cynics will argue that this is what education mainly consists of, but few will argue that it is the best goal for education.]

Here I am ignoring the idea that immigration should be restricted to "conserve IQ". Besides its repugnant nature, this is a very weak argument. You can reach the same conclusions on immigration by arguing for greater social assimilation, and against dilution of America's culture of honesty and opportunity; and these latter arguments have some justification outside mere prejudice.

I also oppose the conflation of IQ with social productivity. Oddly, the two are often merged by self-styled progressives, seeking to minimize the case that poverty is self-inflicted. I have written before about this.

Finally, there is a good case to be made that we should encourage reproduction among the upper classes, if only because demographic decline seems a greater threat than overpopulation. This can only be accomplished by ending the lifelong discrimination against mothers in skilled jobs, which is fantastically expensive in its own right. This spills into an unrelated point, which is that social welfare would be greatly increased by getting as many 20-25 year olds as possible out of college.

[Mr. Cowen's own answer is here.]

Delights

A loyal Marginal Revolution reader asks for discussion of:

... something I've been thinking about a lot as I pack up my house to move: Why do we buy books and videos? Doesn't it make much more sense to outsource their storage to libraries and video stores or services like Netflix?

This question is only meaningful to city dwellers, or to those with uniformly mainstream tastes in books. Most libraries, even good ones, are thinly stocked; and anything shorter than book length is exceedingly hard to find. For examples, go to your library and try to obtain the following:

a Kingsley Amis book other than Lucky Jim or The Old Devils

the Roger Zelazny novella He Who Shapes

the Richard Connell story "The Most Dangerous Game"

Also, books are not like hamburgers, consumed once and then unneeded. Picking up a familiar book and reading just a couple of pages, to refresh its world in memory, is a valuable pleasure which cannot be obtained without a physical inventory.

The interlocutor's case makes more sense for movies, which are more reliably consumed as units. Even here there are problems, like the mismatch between the Platonic ideal of outsourcing storage and the real nature of Netflix and its competitors, which are likely to make you watch Traffic when you are in the mood for Happy Feet. Udolpho has more, in an uncharacteristically subdued vein, here.

[Mr. Cowen's answer is here.]