Month: March 2015

How following the crowd can doom us all

PNRJ heuristics and biases , , , , , , , , , , , , , , , , , , , , , , , ,

JDN 2457110 EDT 21:30

Humans are nothing if not social animals. We like to follow the crowd, do what everyone else is doing—and many of us will continue to do so even if our own behavior doesn’t make sense to us. There is a very famous experiment in cognitive science that demonstrates this vividly.

People are given a very simple task to perform several times: We show you line X and lines A, B, and C. Now tell us which of A, B or C is the same length as X. Couldn’t be easier, right? But there’s a trick: seven other people are in the same room performing the same experiment, and they all say that B is the same length as X, even though you can clearly see that A is the correct answer. Do you stick with what you know, or say what everyone else is saying? Typically, you say what everyone else is saying. Over 18 trials, 75% of people followed the crowd at least once, and some people followed the crowd every single time. Some people even began to doubt their own perception, wondering if B really was the right answer—there are four lights, anyone?

Given that our behavior can be distorted by others in such simple and obvious tasks, it should be no surprise that it can be distorted even more in complex and ambiguous tasks—like those involved in finance. If everyone is buying up Beanie Babies or Tweeter stock, maybe you should too, right? Can all those people be wrong?

In fact, matters are even worse with the stock market, because it is in a sense rational to buy into a bubble if you know that other people will as well. As long as you aren’t the last to buy in, you can make a lot of money that way. In speculation, you try to predict the way that other people will cause prices to move and base your decisions around that—but then everyone else is doing the same thing. By Keynes called it a “beauty contest”; apparently in his day it was common to have contests for picking the most beautiful photo—but how is beauty assessed? By how many people pick it! So you actually don’t want to choose the one you think is most beautiful, you want to choose the one you think most people will think is the most beautiful—or the one you think most people will think most people will think….

Our herd behavior probably made a lot more sense when we evolved it millennia ago; when most of your threats are external and human beings don’t have that much influence over our environment, the majority opinion is quite likely to be right, and can often given you an answer much faster than you could figure it out on your own. (If everyone else thinks a lion is hiding in the bushes, there’s probably a lion hiding in the bushes—and if there is, the last thing you want is to be the only one who didn’t run.) The problem arises when this tendency to follow the ground feeds back on itself, and our behavior becomes driven not by the external reality but by an attempt to predict each other’s predictions of each other’s predictions. Yet this is exactly how financial markets are structured.

With this in mind, the surprise is not why markets are unstable—the surprise is why markets are ever stable. I think the main reason markets ever manage price stability is actually something most economists think of as a failure of markets: Price rigidity and so-called “menu costs“. If it’s costly to change your price, you won’t be constantly trying to adjust it to the mood of the hour—or the minute, or the microsecond—but instead trying to tie it to the fundamental value of what you’re selling so that the price will continue to be close for a long time ahead. You may get shortages in times of high demand and gluts in times of low demand, but as long as those two things roughly balance out you’ll leave the price where it is. But if you can instantly and costlessly change the price however you want, you can raise it when people seem particularly interested in buying and lower it when they don’t, and then people can start trying to buy when your price is low and sell when it is high. If people were completely rational and had perfect information, this arbitrage would stabilize prices—but since they’re not, arbitrage attempts can over- or under-compensate, and thus result in cyclical or even chaotic changes in prices.

Our herd behavior then makes this worse, as more people buying leads to, well, more people buying, and more people selling leads to more people selling. If there were no other causes of behavior, the result would be prices that explode outward exponentially; but even with other forces trying to counteract them, prices can move suddenly and unpredictably.

If most traders are irrational or under-informed while a handful are rational and well-informed, the latter can exploit the former for enormous amounts of money; this fact is often used to argue that irrational or under-informed traders will simply drop out, but it should only take you a few moments of thought to see why that isn’t necessarily true. The incentives isn’t just to be well-informed but also to keep others from being well-informed. If everyone were rational and had perfect information, stock trading would be the most boring job in the world, because the prices would never change except perhaps to grow with the growth rate of the overall economy. Wall Street therefore has every incentive in the world not to let that happen. And now perhaps you can see why they are so opposed to regulations that would require them to improve transparency or slow down market changes. Without the ability to deceive people about the real value of assets or trigger irrational bouts of mass buying or selling, Wall Street would make little or no money at all. Not only are markets inherently unstable by themselves, in addition we have extremely powerful individuals and institutions who are driven to ensure that this instability is never corrected.

This is why as our markets have become ever more streamlined and interconnected, instead of becoming more efficient as expected, they have actually become more unstable. They were never stable—and the gold standard made that instability worse—but despite monetary policy that has provided us with very stable inflation in the prices of real goods, the prices of assets such as stocks and real estate have continued to fluctuate wildly. Real estate isn’t as bad as stocks, again because of price rigidity—houses rarely have their values re-assessed multiple times per year, let alone multiple times per second. But real estate markets are still unstable, because of so many people trying to speculate on them. We think of real estate as a good way to make money fast—and if you’re lucky, it can be. But in a rational and efficient market, real estate would be almost as boring as stock trading; your profits would be driven entirely by population growth (increasing the demand for land without changing the supply) and the value added in construction of buildings. In fact, the population growth effect should be sapped by a land tax, and then you should only make a profit if you actually build things. Simply owning land shouldn’t be a way of making money—and the reason for this should be obvious: You’re not actually doing anything. I don’t like patent rents very much, but at least inventing new technologies is actually beneficial for society. Owning land contributes absolutely nothing, and yet it has been one of the primary means of amassing wealth for centuries and continues to be today.

But (so-called) investors and the banks and hedge funds they control have little reason to change their ways, as long as the system is set up so that they can keep profiting from the instability that they foster. Particularly when we let them keep the profits when things go well, but immediately rush to bail them out when things go badly, they have basically no incentive at all not to take maximum risk and seek maximum instability. We need a fundamentally different outlook on the proper role and structure of finance in our economy.

