Month: June 2016

Two terms in marginal utility of wealth

PNRJ cognitive science, ethics, heuristics and biases , , , , , , , , , , , , , ,

JDN 2457569

This post is going to be a little wonkier than most; I’m actually trying to sort out my thoughts and draw some public comment on a theory that has been dancing around my head for awhile. The original idea of separating terms in marginal utility of wealth was actually suggested by my boyfriend, and from there I’ve been trying to give it some more mathematical precision to see if I can come up with a way to test it experimentally. My thinking is also influenced by a paper Miles Kimball wrote about the distinction between happiness and utility.

There are lots of ways one could conceivably spend money—everything from watching football games to buying refrigerators to building museums to inventing vaccines. But insofar as we are rational (and we are after all about 90% rational), we’re going to try to spend our money in such a way that its marginal utility is approximately equal across various activities. You’ll buy one refrigerator, maybe two, but not seven, because the marginal utility of refrigerators drops off pretty fast; instead you’ll spend that money elsewhere. You probably won’t buy a house that’s twice as large if it means you can’t afford groceries anymore. I don’t think our spending is truly optimal at maximizing utility, but I think it’s fairly good.

Therefore, it doesn’t make much sense to break down marginal utility of wealth into all these different categories—cars, refrigerators, football games, shoes, and so on—because we already do a fairly good job of equalizing marginal utility across all those different categories. I could see breaking it down into a few specific categories, such as food, housing, transportation, medicine, and entertainment (and this definitely seems useful for making your own household budget); but even then, I don’t get the impression that most people routinely spend too much on one of these categories and not enough on the others.

However, I can think of two quite different fundamental motives behind spending money, which I think are distinct enough to be worth separating.

One way to spend money is on yourself, raising your own standard of living, making yourself more comfortable. This would include both football games and refrigerators, really anything that makes your life better. We could call this the consumption motive, or maybe simply the self-directed motive.

The other way is to spend it on other people, which, depending on your personality can take either the form of philanthropy to help others, or as a means of self-aggrandizement to raise your own relative status. It’s also possible to do both at the same time in various combinations; while the Gates Foundation is almost entirely philanthropic and Trump Tower is almost entirely self-aggrandizing, Carnegie Hall falls somewhere in between, being at once a significant contribution to our society and an obvious attempt to bring praise and adulation to himself. I would also include spending on Veblen goods that are mainly to show off your own wealth and status in this category. We can call this spending the philanthropic/status motive, or simply the other-directed motive.

There is some spending which combines both motives: A car is surely useful, but a Ferrari is mainly for show—but then, a Lexus or a BMW could be either to show off or really because you like the car better. Some form of housing is a basic human need, and bigger, fancier houses are often better, but the main reason one builds mansions in Beverly Hills is to demonstrate to the world that one is fabulously rich. This complicates the theory somewhat, but basically I think the best approach is to try to separate a sort of “spending proportion” on such goods, so that say $20,000 of the Lexus is for usefulness and $15,000 is for show. Empirically this might be hard to do, but theoretically it makes sense.

One of the central mysteries in cognitive economics right now is the fact that while self-reported happiness rises very little, if at all, as income increases, a finding which was recently replicated even in poor countries where we might not expect it to be true, nonetheless self-reported satisfaction continues to rise indefinitely. A number of theories have been proposed to explain this apparent paradox.

This model might just be able to account for that, if by “happiness” we’re really talking about the self-directed motive, and by “satisfaction” we’re talking about the other-directed motive. Self-reported happiness seems to obey a rule that $100 is worth as much to someone with $10,000 as $25 is to someone with $5,000, or $400 to someone with $20,000.

Self-reported satisfaction seems to obey a different rule, such that each unit of additional satisfaction requires a roughly equal proportional increase in income.

By having a utility function with two terms, we can account for both of these effects. Total utility will be u(x), happiness h(x), and satisfaction s(x).

u(x) = h(x) + s(x)

To obey the above rule, happiness must obey harmonic utility, like this, for some constants h0 and r:

h(x) = h0 – r/x

Proof of this is straightforward, though to keep it simple I’ve hand-waved why it’s a power law:

Given

h'(2x) = 1/4 h'(x)

Let

h'(x) = r x^n

h'(2x) = r (2x)^n

r (2x)^n = 1/4 r x^n

n = -2

h'(x) = r/x^2

h(x) = – r x^(-1) + C

h(x) = h0 – r/x

Miles Kimball also has some more discussion on his blog about how a utility function of this form works. (His statement about redistribution at the end is kind of baffling though; sure, dollar for dollar, redistributing wealth from the middle class to the poor would produce a higher gain in utility than redistributing wealth from the rich to the middle class. But neither is as good as redistributing from the rich to the poor, and the rich have a lot more dollars to redistribute.)

Satisfaction, however, must obey logarithmic utility, like this, for some constants s0 and k.

The x+1 means that it takes slightly less proportionally to have the same effect as your wealth increases, but it allows the function to be equal to s0 at x=0 instead of going to negative infinity:

s(x) = s0 + k ln(x)

Proof of this is very simple, almost trivial:

Given

s'(x) = k/x

s(x) = k ln(x) + s0

Both of these functions actually have a serious problem that as x approaches zero, they go to negative infinity. For self-directed utility this almost makes sense (if your real consumption goes to zero, you die), but it makes no sense at all for other-directed utility, and since there are causes most of us would willingly die for, the disutility of dying should be large, but not infinite.

Therefore I think it’s probably better to use x +1 in place of x:

h(x) = h0 – r/(x+1)

s(x) = s0 + k ln(x+1)

This makes s0 the baseline satisfaction of having no other-directed spending, though the baseline happiness of zero self-directed spending is actually h0 – r rather than just h0. If we want it to be h0, we could use this form instead:

h(x) = h0 + r x/(x+1)

This looks quite different, but actually only differs by a constant.