Fortunately one is emerging, summarized in a slogan among economically-savvy liberals: Banking should be boring. (Elizabeth Warren has said this, as have Joseph Stiglitz and Paul Krugman.) And indeed it should, for all banks are supposed to be doing is lending money from people who have it and don’t need it to people who need it but don’t have it. They aren’t supposed to be making large profits of their own, because they aren’t the ones actually adding value to the economy. Indeed it was never quite clear to me why banks should be privatized in the first place, though I guess it makes more sense than, oh, say, prisons.

Unfortunately, the majority opinion right now, at least among those who make policy, seems to be that banks don’t need to be restructured or even placed on a tighter leash; no, they need to be set free so they can work their magic again. Even otherwise reasonable, intelligent people quickly become unshakeable ideologues when it comes to the idea of raising taxes or tightening regulations. And as much as I’d like to think that it’s just a small but powerful minority of people who thinks this way, I know full well that a large proportion of Americans believe in these views and intentionally elect politicians who will act upon them.

All the more reason to break from the crowd, don’t you think?

Why did we ever privatize prisons?

PNRJ public policy , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,

JDN 2457103 EDT 10:24.

Since the Reagan administration (it’s always Reagan), the United States has undergone a spree of privatization of public services, in which services that are ordinarily performed by government agencies are instead contracted out to private companies. Enormous damage to our society has been done by this sort of privatization, from healthcare to parking meters.

This process can vary in magnitude.

The weakest form, which is relatively benign, is for the government to buy specific services like food service or equipment manufacturing from companies that already provide them to consumers. There’s no particular reason for the government to make their own toothpaste or wrenches rather than buy them from corporations like Proctor & Gamble and Sears. Toothpaste is toothpaste and wrenches are wrenches.

The moderate form is for the government to contract services to specific companies that may involve government-specific features like security clearances or powerful military weapons. This is already raising a lot of problems: When Northrop-Grumman makes our stealth bombers, and Boeing builds our nuclear ICBMs, these are publicly-traded, for-profit corporations manufacturing some of the deadliest weapons ever created—weapons that could literally destroy human civilization in a matter of minutes. Markets don’t work well in the presence of externalities, and weapons by definition are almost nothing but externalities; their entire function is to cause harm—typically, death—to people without their consent. While this violence may sometimes be justified, it must never be taken lightly; and we are right to be uncomfortable with the military-industrial complex whose shareholders profit from death and destruction. (Eisenhower tried to warn us!) Still, there are some good arguments to be made for this sort of privatization, since many of these corporations already have high-tech factories and skilled engineers that they can easily repurpose, and competitive bids between different corporations can keep the price down. (Of course, with no-bid contracts that no longer applies; and it certainly hasn’t stopped us from spending nearly as much on the military as the rest of the world combined.)

What I’d really like to focus on today is the strongest form of privatization, in which basic government services are contracted out to private companies. This is what happens when you attempt to privatize soldiers, SWAT teams, and prisons—all of which the United States has done since Reagan.

I say “attempt” to privatize because in a very real sense the privatization of these services is incoherent—they are functions so basic to government that simply to do them makes you, de facto, part of the government. (Or, if done without government orders, it would be organized crime.) All you’ve really done by “privatizing” these services is reduced their transparency and accountability, as well as siphoning off a portion of the taxpayer money in the form of profits for shareholders.

The benefits of privatization, when they exist, are due to competition and consumer freedom. The foundation of a capitalist economy is the ability to say “I’ll take my business elsewhere.” (This is why the notion that a bank can sell your loan to someone else is the opposite of a free market; forcing you to write a check to someone you never made a contract with is antithetical to everything the free market stands for.) Actually the closest thing to a successful example of privatized government services is the United States Postal Service, which collects absolutely no tax income. They do borrow from the government and receive subsidies for some of their services—but so does General Motors. Frankly I think the Postal Service has a better claim to privatization than GM, which you may recall only exists today because of a massive government bailout with a net cost to the US government of $11 billion. All the Postal Service does differently is act as a tightly-regulated monopoly that provides high-quality service to everyone at low prices and pays good wages and pensions, all without siphoning profits to shareholders. (They really screwed up my mail forwarding lately, but they are still one of the best postal systems in the world.) It is in many ways the best of both worlds, the efficiency of capitalism with the humanity of socialism.

The Corrections Corporation of America, on the other hand, is the exact opposite, the worst of both worlds, the inefficiency of socialism with the inhumanity of capitalism. It is not simply corrupt but frankly inherently corrupt—there is simply no way you can have a for-profit prison system that isn’t corrupt. Maybe it can be made less corrupt or more corrupt, but the mere fact that shareholders are earning profits from incarcerating prisoners is fundamentally antithetical to a free and just society.

I really can’t stress this enough: Privatizing soldiers and prisons makes no sense at all. It doesn’t even make sense in a world of infinite identical psychopaths; nothing in neoclassical economic theory in any way supports these privatizations. Neoclassical theory is based upon the presumption of a stable government that enforces property rights, a government that provides as much service as necessary exactly at cost and is not attempting to maximize any notion of its own “profit”.

That’s ridiculous, of course—much like the neoclassical rational agent—and more recent work has been done in public choice theory about the various interest groups that act against each other in government, including lobbyists for private corporations—but public choice theory is above all a theory of government failure. It is a theory of why governments don’t work as well as we would like them to—the main question is how we can suppress the influence of special interest groups to advance the public good. Privatization of prisons means creating special interest groups where none existed, making the government less directed at the public good.

Privatizing government services is often described as “reducing the size of government”, usually interpreted in the most narrow sense to mean the tax burden. But Big Government doesn’t mean you pay 22% of GDP instead of 18% of GDP; Big Government means you can be arrested and imprisoned without trial. Even using the Heritage Foundation’s metrics, the correlation between tax burden and overall freedom is positive. Tyrannical societies don’t bother with taxes; they own the oil refineries directly (Venezuela), or print money whenever they want (Zimbabwe), or build the whole society around doing what they want (North Korea).

The incarceration rate is a much better measure of a society’s freedom than the tax rate will ever be—and the US isn’t doing so well in that regard; indeed we have by some measures the highest incarceration rate in the world. Fortunately we do considerably better when it comes to things like free speech and freedom of religion—indeed we are still above average in overall freedom. Though we do imprison more of our people than China, I’m not suggesting that China has a freer society. But why do we imprison so many people?

Well, it seems to have something to do with privatization of prisons. Indeed, there is a strong correlation between the privatization of US prisons and the enormous explosion of incarceration in the United States. In fact privatized prisons don’t even reduce the tax burden, because privatization does not decrease demand and “privatized” prisons must still be funded by taxes. Prisons do not have customers who choose between different competing companies and shop for the highest quality and lowest price—prisoners go to the prison they are assigned to and they can’t leave (which is really the whole point). Even competition at the purchase end doesn’t make much sense, since the government can’t easily transfer all the prisoners to a new company. Maybe they could transfer ownership of the prison to a different company, but even then the transition costs would be substantial, and besides, there are only a handful of prison corporations that corner most of the (so-called) market.

There is simply no economic basis for privatization of prisons. Nothing in either neoclassical theory or more modern cognitive science in any way supports the idea. So the real question is: Why did we ever privatize prisons?

Basically there is only one reason: Ideology. The post-Reagan privatization spree was not actually based on economics—it was based on economic ideology. Either because they actually believed it, or by the Upton Sinclair Principle, a large number of economists adopted a radical far-right ideology that government basically should not exist—that the more we give more power to corporations and less power to elected officials the better off we will be.

They defended this ideology on vaguely neoclassical grounds, mumbling something about markets being more efficient; but this isn’t even like cutting off the wings of the airplane because we’re assuming frictionless vacuum—it’s like cutting off the engines of the airplane because we simply hate engines and are looking for any excuse to get rid of them. There is absolutely nothing in neoclassical economic theory that says it would be efficient or really beneficial in any way to privatize prisons. It was all about taking power away from the elected government and handing it over to for-profit corporations.

This is a bit of consciousness-raising I’m trying to do: Any time you hear someone say that something should be apolitical, I want you to substitute the word undemocratic. When they say that judges shouldn’t be elected so that they can be apolitical—they mean undemocratic. When they say that the Federal Reserve should be independent of politics—they mean independent of voting. They want to take decision power away from the public at large and concentrate it more in the hands of an elite. People who say this sort of thing literally do not believe in democracy.

To be fair, there may actually be good reasons to not believe in democracy, or at least to believe that democracy should be constrained by a constitution and a system of representation. Certain rights are inalienable, regardless of what the voting public may say, which is why we need a constitution that protects those rights above all else. (In theory… there’s always the PATRIOT ACT, speaking of imprisoning people without trial.) Moreover, most people are simply not interested enough—or informed enough—to vote on every single important decision the government makes. It makes sense for us to place this daily decision-making power in the hands of an elite—but it must be an elite we choose.

And yes, people often vote irrationally. One of the central problems in the United States today is that almost half the population consistently votes against rational government and their own self-interest on the basis of a misguided obsession with banning abortion, combined with a totally nonsensical folk theory of economics in which poor people are poor because they are lazy, the government inherently destroys whatever wealth it touches, and private-sector “job creators” simply hand out jobs to other people because they have extra money lying around. Then of course there’s—let’s face it—deep-seated bigotry toward women, racial minorities, and LGBT people. (The extreme hatred toward Obama and suspicion that he isn’t really born in the US really can’t be explained any other way.) In such circumstances it may be tempting to say that we should give up on democracy and let expert technocrats take charge; but in the absence of democratic safeguards, technocracy is little more than another name for oligarchy. Maybe it’s enough that the President appoints the Federal Reserve chair and the Supreme Court? I’m not so sure. Ben Bernanke definitely handled the Second Depression better than Congress did, I’ll admit; but I’m not sure Alan Greenspan would have in his place, and given his babbling lately about returning to Bretton Woods I’m pretty sure Paul Volcker wouldn’t have. (If you don’t see what’s wrong with going back to Bretton Woods, which was basically a variant of the gold standard, you should read what Krugman has to say about the gold standard.) So basically we got lucky and our monetary quasi-tyrant was relatively benevolent and wise. (Or maybe Bernanke was better because Obama appointed him, while Reagan appointed Greenspan. Carter appointed Volcker, oddly enough; but Reagan reappointed him. It’s always Reagan.) And if you could indeed ensure that tyrants would always be benevolent and wise, tyranny would be a great system—but you can’t.

Democracy doesn’t always lead to the best outcomes, but that’s really not what it’s for. Rather, democracy is for preventing the worst outcomes—no large-scale famine has ever occurred under a mature democracy, nor has any full-scale genocide. Democracies do sometimes forcibly “relocate” populations (particularly indigenous populations, as the US did under Andrew Jackson), and we should not sugar-coat that; people are forced out of their homes and many die. It could even be considered something close to genocide. But no direct and explicit mass murder of millions has ever occurred under a democratic government—no, the Nazis were not democratically elected—and that by itself is a fully sufficient argument for democracy. It could be true that democracies are economically inefficient (they are economically efficient), unbearably corrupt (they are less corrupt), and full of ignorant idiotic hicks (they have higher average educational attainment), and democracy would still be better simply because it prevents famine and genocide. As Churchill said, “Democracy is the worst system, except for all the others.”

Indeed, I think the central reason why American democracy isn’t working well right now is that it’s not very democratic; a two-party system with a plurality “first-past-the-post” vote is literally the worst possible voting system that can still technically be considered democracy. Any worse than that and you only have one party. If we had a range voting system (which is mathematically optimal) and say a dozen parties (they have about a dozen parties in France), people would be able to express their opinions more clearly and in more detail, with less incentive for strategic voting. We probably wouldn’t have such awful turnout at that point, and after realizing that they actually had such a strong voice, maybe people would even start educating themselves about politics in order to make better decisions.

Privatizing prisons and soldiers takes us in exactly the opposite direction: It makes our government deeply less democratic, fundamentally less accountable to voters. It hands off the power of life and death to institutions whose sole purpose for existence is their own monetary gain. We should never have done it—and we must undo it as soon as we possibly can.