Therefore, my final answer for the utility of wealth (or possibly income, or spending? I’m not sure which interpretation is best just yet) is actually this:

u(x) = h(x) + s(x)

h(x) = h0 + r x/(x+1)

s(x) = s0 + k ln(x+1)

Marginal utility is then the derivatives of these:

h'(x) = r/(x+1)^2

s'(x) = k/(x+1)

Let’s assign some values to the constants so that we can actually graph these.

Let h0 = s0 = 0, so our baseline is just zero.

Furthermore, let r = k = 1, which would mean that the value of $1 is the same whether spent either on yourself or on others, if $1 is all you have. (This is probably wrong, actually, but it’s the simplest to start with. Shortly I’ll discuss what happens as you vary the ratio k/r.)

Here is the result graphed on a linear scale:

Utility_linear

And now, graphed with wealth on a logarithmic scale:

Utility_log

As you can see, self-directed marginal utility drops off much faster than other-directed marginal utility, so the amount you spend on others relative to yourself rapidly increases as your wealth increases. If that doesn’t sound right, remember that I’m including Veblen goods as “other-directed”; when you buy a Ferrari, it’s not really for yourself. While proportional rates of charitable donation do not increase as wealth increases (it’s actually a U-shaped pattern, largely driven by poor people giving to religious institutions), they probably should (people should really stop giving to religious institutions! Even the good ones aren’t cost-effective, and some are very, very bad.). Furthermore, if you include spending on relative power and status as the other-directed motive, that kind of spending clearly does proportionally increase as wealth increases—gotta keep up with those Joneses.

If r/k = 1, that basically means you value others exactly as much as yourself, which I think is implausible (maybe some extreme altruists do that, and Peter Singer seems to think this would be morally optimal). r/k < 1 would mean you should never spend anything on yourself, which not even Peter Singer believes. I think r/k = 10 is a more reasonable estimate.

For any given value of r/k, there is an optimal ratio of self-directed versus other-directed spending, which can vary based on your total wealth.

Actually deriving what the optimal proportion would be requires a whole lot of algebra in a post that probably already has too much algebra, but the point is, there is one, and it will depend strongly on the ratio r/k, that is, the overall relative importance of self-directed versus other-directed motivation.

Take a look at this graph, which uses r/k = 10.

Utility_marginal

If you only have 2 to spend, you should spend it entirely on yourself, because up to that point the marginal utility of self-directed spending is always higher. If you have 3 to spend, you should spend most of it on yourself, but a little bit on other people, because after you’ve spent about 2.2 on yourself there is more marginal utility for spending on others than on yourself.

If your available wealth is W, you would spend some amount x on yourself, and then W-x on others:

u(x) = h(x) + s(W-x)

u(x) = r x/(x+1) + k ln(W – x + 1)

Then you take the derivative and set it equal to zero to find the local maximum. I’ll spare you the algebra, but this is the result of that optimization:

x = – 1 – r/(2k) + sqrt(r/k) sqrt(2 + W + r/(4k))

As long as k <= r (which more or less means that you care at least as much about yourself as about others—I think this is true of basically everyone) then as long as W > 0 (as long as you have some money to spend) we also have x > 0 (you will spend at least something on yourself).

Below a certain threshold (depending on r/k), the optimal value of x is greater than W, which means that, if possible, you should be receiving donations from other people and spending them on yourself. (Otherwise, just spend everything on yourself). After that, x < W, which means that you should be donating to others. The proportion that you should be donating smoothly increases as W increases, as you can see on this graph (which uses r/k = 10, a figure I find fairly plausible):

Utility_donation

While I’m sure no one literally does this calculation, most people do seem to have an intuitive sense that you should donate an increasing proportion of your income to others as your income increases, and similarly that you should pay a higher proportion in taxes. This utility function would justify that—which is something that most proposed utility functions cannot do. In most models there is a hard cutoff where you should donate nothing up to the point where your marginal utility is equal to the marginal utility of donating, and then from that point forward you should donate absolutely everything. Maybe a case can be made for that ethically, but psychologically I think it’s a non-starter.

I’m still not sure exactly how to test this empirically. It’s already quite difficult to get people to answer questions about marginal utility in a way that is meaningful and coherent (people just don’t think about questions like “Which is worth more? $4 to me now or $10 if I had twice as much wealth?” on a regular basis). I’m thinking maybe they could play some sort of game where they have the opportunity to make money at the game, but must perform tasks or bear risks to do so, and can then keep the money or donate it to charity. The biggest problem I see with that is that the amounts would probably be too small to really cover a significant part of anyone’s total wealth, and therefore couldn’t cover much of their marginal utility of wealth function either. (This is actually a big problem with a lot of experiments that use risk aversion to try to tease out marginal utility of wealth.) But maybe with a variety of experimental participants, all of whom we get income figures on?

“But wait, there’s more!”: The clever tricks of commercials

PNRJ cognitive science, heuristics and biases, market failure , , , , , , , , , , , , , , , ,

JDN 2457565

I’m sure you’ve all seen commercials like this dozens of times:

A person is shown (usually in black-and-white) trying to use an ordinary consumer product, and failing miserably. Often their failure can only be attributed to the most abject incompetence, but the narrator will explain otherwise: “Old product is so hard to use. Who can handle [basic household activity] and [simple instructions]?”

“Struggle no more!” he says (it’s almost always a masculine narrator), and the video turns to full color as the same person is shown using the new consumer product effortlessly. “With innovative high-tech new product, you can do [basic household activity] with ease in no time!”

“Best of all, new product, a $400 value, can be yours for just five easy payments of $19.95. That’s five easy payments of $19.95!”

And then, here it comes: “But wait. There’s more! Order within the next 15 minutes and you will get two new products, for the same low price. That’s $800 in value for just five easy payments of $19.95! And best of all, your satisfaction is guaranteed! If you don’t like new product, return it within 30 days for your money back!” (A much quieter, faster voice says: “Just pay shipping and handling.”)

Call 555-1234. That’s 555-1234.

“CALL NOW!”

Did you ever stop and think about why so many commercials follow this same precise format?

In short, because it works. Indeed, it works a good deal better than simply presenting the product’s actual upsides and downsides and reporting a sensible market price—even if that sensible market price is lower than the “five easy payments of $19.95”.

We owe this style of marketing to one Ron Popeil; Ron Popeil was a prolific inventor, but none of his inventions have had so much impact as the market methods he used to sell them.

Let’s go through step by step. Why is the person using the old product so incompetent? Surely they could sell their product without implying that we don’t know how to do basic household activities like boiling pasta and cutting vegetables?

Well, first of all, many of these products do nothing but automate such simple household activities (like the famous Veg-O-Matic which cuts vegetables and “It slices! It dices!”), so if they couldn’t at least suggest that this is a lot of work they’re saving us, we’d have no reason to want their product.

But there’s another reason as well: Watching someone else fumble with basic household appliances is funny, as any fan of the 1950s classic I Love Lucy would attest (in fact, it may not be a coincidence that the one fumbling with the vegetables is often a woman who looks a lot like Lucy), and meta-analysis of humor in advertising has shown that it draws attention and triggers positive feelings.

Why use black-and-white for the first part? The switch to color enhances the feeling of contrast, and the color video is more appealing. You wouldn’t consciously say “Wow, that slicer changed the tomatoes from an ugly grey to a vibrant red!” but your subconscious mind is still registering that association.

Then they will hit you with appealing but meaningless buzzwords. For technology it will be things like “innovative”, “ground-breaking”, “high-tech” and “state-of-the-art”, while for foods and nutritional supplements it will be things like “all-natural”, “organic”, “no chemicals”, and “just like homemade”. It will generally be either so vague as to be unverifiable (what constitutes “innovative”?), utterly tautological (all carbon-based substances are “organic” and this term is not regulated), or transparently false but nonetheless not specific enough to get them in trouble (“just like homemade” literally can’t be true if you’re buying it from a TV ad). These give you positive associations without forcing the company to commit to making a claim they could actually be sued for breaking. It’s the same principle as the Applause Lights that politicians bring to every speech: “Three cheers for moms!” “A delicious slice of homemade apple pie!” “God Bless America!”

Occasionally you’ll also hear buzzwords that do have some meaning, but often not nearly as strong as people imagine: “Patent pending” means that they applied for the patent and it wasn’t summarily rejected—but not that they’ll end up getting it approved. “Certified organic” means that the USDA signed off on the farming standards, which is better than nothing but leaves a lot of wiggle room for animal abuse and irresponsible environmental practices.

And then we get to the price. They’ll quote some ludicrous figure for its “value”, which may be a price that no one has ever actually paid for a product of this kind, then draw a line through it and replace it with the actual price, which will be far lower.

Indeed, not just lower: The actual price is almost always $19.99 or $19.95. If the product is too expensive to make for them to sell it at $19.95, they will sell it at several payments of $19.95, and emphasize that these are “easy” payments, as though the difficulty of writing the check were a major factor in people’s purchasing decisions. (That actually is a legitimate concern for micropayments, but not for buying kitchen appliances!) They’ll repeat the price because repetition improves memory and also makes statements more persuasive.

This is what we call psychological pricing, and it’s one of those enormous market distortions that once you realize it’s there, you see it everywhere and start to wonder how our whole market system hasn’t collapsed on itself from the sheer weight of our overwhelming irrationality. The price of a product sold on TV will almost always be just slightly less than $20.

In general, most prices will take the form of $X.95 or $X.99; Costco even has a code system they use in the least significant digit. Continuous substances like gasoline can even be sold at fractional pennies, and so they’ll usually be at $X.X99, being not even one penny less. It really does seem to work; despite being an eminently trivial difference from the round number, and typically rounded up from what it actually should have been, it just feels like less to see $19.95 rather than $20.00.

Moreover, I have less data to support this particular hypothesis, but I think that $20 in particular is a very specific number, because $19.95 pops up so very, very often. I think most Americans have what we might call a “Jackson heuristic”, which is as follows: If something costs less than a Jackson (a $20 bill, though hopefully they’ll put Harriet Tubman on soon, so “Tubman heuristic”), you’re allowed to buy it on impulse without thinking too hard about whether it’s worth it. But if it costs more than a Jackson, you need to stop and think about it, weigh the alternatives before you come to a decision. Since these TV ads are almost always aiming for the thoughtless impulse buy, they try to scrape in just under the Jackson heuristic.

Of course, inflation will change the precise figure over time; in the 1980s it was probably a Hamilton heuristic, in the 1970s a Lincoln heuristic, in the 1940s a Washington heuristic. Soon enough it will be a Grant heuristic and then a Benjamin heuristic. In fact it’s probably something like “The closest commonly-used cash denomination to half a milliQALY”, but nobody does that calculation consciously; the estimate is made automatically without thinking. This in turn is probably figured because you could literally do that once a day every single day for only about 20% of your total income, and if you hold it to once a week you’re under 3% of your income. So if you follow the Jackson heuristic on impulse buys every week or so, your impulse spending is a “statistically insignificant” proportion of your income. (Why do we use that anyway? And suddenly we realize: The 95% confidence level is itself nothing more than a heuristic.)