In honor of Pi Day, I for one welcome our new robot overlords

PNRJ core principles , , , , , , , , , , , , , , , , , , , , , , ,

JDN 2457096 EDT 16:08

Despite my preference to use the Julian Date Number system, it has not escaped my attention that this weekend was Pi Day of the Century, 3/14/15. Yesterday morning we had the Moment of Pi: 3/14/15 9:26:53.58979… We arguably got an encore that evening if we allow 9:00 PM instead of 21:00.

Though perhaps it is a stereotype and/or cheesy segue, pi and associated mathematical concepts are often associated with computers and robots. Robots are an increasing part of our lives, from the industrial robots that manufacture our cars to the precision-timed satellites that provide our GPS navigation. When you want to know how to get somewhere, you pull out your pocket thinking machine and ask it to commune with the space robots who will guide you to your destination.

There are obvious upsides to these robots—they are enormously productive, and allow us to produce great quantities of useful goods at astonishingly low prices, including computers themselves, creating a positive feedback loop that has literally lowered the price of a given amount of computing power by a factor of one trillion in the latter half of the 20th century. We now very much live in the early parts of a cyberpunk future, and it is due almost entirely to the power of computer automation.

But if you know your SF you may also remember another major part of cyberpunk futures aside from their amazing technology; they also tend to be dystopias, largely because of their enormous inequality. In the cyberpunk future corporations own everything, governments are virtually irrelevant, and most individuals can barely scrape by—and that sounds all too familiar, doesn’t it? This isn’t just something SF authors made up; there really are a number of ways that computer technology can exacerbate inequality and give more power to corporations.

Why? The reason that seems to get the most attention among economists is skill-biased technological change; that’s weird because it’s almost certainly the least important. The idea is that computers can automate many routine tasks (no one disputes that part) and that routine tasks tend to be the sort of thing that uneducated workers generally do more often than educated ones (already this is looking fishy; think about accountants versus artists). But educated workers are better at using computers and the computers need people to operate them (clearly true). Hence while uneducated workers are substitutes for computers—you can use the computers instead—educated workers are complements for computers—you need programmers and engineers to make the computers work. As computers get cheaper, their substitutes also get cheaper—and thus wages for uneducated workers go down. But their complements get more valuable—and so wages for educated workers go up. Thus, we get more inequality, as high wages get higher and low wages get lower.

Or, to put it more succinctly, robots are taking our jobs. Not all our jobs—actually they’re creating jobs at the top for software programmers and electrical engineers—but a lot of our jobs, like welders and metallurgists and even nurses. As the technology improves more and more jobs will be replaced by automation.

The theory seems plausible enough—and in some form is almost certainly true—but as David Card has pointed out, this fails to explain most of the actual variation in inequality in the US and other countries. Card is one of my favorite economists; he is also famous for completely revolutionizing the economics of minimum wage, showing that prevailing theory that minimum wages must hurt employment simply doesn’t match the empirical data.

If it were just that college education is getting more valuable, we’d see a rise in income for roughly the top 40%, since over 40% of American adults have at least an associate’s degree. But we don’t actually see that; in fact contrary to popular belief we don’t even really see it in the top 1%. The really huge increases in income for the last 40 years have been at the top 0.01%—the top 1% of 1%.

Many of the jobs that are now automated also haven’t seen a fall in income; despite the fact that high-frequency trading algorithms do what stockbrokers do a thousand times better (“better” at making markets more unstable and siphoning wealth from the rest of the economy that is), stockbrokers have seen no such loss in income. Indeed, they simply appropriate the additional income from those computer algorithms—which raises the question why welders couldn’t do the same thing. And indeed, I’ll get to in a moment why that is exactly what we must do, that the robot revolution must also come with a revolution in property rights and income distribution.

No, the real reasons why technology exacerbates inequality are twofold: Patent rents and the winner-takes-all effect.

In an earlier post I already talked about the winner-takes-all effect, so I’ll just briefly summarize it this time around. Under certain competitive conditions, a small fraction of individuals can reap a disproportionate share of the rewards despite being only slightly more productive than those beneath them. This often happens when we have network externalities, in which a product becomes more valuable when more people use it, thus creating a positive feedback loop that makes the products which are already successful wildly so and the products that aren’t successful resigned to obscurity.

Computer technology—more specifically, the Internet—is particularly good at creating such situations. Facebook, Google, and Amazon are all examples of companies that (1) could not exist without Internet technology and (2) depend almost entirely upon network externalities for their business model. They are the winners who take all; thousands of other software companies that were just as good or nearly so are now long forgotten. The winners are not always the same, because the system is unstable; for instance MySpace used to be much more important—and much more profitable—until Facebook came along.

But the fact that a different handful of upper-middle-class individuals can find themselves suddenly and inexplicably thrust into fame and fortune while the rest of us toil in obscurity really isn’t much comfort, now is it? While technically the rise and fall of MySpace can be called “income mobility”, it’s clearly not what we actually mean when we say we want a society with a high level of income mobility. We don’t want a society where the top 10% can by little more than chance find themselves becoming the top 0.01%; we want a society where you don’t have to be in the top 10% to live well in the first place.

Even without network externalities the Internet still nurtures winner-takes-all markets, because digital information can be copied infinitely. When it comes to sandwiches or even cars, each new one is costly to make and costly to transport; it can be more cost-effective to choose the ones that are made near you even if they are of slightly lower quality. But with books (especially e-books), video games, songs, or movies, each individual copy costs nothing to create, so why would you settle for anything but the best? This may well increase the overall quality of the content consumers get—but it also ensures that the creators of that content are in fierce winner-takes-all competition. Hence J.K. Rowling and James Cameron on the one hand, and millions of authors and independent filmmakers barely scraping by on the other. Compare a field like engineering; you probably don’t know a lot of rich and famous engineers (unless you count engineers who became CEOs like Bill Gates and Thomas Edison), but nor is there a large segment of “starving engineers” barely getting by. Though the richest engineers (CEOs excepted) are not nearly as rich as the richest authors, the typical engineer is much better off than the typical author, because engineering is not nearly as winner-takes-all.