Then they take advantage of our difficulty in discounting time rationally, by spreading it into payments; “five easy payments of $19.95” sounds a lot more affordable than “$100”, but they are in fact basically the same. (You save $0.25 by the payment plan, maybe as much as a few dollars if your cashflow is very bad and thus you have a high temporal discount rate.)

And then, finally, “But wait. There’s more!” They offer you another of the exact same product, knowing full well you’ll probably have no use for the second one. They’ll multiply their previous arbitrary “value” by 2 to get an even more ludicrous number. Now it sounds like they’re doing you a favor, so you’ll feel obliged to do one back by buying the product. Gifts often have this effect in experiments: People are significantly more motivated to answer a survey if you give them a small gift beforehand, even if they get to keep it without taking the survey.

They’ll tell you to call in the next 15 minutes so that you feel like part of an exclusive club (when in reality you could probably call at any time and get the same deal). This also ensures that you’re staying in impulse-buy mode, since if you wait longer to think, you’ll miss the window!

They will offer a “money-back guarantee” to give you a sense of trust in the product, and this would be a rational response, except for that little disclaimer: “Just pay shipping and handling.” For many products, especially nutritional supplements (which cost basically nothing to make), the “handling” fee is high enough that they don’t lose much money, if any, even if you immediately send it back for a refund. Besides, they know that hardly anyone actually bothers to return products. Retailers are currently in a panic about “skyrocketing” rates of product returns that are still under 10%.

Then, they’ll repeat their phone number, followed by a remarkably brazen direct command: “Call now!” Personally I tend to bristle at direct commands, even from legitimate authorities; but apparently I’m unusual in that respect, and most people will in fact obey direct commands from random strangers as long as they aren’t too demanding. A famous demonstration of this you could try yourself if you’re feeling like a prankster is to walk into a room, point at someone, and say “You! Stand up!” They probably will. There’s a whole literature in social psychology about what makes people comply with commands of this sort.

And all, to make you buy a useless gadget you’ll try to use once and then leave in a cupboard somewhere. What untold billions of dollars in wealth are wasted this way?

What is the price of time?

PNRJ critique of neoclassical economics, heuristics and biases , , , , , , , , , , , , , , ,

JDN 2457562

If they were asked outright, “What is the price of time?” most people would find that it sounds nonsensical, like I’ve asked you “What is the diameter of calculus?” or “What is the electric charge of justice?” (It’s interesting that we generally try to assign meaning to such nonsensical questions, and they often seem strangely profound when we do; a good deal of what passes for “profound wisdom” is really better explained as this sort of reaction to nonsense. Deepak Chopra, for instance.)

But there is actually a quite sensible economic meaning of this question, and answering it turns out to have many important implications for how we should run our countries and how we should live our lives.

What we are really asking for is temporal discounting; we want to know how much more money today is worth compared to tomorrow, and how much more money tomorrow is worth compared to two days from now.

If you say that they are exactly the same, your discount rate (your “price of time”) is zero; if that is indeed how you feel, may I please borrow your entire net wealth at 0% interest for the next thirty years? If you like we can even inflation-index the interest rate so it always produces a real interest rate of zero, thus protecting you from potential inflation risk.
What? You don’t like my deal? You say you need that money sooner? Then your discount rate is not zero. Similarly, it can’t be negative; if you actually valued money tomorrow more than money today, you’d gladly give me my loan.

Money today is worth more to you than money tomorrow—the only question is how much more.

There’s a very simple theorem which says that as long as your temporal discounting doesn’t change over time, so it is dynamically consistent, it must have a very specific form. I don’t normally use math this advanced in my blog, but this one is so elegant I couldn’t resist. I’ll encase it in blockquotes so you can skim over it if you must.

The value of $1 today relative to… today is of course 1; f(0) = 1.

If you are dynamically consistent, at any time t you should discount tomorrow relative to today the same as you discounted today relative to yesterday, so for all t, f(t+1)/f(t) = f(t)/f(t-1)
Thus, f(t+1)/f(t) is independent of t, and therefore equal to some constant, which we can call r:

f(t+1)/f(t) = r, which implies f(t+1) = r f(t).

Starting at f(0) = 1, we have:

f(0) = 1, f(1) = r, f(2) = r^2

We can prove that this pattern continues to hold by mathematical induction.

Suppose the following is true for some integer k; we already know it works for k = 1:

f(k) = r^k

Let t = k:

f(k+1) = r f(k)

Therefore:

f(k+1) = r^(k+1)

Which by induction proves that for all integers n:

f(n) = r^n

The name of the variable doesn’t matter. Therefore:

f(t) = r^t

Whether you agree with me that this is beautiful, or you have no idea what I just said, the take-away is the same: If your discount rate is consistent over time, it must be exponential. There must be some constant number 0 < r < 1 such that each successive time period is worth r times as much as the previous. (You can also generalize this to the case of continuous time, where instead of r^t you get e^(-r t). This requires even more advanced math, so I’ll spare you.)

Most neoclassical economists would stop right there. But there are two very big problems with this argument:

(1) It doesn’t tell us the value r should actually be, only that it should be a constant.

(2) No actual human being thinks of time this way.

There is still ongoing research as to exactly how real human beings discount time, but one thing is quite clear from the experiments: It certainly isn’t exponential.

From about 2000 to 2010, the consensus among cognitive economists was that humans discount time hyperbolically; that is, our discount function looks like this:

f(t) = 1/(1 + r t)

In the 1990s there were a couple of experiments supporting hyperbolic discounting. There is even some theoretical work trying to show that this is actually optimal, given a certain kind of uncertainty about the future, and the argument for exponential discounting relies upon certainty we don’t actually have. Hyperbolic discounting could also result if we were reasoning as though we are given a simple interest rate, rather than a compound interest rate.

But even that doesn’t really seem like humans think, now does it? It’s already weird enough for someone to say “Should I take out this loan at 5%? Well, my discount rate is 7%, so yes.” But I can at least imagine that happening when people are comparing two different interest rates (“Should I pay down my student loans, or my credit cards?”). But I can’t imagine anyone thinking, “Should I take out this loan at 5% APR which I’d need to repay after 5 years? Well, let’s check my discount function, 1/(1+0.05 (5)) = 0.8, multiplied by 1.05^5 = 1.28, the product of which is 1.02, greater than 1, so no, I shouldn’t.” That isn’t how human brains function.

Moreover, recent experiments have shown that people often don’t seem to behave according to what hyperbolic discounting would predict.

Therefore I am very much in the other camp of cognitive economists, who say that we don’t have a well-defined discount function. It’s not exponential, it’s not hyperbolic, it’s not “quasi-hyperbolic” (yes that is a thing); we just don’t have one. We reason about time by simple heuristics. You can’t make a coherent function out of it because human beings… don’t always reason coherently.

Some economists seem to have an incredible amount of trouble accepting that; here we have one from the University of Chicago arguing that hyperbolic discounting can’t possibly exist, because then people could be Dutch-booked out of all their money; but this amounts to saying that human behavior cannot ever be irrational, lest all our money magically disappear. Yes, we know hyperbolic discounting (and heuristics) allow for Dutch-booking; that’s why they’re irrational. If you really want to know the formal assumption this paper makes that is wrong, it assumes that we have complete markets—and yes, complete markets essentially force you to be perfectly rational or die, because the slightest inconsistency in your reasoning results in someone convincing you to bet all your money on a sure loss. Why was it that we wanted complete markets, again? (Oh, yes, the fanciful Arrow-Debreu model, the magical fairy land where everyone is perfectly rational and all markets are complete and we all have perfect information and the same amount of wealth and skills and the same preferences, where everything automatically achieves a perfect equilibrium.)

There was a very good experiment on this, showing that rather than discount hyperbolically, behavior is better explained by a heuristic that people judge which of two options is better by a weighted sum of the absolute distance in time plus the relative distance in time. Now that sounds like something human beings might actually do. “$100 today or $110 tomorrow? That’s only 1 day away, but it’s also twice as long. I’m not waiting.” “$100 next year, or $110 in a year and a day? It’s only 1 day apart, and it’s only slightly longer, so I’ll wait.”

That might not actually be the precise heuristic we use, but it at least seems like one that people could use.

John Duffy, whom I hope to work with at UCI starting this fall, has been working on another experiment to test a different heuristic, based on the work of Daniel Kahneman, saying essentially that we have a fast, impulsive, System 1 reasoning layer and a slow, deliberative, System 2 reasoning layer; the result is that our judgments combine both “hand to mouth” where our System 1 essentially tries to get everything immediately and spend whatever we can get our hands on, and a more rational assessment by System 2 that might actually resemble an exponential discount rate. In the 5-minute judgment, System 1’s voice is overwhelming; but if we’re already planning a year out, System 1 doesn’t even care anymore and System 2 can take over. This model also has the nice feature of explaining why people with better self-control seem to behave more like they use exponential discounting,[PDF link] and why people do on occasion reason more or less exponentially, while I have literally never heard anyone try to reason hyperbolically, only economic theorists trying to use hyperbolic models to explain behavior.

Another theory is that discounting is “subadditive”, that is, if you break up a long time interval into many short intervals, people will discount it more, because it feels longer that way. Imagine a century. Now imagine a year, another year, another year, all the way up to 100 years. Now imagine a day, another day, another day, all the way up to 365 days for the first year, and then 365 days for the second year, and that on and on up to 100 years. It feels longer, doesn’t it? It is of course exactly the same. This can account for some weird anomalies in choice behavior, but I’m not convinced it’s as good as the two-system model.

Another theory is that we simply have a “present bias”, which we treat as a sort of fixed cost that we incur regardless of what the payments are. I like this because it is so supremely simple, but there’s something very fishy about it, because in this experiment it was just fixed at $4, and that can’t be right. It must be fixed at some proportion of the rewards, or something like that; or else we would always exhibit near-perfect exponential discounting for large amounts of money, which is more expensive to test (quite directly), but still seems rather unlikely.

Why is this important? This post is getting long, so I’ll save it for future posts, but in short, the ways that we value future costs and benefits, both as we actually do, and as we ought to, have far-reaching implications for everything from inflation to saving to environmental sustainability.

The difference between price, cost, and value

PNRJ core principles, critique of neoclassical economics, heuristics and biases, market failure, public policy , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,

JDN 2457559

This topic has been on the voting list for my Patreons for several months, but it never quite seems to win the vote. Well, this time it did. I’m glad, because I was tempted to do it anyway.

“Price”, “cost”, and “value”; the words are often used more or less interchangeably, not only by regular people but even by economists. I’ve read papers that talked about “rising labor costs” when what they clearly meant was rising wages—rising labor prices. I’ve read papers that tried to assess the projected “cost” of climate change by using the prices of different commodity futures. And hardly a day goes buy that I don’t see a TV commercial listing one (purely theoretical) price, cutting it in half (to the actual price), and saying they’re now giving you “more value”.

As I’ll get to, there are reasons to think they would be approximately the same for some purposes. Indeed, they would be equal, at the margin, in a perfectly efficient market—that may be why so many economists use them this way, because they implicitly or explicitly assume efficient markets. But they are fundamentally different concepts, and it’s dangerous to equate them casually.