But the main topic for today is actually patent rents. These are a greatly underappreciated segment of our economy, and they grow more important all the time. A patent rent is more or less what it sounds like; it’s the extra money you get from owning a patent on something. You can get that money either by literally renting it—charging license fees for other companies to use it—or simply by being the only company who is allowed to manufacture something, letting you sell it at monopoly prices. It’s surprisingly difficult to assess the real value of patent rents—there’s a whole literature on different econometric methods of trying to tackle this—but one thing is clear: Some of the largest, wealthiest corporations in the world are built almost entirely upon patent rents. Drug companies, R&D companies, software companies—even many manufacturing companies like Boeing and GM obtain a substantial portion of their income from patents.

What is a patent? It’s a rule that says you “own” an idea, and anyone else who wants to use it has to pay you for the privilege. The very concept of owning an idea should trouble you—ideas aren’t limited in number, you can easily share them with others. But now think about the fact that most of these patents are owned by corporations—not by inventors themselves—and you’ll realize that our system of property rights is built around the notion that an abstract entity can own an idea—that one idea can own another.

The rationale behind patents is that they are supposed to provide incentives for innovation—in exchange for investing the time and effort to invent something, you receive a certain amount of time where you get to monopolize that product so you can profit from it. But how long should we give you? And is this really the best way to incentivize innovation?

I contend it is not; when you look at the really important world-changing innovations, very few of them were done for patent rents, and virtually none of them were done by corporations. Jonas Salk was indignant at the suggestion he should patent the polio vaccine; it might have made him a billionaire, but only by letting thousands of children die. (To be fair, here’s a scholar arguing that he probably couldn’t have gotten the patent even if he wanted to—but going on to admit that even then the patent incentive had basically nothing to do with why penicillin and the polio vaccine were invented.)

Who landed on the moon? Hint: It wasn’t Microsoft. Who built the Hubble Space Telescope? Not Sony. The Internet that made Google and Facebook possible was originally invented by DARPA. Even when corporations seem to do useful innovation, it’s usually by profiting from the work of individuals: Edison’s corporation stole most of its good ideas from Nikola Tesla, and by the time the Wright Brothers founded a company their most important work was already done (though at least then you could argue that they did it in order to later become rich, which they ultimately did). Universities and nonprofits brought you the laser, light-emitting diodes, fiber optics, penicillin and the polio vaccine. Governments brought you liquid-fuel rockets, the Internet, GPS, and the microchip. Corporations brought you, uh… Viagra, the Snuggie, and Furbies. Indeed, even Google’s vaunted search algorithms were originally developed by the NSF. I can think of literally zero examples of a world-changing technology that was actually invented by a corporation in order to secure a patent. I’m hesitant to say that none exist, but clearly the vast majority of seminal inventions have been created by governments and universities.

This has always been true throughout history. Rome’s fire departments were notorious for shoddy service—and wholly privately-owned—but their great aqueducts that still stand today were built as government projects. When China invented paper, turned it into money, and defended it with the Great Wall, it was all done on government funding.

The whole idea that patents are necessary for innovation is simply a lie; and even the idea that patents lead to more innovation is quite hard to defend. Imagine if instead of letting Google and Facebook patent their technology all the money they receive in patent rents were instead turned into tax-funded research—frankly is there even any doubt that the results would be better for the future of humanity? Instead of better ad-targeting algorithms we could have had better cancer treatments, or better macroeconomic models, or better spacecraft engines.

When they feel their “intellectual property” (stop and think about that phrase for awhile, and it will begin to seem nonsensical) has been violated, corporations become indignant about “free-riding”; but who is really free-riding here? The people who copy music albums for free—because they cost nothing to copy, or the corporations who make hundreds of billions of dollars selling zero-marginal-cost products using government-invented technology over government-funded infrastructure? (Many of these companies also continue receive tens or hundreds of millions of dollars in subsidies every year.) In the immortal words of Barack Obama, “you didn’t build that!”

Strangely, most economists seem to be supportive of patents, despite the fact that their own neoclassical models point strongly in the opposite direction. There’s no logical connection between the fixed cost of inventing a technology and the monopoly rents that can be extracted from its patent. There is some connection—albeit a very weak one—between the benefits of the technology and its monopoly profits, since people are likely to be willing to pay more for more beneficial products. But most of the really great benefits are either in the form of public goods that are unenforceable even with patents (go ahead, try enforcing on that satellite telescope on everyone who benefits from its astronomical discoveries!) or else apply to people who are so needy they can’t possibly pay you (like anti-malaria drugs in Africa), so that willingness-to-pay link really doesn’t get you very far.

I guess a lot of neoclassical economists still seem to believe that willingness-to-pay is actually a good measure of utility, so maybe that’s what’s going on here; if it were, we could at least say that patents are a second-best solution to incentivizing the most important research.

But even then, why use second-best when you have best? Why not devote more of our society’s resources to governments and universities that have centuries of superior track record in innovation? When this is proposed the deadweight loss of taxation is always brought up, but somehow the deadweight loss of monopoly rents never seems to bother anyone. At least taxes can be designed to minimize deadweight loss—and democratic governments actually have incentives to do that; corporations have no interest whatsoever in minimizing the deadweight loss they create so long as their profit is maximized.

I’m not saying we shouldn’t have corporations at all—they are very good at one thing and one thing only, and that is manufacturing physical goods. Cars and computers should continue to be made by corporations—but their technologies are best invented by government. Will this dramatically reduce the profits of corporations? Of course—but I have difficulty seeing that as anything but a good thing.

Why am I talking so much about patents, when I said the topic was robots? Well, it’s typically because of the way these patents are assigned that robots taking people’s jobs becomes a bad thing. The patent is owned by the company, which is owned by the shareholders; so when the company makes more money by using robots instead of workers, the workers lose.

If when a robot takes your job, you simply received the income produced by the robot as capital income, you’d probably be better off—you get paid more and you also don’t have to work. (Of course, if you define yourself by your career or can’t stand the idea of getting “handouts”, you might still be unhappy losing your job even though you still get paid for it.)

There’s a subtler problem here though; robots could have a comparative advantage without having an absolute advantage—that is, they could produce less than the workers did before, but at a much lower cost. Where it cost $5 million in wages to produce $10 million in products, it might cost only $3 million in robot maintenance to produce $9 million in products. Hence you can’t just say that we should give the extra profits to the workers; in some cases those extra profits only exist because we are no longer paying the workers.