Price

Price is exactly what you think it is: The number of dollars you must pay to purchase something. Most of the time when we talk about “cost” or “value” and then give a dollar figure, we’re actually talking about some notion of price.

Generally we speak in terms of nominal prices, which are the usual concept of prices in actual dollars paid, but sometimes we do also speak in terms of real prices, which are relative prices of different things once you’ve adjusted for overall inflation. “Inflation-adjusted price” can be a somewhat counter-intuitive concept; if a good’s (nominal) price rises, but by less than most other prices have risen, its real price has actually fallen.

You also need to be careful about just what price you’re looking at. When we look at labor prices, for example, we need to consider not only cash wages, but also fringe benefits and other compensation such as stock options. But other than that, prices are fairly straightforward.

Cost

Cost is probably not at all what you think it is. The real cost of something has nothing to do with money; saying that a candy bar “costs $2” or a computer “costs $2,000” is at best a somewhat sloppy shorthand and at worst a fundamental distortion of what cost is and why it matters. No, those are prices. The cost of a candy bar is the toil of children in cocoa farms in Cote d’Ivoire. The cost of a computer is the ecological damage and displaced indigenous people caused by coltan mining in Congo.

The cost of something is the harm that it does to human well-being (or for that matter to the well-being of any sentient being). It is not measured in money but in “the sweat of our laborers, the genius of our scientists, the hopes of our children” (to quote Eisenhower, who understood real cost better than most economists). There is also opportunity cost, the real cost we pay not by what we did, but by what we didn’t do—what we could have done instead.

This is important precisely because while costs should always be reduced when possible, prices can in fact be too low—and indeed, artificially low prices of goods due to externalities are probably the leading reason why humanity bears so many excess real costs. If the price of that chocolate bar accurately reflected the suffering of those African children (perhaps by—Gasp! Paying them a fair wage?), and the price of that computer accurately reflected the ecological damage of those coltan mines (a carbon tax, at least?), you might not want to buy them anymore; in which case, you should not have bought them. In fact, as I’ll get to once I discuss value, there is reason to think that even if you would buy them at a price that accurately reflected the dollar value of the real cost to their producers, we would still buy more than we should.

There is a point at which we should still buy things even though people get hurt making them; if you deny this, stop buying literally anything ever again. We don’t like to think about it, but any product we buy did cause some person, in some place, some degree of discomfort or unpleasantness in production. And many quite useful products will in fact cause death to a nonzero number of human beings.

For some products this is only barely true—it’s hard to feel bad for bestselling authors and artists who sell their work for millions, for whatever toil they may put into their work, whatever their elevated suicide rate (which is clearly endogenous; people aren’t randomly assigned to be writers), they also surely enjoy it a good deal of the time, and even if they didn’t, their work sells for millions. But for many products it is quite obviously true: A certain proportion of roofers, steelworkers, and truck drivers will die doing their jobs. We can either accept that, recognizing that it’s worth it to have roofs, steel, and trucking—and by extension, industrial capitalism, and its whole babies not dying thing—or we can give up on the entire project of human civilization, and go back to hunting and gathering; even if we somehow managed to avoid the direct homicide most hunter-gatherers engage in, far more people would simply die of disease or get eaten by predators.

Of course, we should have safety standards; but the benefits of higher safety must be carefully weighed against the potential costs of inefficiency, unemployment, and poverty. Safety regulations can reduce some real costs and increase others, even if they almost always increase prices. A good balance is struck when real cost is minimized, where any additional regulation would increase inefficiency more than it improves safety.

Actually OSHA are unsung heroes for their excellent performance at striking this balance, just as EPA are unsung heroes for their balance in environmental regulations (and that whole cutting crime in half business). If activists are mad at you for not banning everything bad and business owners are mad at you for not letting them do whatever they want, you’re probably doing it right. Would you rather people saved from fires, or fires prevented by good safety procedures? Would you rather murderers imprisoned, or boys who grow up healthy and never become murderers? If an ounce of prevention is worth a pound of cure, why does everyone love firefighters and hate safety regulators?So let me take this opportunity to say thank you, OSHA and EPA, for doing the jobs of firefighters and police way better than they do, and unlike them, never expecting to be lauded for it.

And now back to our regularly scheduled programming. Markets are supposed to reflect costs in prices, which is why it’s not totally nonsensical to say “cost” when you mean “price”; but in fact they aren’t very good at that, for reasons I’ll get to in a moment.

Value

Value is how much something is worth—not to sell it (that’s the price again), but to use it. One of the core principles of economics is that trade is nonzero-sum, because people can exchange goods that they value differently and thereby make everyone better off. They can’t price them differently—the buyer and the seller must agree upon a price to make the trade. But they can value them differently.

To see how this works, let’s look at a very simple toy model, the simplest essence of trade: Alice likes chocolate ice cream, but all she has is a gallon of vanilla ice cream. Bob likes vanilla ice cream, but all he has is a gallon of chocolate ice cream. So Alice and Bob agree to trade their ice cream, and both of them are happier.

We can measure value in “willingness-to-pay” (WTP), the highest price you’d willingly pay for something. That makes value look more like a price; but there are several reasons we must be careful when we do that. The obvious reason is that WTP is obviously going to vary based on overall inflation; since $5 isn’t worth as much in 2016 as it was in 1956, something with a WTP of $5 in 1956 would have a much higher WTP in 2016. The not-so-obvious reason is that money is worth less to you the more you have, so we also need to take into account the effect of wealth, and the marginal utility of wealth. The more money you have, the more money you’ll be willing to pay in order to get the same amount of real benefit. (This actually creates some very serious market distortions in the presence of high income inequality, which I may make the subject of a post or even a paper at some point.) Similarly there is “willingness-to-accept” (WTA), the lowest price you’d willingly accept for it. In theory these should be equal; in practice, WTA is usually slightly higher than WTP in what’s called endowment effect.

So to make our model a bit more quantitative, we could suppose that Alice values vanilla at $5 per gallon and chocolate at $10 per gallon, while Bob also values vanilla at $5 per gallon but only values chocolate at $4 per gallon. (I’m using these numbers to point out that not all the valuations have to be different for trade to be beneficial, as long as some are.) Therefore, if Alice sells her vanilla ice cream to Bob for $5, both will (just barely) accept that deal; and then Alice can buy chocolate ice cream from Bob for anywhere between $4 and $10 and still make both people better off. Let’s say they agree to also sell for $5, so that no net money is exchanged and it is effectively the same as just trading ice cream for ice cream. In that case, Alice has gained $5 in consumer surplus (her WTP of $10 minus the $5 she paid) while Bob has gained $1 in producer surplus (the $5 he received minus his $4 WTP). The total surplus will be $6 no matter what price they choose, which we can compute directly from Alice’s WTP of $10 minus Bob’s WTA of $4. The price ultimately decides how that total surplus is distributed between the two parties, and in the real world it would very likely be the result of which one is the better negotiator.

The enormous cost of our distorted understanding

(See what I did there?) If markets were perfectly efficient, prices would automatically adjust so that, at the margin, value is equal to price is equal to cost. What I mean by “at the margin” might be clearer with an example: Suppose we’re selling apples. How many apples do you decide to buy? Well, the value of each successive apple to you is lower, the more apples you have (the law of diminishing marginal utility, which unlike most “laws” in economics is actually almost always true). At some point, the value of the next apple will be just barely above what you have to pay for it, so you’ll stop there. By a similar argument, the cost of producing apples increases the more apples you produce (the law of diminishing returns, which is a lot less reliable, more like the Pirate Code), and the producers of apples will keep selling them until the price they can get is only just barely larger than the cost of production. Thus, in the theoretical limit of infinitely-divisible apples and perfect rationality, marginal value = price = marginal cost. In such a world, markets are perfectly efficient and they maximize surplus, which is the difference between value and cost.

But in the real world of course, none of those assumptions are true. No product is infinitely divisible (though the gasoline in a car is obviously a lot more divisible than the car itself). No one is perfectly rational. And worst of all, we’re not measuring value in the same units. As a result, there is basically no reason to think that markets are optimizing anything; their optimization mechanism is setting two things equal that aren’t measured the same way, like trying to achieve thermal equilibrium by matching the temperature of one thing in Celsius to the temperature of other things in Fahrenheit.

An implicit assumption of the above argument that didn’t even seem worth mentioning was that when I set value equal to price and set price equal to cost, I’m setting value equal to cost; transitive property of equality, right? Wrong. The value is equal to the price, as measured by the buyer. The cost is equal to the price, as measured by the seller.

If the buyer and seller have the same marginal utility of wealth, no problem; they are measuring in the same units. But if not, we convert from utility to money and then back to utility, using a different function to convert each time. In the real world, wealth inequality is massive, so it’s wildly implausible that we all have anything close to the same marginal utility of wealth. Maybe that’s close enough if you restrict yourself to middle-class people in the First World; so when a tutoring client pays me, we might really be getting close to setting marginal value equal to marginal cost. But once you include corporations that are owned by billionaires and people who live on $2 per day, there’s simply no way that those price-to-utility conversions are the same at each end. For Bill Gates, a million dollars is a rounding error. For me, it would buy a house, give me more flexible work options, and keep me out of debt, but not radically change the course of my life. For a child on a cocoa farm in Cote d’Ivoire, it could change her life in ways she can probably not even comprehend.

The market distortions created by this are huge; indeed, most of the fundamental flaws in capitalism as we know it are ultimately traceable to this. Why do Americans throw away enough food to feed all the starving children in Africa? Marginal utility of wealth. Why are Silicon Valley programmers driving the prices for homes in San Francisco higher than most Americans will make in their lifetimes? Marginal utility of wealth. Why are the Koch brothers spending more on this year’s elections than the nominal GDP of the Gambia? Marginal utility of wealth. It’s the sort of pattern that once you see it suddenly seems obvious and undeniable, a paradigm shift a bit like the heliocentric model of the solar system. Forget trade barriers, immigration laws, and taxes; the most important market distortions around the world are all created by wealth inequality. Indeed, the wonder is that markets work as well as they do.

The real challenge is what to do about it, how to reduce this huge inequality of wealth and therefore marginal utility of wealth, without giving up entirely on the undeniable successes of free market capitalism. My hope is that once more people fully appreciate the difference between price, cost, and value, this paradigm shift will be much easier to make; and then perhaps we can all work together to find a solution.

Selling debt goes against everything the free market stands for

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JDN 2457555

I don’t think most people—or even most economists—have any concept of just how fundamentally perverse and destructive our financial system has become, and a large chunk of it ultimately boils down to one thing: Selling debt.

Certainly collateralized debt obligations (CDOs), and their meta-form, CDO2s (pronounced “see-dee-oh squareds”), are nothing more than selling debt, and along with credit default swaps (CDS; they are basically insurance, but without those pesky regulations against things like fraud and conflicts of interest) they were directly responsible for the 2008 financial crisis and the ensuing Great Recession and Second Depression.

But selling debt continues in a more insidious way, underpinning the entire debt collection industry which raises tens of billions of dollars per year by harassment, intimidation and extortion, especially of the poor and helpless. Frankly, I think what’s most shocking is how little money they make, given the huge number of people they harass and intimidate.

John Oliver did a great segment on debt collections (with a very nice surprise at the end):

But perhaps most baffling to me is the number of people who defend the selling of debt on the grounds that it is a “free market” activity which must be protected from government “interference in personal liberty”. To show this is not a strawman, here’s the American Enterprise Institute saying exactly that.