As a society, we still want those transactions to happen, because producing less at lower cost can still make our economy more efficient and more productive than it was before. Those displaced workers can—in theory at least—go on to other jobs where they are needed more.

The problem is that this often doesn’t happen, or it takes such a long time that workers suffer in the meantime. Hence the Luddites; they don’t want to be made obsolete even if it does ultimately make the economy more productive.

But this is where patents become important. The robots were probably invented at a university, but then a corporation took them and patented them, and is now selling them to other corporations at a monopoly price. The manufacturing company that buys the robots now has to spend more in order to use the robots, which drives their profits down unless they stop paying their workers.

If instead those robots were cheap because there were no patents and we were only paying for the manufacturing costs, the workers could be shareholders in the company and the increased efficiency would allow both the employers and the workers to make more money than before.

What if we don’t want to make the workers into shareholders who can keep their shares after they leave the company? There is a real downside here, which is that once you get your shares, why stay at the company? We call that a “golden parachute” when CEOs do it, which they do all the time; but most economists are in favor of stock-based compensation for CEOs, and once again I’m having trouble seeing why it’s okay when rich people do it but not when middle-class people do.

Another alternative would be my favorite policy, the basic income: If everyone knows they can depend on a basic income, losing your job to a robot isn’t such a terrible outcome. If the basic income is designed to grow with the economy, then the increased efficiency also raises everyone’s standard of living, as economic growth is supposed to do—instead of simply increasing the income of the top 0.01% and leaving everyone else where they were. (There is a good reason not to make the basic income track economic growth too closely, namely the business cycle; you don’t want the basic income payments to fall in a recession, because that would make the recession worse. Instead they should be smoothed out over multiple years or designed to follow a nominal GDP target, so that they continue to rise even in a recession.)

We could also combine this with expanded unemployment insurance (explain to me again why you can’t collect unemployment if you weren’t working full-time before being laid off, even if you wanted to be or you’re a full-time student?) and active labor market policies that help people re-train and find new and better jobs. These policies also help people who are displaced for reasons other than robots making their jobs obsolete—obviously there are all sorts of market conditions that can lead to people losing their jobs, and many of these we actually want to happen, because they involve reallocating the resources of our society to more efficient ends.

Why aren’t these sorts of policies on the table? I think it’s largely because we don’t think of it in terms of distributing goods—we think of it in terms of paying for labor. Since the worker is no longer laboring, why pay them?

This sounds reasonable at first, but consider this: Why give that money to the shareholder? What did they do to earn it? All they do is own a piece of the company. They may not have contributed to the goods at all. Honestly, on a pay-for-work basis, we should be paying the robot!

If it bothers you that the worker collects dividends even when he’s not working—why doesn’t it bother you that shareholders do exactly the same thing? By definition, a shareholder is paid according to what they own, not what they do. All this reform would do is make workers into owners.

If you justify the shareholder’s wealth by his past labor, again you can do exactly the same to justify worker shares. (And as I said above, if you’re worried about the moral hazard of workers collecting shares and leaving, you should worry just as much about golden parachutes.)

You can even justify a basic income this way: You paid taxes so that you could live in a society that would protect you from losing your livelihood—and if you’re just starting out, your parents paid those taxes and you will soon enough. Theoretically there could be “welfare queens” who live their whole lives on the basic income, but empirical data shows that very few people actually want to do this, and when given opportunities most people try to find work. Indeed, even those who don’t, rarely seem to be motivated by greed (even though, capitalists tell us, “greed is good”); instead they seem to be de-motivated by learned helplessness after trying and failing for so long. They don’t actually want to sit on the couch all day and collect welfare payments; they simply don’t see how they can compete in the modern economy well enough to actually make a living from work.

One thing is certain: We need to detach income from labor. As a society we need to get over the idea that a human being’s worth is decided by the amount of work they do for corporations. We need to get over the idea that our purpose in life is a job, a career, in which our lives are defined by the work we do that can be neatly monetized. (I admit, I suffer from the same cultural blindness at times, feeling like a failure because I can’t secure the high-paying and prestigious employment I want. I feel this clear sense that my society does not value me because I am not making money, and it damages my ability to value myself.)

As robots do more and more of our work, we will need to redefine the way we live by something else, like play, or creativity, or love, or compassion. We will need to learn to see ourselves as valuable even if nothing we do ever sells for a penny to anyone else.

A basic income can help us do that; it can redefine our sense of what it means to earn money. Instead of the default being that you receive nothing because you are worthless unless you work, the default is that you receive enough to live on because you are a human being of dignity and a citizen. This is already the experience of people who have substantial amounts of capital income; they can fall back on their dividends if they ever can’t or don’t want to find employment. A basic income would turn us all into capital owners, shareholders in the centuries of established capital that has been built by our forebears in the form of roads, schools, factories, research labs, cars, airplanes, satellites, and yes—robots.

Scope neglect and the question of optimal altruism

PNRJ heuristics and biases , , , , , , , , , , , , , , , , , , , ,

JDN 2457090 EDT 16:15.

We’re now on Eastern Daylight Time because of this bizarre tradition of shifting our time zone forward for half of the year. It’s supposed to save energy, but a natural experiment in India suggests it actually increases energy demand. So why do we do it? Like every ridiculous tradition (have you ever tried to explain Groundhog Day to someone from another country?), we do it because we’ve always done it.
This week’s topic is scope neglect, one of the most pervasive—and pernicious—cognitive heuristics human beings face. Scope neglect raises a great many challenges not only practically but also theoretically—it raises what I call the question of optimal altruism.

The question is simple to ask yet remarkably challenging to answer: How much should we be willing to sacrifice in order to benefit others? If we think of this as a number, your solidarity coefficient (s), it is equal to the cost you are willing to pay divided by the benefit your action has for someone else: s B > C.

This is analogous to the biological concept relatedness (r), on which Hamilton’s Rule applies: r B > C. Solidarity is the psychological analogue; instead of valuing people based on their genetic similarity to you, you value them based on… well, that’s the problem.

I can easily place upper and lower bounds: The lower bound is zero: You should definitely be willing to sacrifice something to help other people—otherwise you are a psychopath. The upper bound is one: There’s no point in paying more cost than you produce in benefit, and in fact even paying the same cost to yourself as you yield in benefits for other people doesn’t make a lot of sense, because it means that your own self-interest is meaningless and the fact that you understand your own needs better than the needs of others is also irrelevant.

But beyond that, it gets a lot harder—and that may explain why we suffer scope neglect in the first place. Should it be 90%? 50%? 10%? 1%? How should it vary between friends versus family versus strangers? It’s really hard to say. And this inability to precisely decide how much other people should be worth to us may be part of why we suffer scope neglect.

Scope neglect is the fact that we are not willing to expend effort or money in direct proportion to the benefit it would have. When different groups were asked how much they would be willing to donate in order to save the lives of 2,000 birds, 20,000 birds, or 200,000 birds, the answers they gave were statistically indistinguishable—always about $80. But however much a bird’s life is worth to you, shouldn’t 200,000 birds be worth, well, 200,000 times as much? In fact, more than that, because the marginal utility of wealth is decreasing, but I see no reason to think that the marginal utility of birds decreases nearly as fast.

But therein lies the problem: Usually we can’t pay 200,000 times as much. I’d feel like a horrible person if I weren’t willing to expend at least $10 or an equivalent amount of effort in order to save a bird. To save 200,000 birds that means I’d owe $2 million—and I simply don’t have $2 million.

You can get similar results to the bird experiment if you use children—though, as one might hope, the absolute numbers are a bit bigger, usually more like $500 to $1000. (And this, it turns out, is actually about how much it actually costs to save a child’s life by a particularly efficient means, such as anti-malaria nets, de-worming, or direct cash transfer. So please, by all means, give $1000 to UNICEF or the Against Malaria Foundation. If you can’t give $1000, give $100; if you can’t give $100, give $10.) It doesn’t much matter whether you say that the project will save 500 children, 5,000 children, or 50,000 children—people still will give about $500 to $1000. But once again, if I’m willing to spend $1000 to save a child—and I definitely am—how much should I be willing to spend to end malaria, which kills 500,000 children a year? Apparently $500 million, which not only do I not have, I almost certainly will not make that much money cumulatively through my entire life. ($2 million, on the other hand, I almost certainly will make cumulatively—the median income of an economist is $90,000 per year, so if I work for at least 22 years with that as my average income I’ll have cumulatively made $2 million. My net wealth may never be that high—though if I get better positions, or I’m lucky enough or clever enough with the stock market it might—but my cumulative income almost certainly will. Indeed, the average gain in cumulative income from a college degree is about $1 million. Because it takes time—time is money—and loans carry interest, this gives it a net present value of about $300,000.)

But maybe scope neglect isn’t such a bad thing after all. There is a very serious problem with these sort of moral dilemmas: The question didn’t say I would single-handedly save 200,000 birds—and indeed, that notion seems quite ridiculous. If I knew that I could actually save 200,000 birds and I were the only one who could do it, dammit, I would try to come up with that $2 million. I might not succeed, but I really would try as hard as I could.

And if I could single-handedly end malaria, I hereby vow that I would do anything it took to achieve that. Short of mass murder, anything I could do couldn’t be a higher cost to the world than malaria itself. I have no idea how I’d come up with $500 million, but I’d certainly try. Bill Gates could easily come up with that $500 million—so he did. In fact he endowed the Gates Foundation with $28 billion, and they’ve spent $1.3 billion of that on fighting malaria, saving hundreds of thousands of lives.

With this in mind, what is scope neglect really about? I think it’s about coordination. It’s not that people don’t care more about 200,000 birds than they do about 2,000; and it’s certainly not that they don’t care more about 50,000 children than they do about 500. Rather, the problem is that people don’t know how many other people are likely to donate, or how expensive the total project is likely to be; and we don’t know how much we should be willing to pay to save the life of a bird or a child.

Hence, what we basically do is give up; since we can’t actually assess the marginal utility of our donation dollars, we fall back on our automatic emotional response. Our mind focuses itself on visualizing that single bird covered in oil, or that single child suffering from malaria. We then hope that the representative heuristic will guide us in how much to give. Or we follow social norms, and give as much as we think others would expect us to give.

While many in the effective altruism community take this to be a failing, they never actually say what we should do—they never give us a figure for how much money we should be willing to donate to save the life of a child. Instead they retreat to abstraction, saying that whatever it is we’re willing to give to save a child, we should be willing to give 50,000 times as much to save 50,000 children.

But it’s not that simple. A bigger project may attract more supporters; if the two occur in direct proportion, then constant donation is the optimal response. Since it’s probably not actually proportional, you likely should give somewhat more to causes that affect more people; but exactly how much more is an astonishingly difficult question. I really don’t blame people—or myself—for only giving a little bit more to causes with larger impact, because actually getting the right answer is so incredibly hard. This is why it’s so important that we have institutions like GiveWell and Charity Navigator which do the hard work to research the effectiveness of charities and tell us which ones we should give to.

Yet even if we can properly prioritize which charities to give to first, that still leaves the question of how much each of us should give. 1% of our income? 5%? 10%? 20%? 50%? Should we give so much that we throw ourselves into the same poverty we are trying to save others from?

In his earlier work Peter Singer seemed to think we should give so much that it throws us into poverty ourselves; he asked us to literally compare every single purchase and ask ourselves whether a year of lattes or a nicer car is worth a child’s life. Of course even he doesn’t live that way, and in his later books Singer seems to have realized this, and now recommends the far more modest standard that everyone give at least 1% of their income. (He himself gives about 33%, but he’s also very rich so he doesn’t feel it nearly as much.) I think he may have overcompensated; while if literally everyone gave at least 1% that would be more than enough to end world hunger and solve many other problems—world nominal GDP is over $70 trillion, so 1% of that is $700 billion a year—we know that this won’t happen. Some will give more, others less; most will give nothing at all. Hence I think those of us who give should give more than our share; hence I lean toward figures more like 5% or 10%.

But then, why not 50% or 90%? It is very difficult for me to argue on principle why we shouldn’t be expected to give that much. Because my income is such a small proportion of the total donations, the marginal utility of each dollar I give is basically constant—and quite high; if it takes about $1000 to save a child’s life on average, and each of these children will then live about 60 more years at about half the world average happiness, that’s about 30 QALY per $1000, or about 30 milliQALY per dollar. Even at my current level of income (incidentally about as much as I think the US basic income should be), I’m benefiting myself only about 150 microQALY per dollar—so my money is worth about 200 times as much to those children as it is to me.

So now we have to ask ourselves the really uncomfortable question: How much do I value those children, relative to myself? If I am at all honest, the value is not 1; I’m not prepared to die for someone I’ve never met 10,000 kilometers away in a nation I’ve never even visited, nor am I prepared to give away all my possessions and throw myself into the same starvation I am hoping to save them from. I value my closest friends and family approximately the same as myself, but I have to admit that I value random strangers considerably less.

Do I really value them at less than 1%, as these figures would seem to imply? I feel like a monster saying that, but maybe it really isn’t so terrible—after all, most economists seem to think that the optimal solidarity coefficient is in fact zero. Maybe we need to become more comfortable admitting that random strangers aren’t worth that much to us, simply so that we can coherently acknowledge that they aren’t worth nothing. Very few of us actually give away all our possessions, after all.

Then again, what do we mean by worth? I can say from direct experience that a single migraine causes me vastly more pain than learning about the death of 200,000 people in an earthquake in Southeast Asia. And while I gave about $100 to the relief efforts involved in that earthquake, I’ve spent considerably more on migraine treatments—thousands, once you include health insurance. But given the chance, would I be willing to suffer a migraine to prevent such an earthquake? Without hesitation. So the amount of pain we feel is not the same as the amount of money we pay, which is not the same as what we would be willing to sacrifice. I think the latter is more indicative of how much people’s lives are really worth to us—but then, what we pay is what has the most direct effect on the world.

It’s actually possible to justify not dying or selling all my possessions even if my solidarity coefficient is much higher—it just leads to some really questionable conclusions. Essentially the argument is this: I am an asset. I have what economists call “human capital”—my health, my intelligence, my education—that gives me the opportunity to affect the world in ways those children cannot. In my ideal imagined future (albeit improbable) in which I actually become President of the World Bank and have the authority to set global development policy, I myself could actually have a marginal impact of megaQALY—millions of person-years of better life. In the far more likely scenario in which I attain some mid-level research or advisory position, I could be one of thousands of people who together have that sort of impact—which still means my own marginal effect is on the order of kiloQALY. And clearly it’s true that if I died, or even if I sold all my possessions, these events would no longer be possible.

The problem with that reasoning is that it’s wildly implausible to say that everyone in the First World are in this same sort of position—Peter Singer can say that, and maybe I can say that, and indeed hundreds of development economists can say that—but at least 99.9% of the First World population are not development economists, nor are they physicists likely to invent cold fusion, nor biomedical engineers likely to cure HIV, nor aid workers who distribute anti-malaria nets and polio vaccines, nor politicians who set national policy, nor diplomats who influence international relations, nor authors whose bestselling books raise worldwide consciousness. Yet I am not comfortable saying that all the world’s teachers, secretaries, airline pilots and truck drivers should give away their possessions either. (Maybe all the world’s bankers and CEOs should—or at least most of them.)

Is it enough that our economy would collapse without teachers, secretaries, airline pilots and truck drivers? But this seems rather like the fact that if everyone in the world visited the same restaurant there wouldn’t be enough room. Surely we could do without any individual teacher, any individual truck driver? If everyone gave the same proportion of their income, 1% would be more than enough to end malaria and world hunger. But we know that everyone won’t give, and the job won’t get done if those of us who do give only 1%.

Moreover, it’s also clearly not the case that everything I spend money on makes me more likely to become a successful and influential development economist. Buying a suit and a car actually clearly does—it’s much easier to get good jobs that way. Even leisure can be justified to some extent, since human beings need leisure and there’s no sense burning myself out before I get anything done. But do I need both of my video game systems? Couldn’t I buy a bit less Coke Zero? What if I watched a 20-inch TV instead of a 40-inch one? I still have free time; could I get another job and donate that money? This is the sort of question Peter Singer tells us to ask ourselves, and it quickly leads to a painfully spartan existence in which most of our time is spent thinking about whether what we’re doing is advancing or damaging the cause of ending world hunger. But then the cost of that stress and cognitive effort must be included; but how do you optimize your own cognitive effort? You need to think about the cost of thinking about the cost of thinking… and on and on. This is why bounded rationality modeling is hard, even though it’s plainly essential to both cognitive science and computer science. (John Stuart Mill wrote an essay that resonates deeply with me about how the pressure to change the world drove him into depression, and how he learned to accept that he could still change the world even if he weren’t constantly pressuring himself to do so—and indeed he did. James Mill set out to create in his son, John Stuart Mill, the greatest philosopher in the history of the world—and I believe that he succeeded.)

Perhaps we should figure out what proportion of the world’s people are likely to give, and how much we need altogether, and then assign the amount we expect from each of them based on that? The more money you ask from each, the fewer people are likely to give. This creates an optimization problem akin to setting the price of a product under monopoly—monopolies maximize profits by carefully balancing the quantity sold with the price at which they sell, and perhaps a similar balance would allow us to maximize development aid. But wouldn’t it be better if we could simply increase the number of people who give, so that we don’t have to ask so much of those who are generous? That means tax-funded foreign aid is the way to go, because it ensures coordination. And indeed I do favor increasing foreign aid to about 1% of GDP—in the US it is currently about $50 billion, 0.3% of GDP, a little more than 1% of the Federal budget. (Most people who say we should “cut” foreign aid don’t realize how small it already is.) But foreign aid is coercive; wouldn’t it be better if people would give voluntarily?

I don’t have a simple answer. I don’t know how much other people’s lives ought to be worth to us, or what it means for our decisions once we assign that value. But I hope I’ve convinced you that this problem is an important one—and made you think a little more about scope neglect and why we have it.