So let me say this in no uncertain terms: Selling debt goes against everything the free market stands for.

One of the most basic principles of free markets, one of the founding precepts of capitalism laid down by no less than Adam Smith (and before him by great political philosophers like John Locke), is the freedom of contract. This is the good part of capitalism, the part that makes sense, the reason we shouldn’t tear it all down but should instead try to reform it around the edges.

Indeed, the freedom of contract is so fundamental to human liberty that laws can only be considered legitimate insofar as they do not infringe upon it without a compelling public interest. Freedom of contract is right up there with freedom of speech, freedom of the press, freedom of religion, and the right of due process.

The freedom of contract is the right to make agreements, including financial agreements, with anyone you please, and under conditions that you freely and rationally impose in a state of good faith and transparent discussion. Conversely, it is the right not to make agreements with those you choose not to, and to not be forced into agreements under conditions of fraud, intimidation, or impaired judgment.

Freedom of contract is the basis of my right to take on debt, provided that I am honest about my circumstances and I can find a lender who is willing to lend to me. So taking on debt is a fundamental part of freedom of contract.

But selling debt is something else entirely. Far from exercising the freedom of contract, it violates it. When I take out a loan from bank A, and then they turn around and sell that loan to bank B, I suddenly owe money to bank B, but I never agreed to do that. I had nothing to do with their decision to work with bank B as opposed to keeping the loan or selling it to bank C.

Current regulations prohibit banks from “changing the terms of the loan”, but in practice they change them all the time—they can’t change the principal balance, the loan term, or the interest rate, but they can change the late fees, the payment schedule, and lots of subtler things about the loan that can still make a very big difference. Indeed, as far as I’m concerned they have changed the terms of the loan—one of the terms of the loan was that I was to pay X amount to bank A, not that I was to pay X amount to bank B. I may or may not have good reasons not to want to pay bank B—they might be far less trustworthy than bank A, for instance, or have a far worse social responsibility record—and in any case it doesn’t matter; it is my choice whether or not I want anything to do with bank B, whatever my reasons might be.

I take this matter quite personally, for it is by the selling of debt that, in moral (albeit not legal) terms, a British bank stole my parents’ house. Indeed, not just any British bank; it was none other than HSBC, the money launderers for terrorists.

When they first obtained their mortgage, my parents did not actually know that HSBC was quite so evil as to literally launder money for terrorists, but they did already know that they were involved in a great many shady dealings, and even specifically told their lender that they did not want the loan sold, and if it was to be sold, it was absolutely never to be sold to HSBC in particular. Their mistake (which was rather like the “mistake” of someone who leaves their car unlocked and has it stolen, or forgets to arm the home alarm system and suffers a burglary) was not to get this written into the formal contract, rather than simply made as a verbal agreement with the bankers. Such verbal contracts are enforceable under the law, at least in theory; but that would require proof of the verbal contract (and what proof could we provide?), and also probably have cost as much as the house in litigation fees.

Oh, by the way, they were given a subprime interest rate of 8% despite being middle-class professionals with good credit, no doubt to maximize the broker’s closing commission. Most banks reserved such behavior for racial minorities, but apparently this one was equal-opportunity in the worst way.Perhaps my parents were naive to trust bankers any further than they could throw them.

As a result, I think you know what happened next: They sold the loan to HSBC.

Now, had it ended there, with my parents unwittingly forced into supporting a bank that launders money for terrorists, that would have been bad enough. But it assuredly did not.

By a series of subtle and manipulative practices that poked through one loophole after another, HSBC proceeded to raise my parents’ payments higher and higher. One particularly insidious tactic they used was to sit on the checks until just after the due date passed, so they could charge late fees on the payments, then they recapitalized the late fees. My parents caught on to this particular trick after a few months, and started mailing the checks certified so they would be date-stamped; and lo and behold, all the payments were suddenly on time! By several other similarly devious tactics, all of which were technically legal or at least not provable, they managed to raise my parents’ monthly mortgage payments by over 50%.

Note that it was a fixed-rate, fixed-term mortgage. The initial payments—what should have been always the payments, that’s the point of a fixed-rate fixed-term mortgage—were under $2000 per month. By the end they were paying over $3000 per month. HSBC forced my parents to overpay on a mortgage an amount equal to the US individual poverty line, or the per-capita GDP of Peru.

They tried to make the payments, but after being wildly over budget and hit by other unexpected expenses (including defects in the house’s foundation that they had to pay to fix, but because of the “small” amount at stake and the overwhelming legal might of the construction company, no lawyer was willing to sue over), they simply couldn’t do it anymore, and gave up. They gave the house to the bank with a deed in lieu of foreclosure.

And that is the story of how a bank that my parents never agreed to work with, never would have agreed to work with, indeed specifically said they would not work with, still ended up claiming their house—our house, the house I grew up in from the age of 12. Legally, I cannot prove they did anything against the law. (I mean, other than laundered money for terrorists.) But morally, how is this any less than theft? Would we not be victimized less had a burglar broken into our home, vandalized the walls and stolen our furniture?

Indeed, that would probably be covered under our insurance! Where can I buy insurance against the corrupt and predatory financial system? Where are my credit default swaps to pay me when everything goes wrong?

And all of this could have been prevented, if banks simply weren’t allowed to violate our freedom of contract by selling their loans to other banks.

Indeed, the Second Depression could probably have been likewise prevented. Without selling debt, there is no securitization. Without securitization, there is far less leverage. Without leverage, there are not bank failures. Without bank failures, there is no depression. A decade of global economic growth was lost because we allowed banks to sell debt whenever they please.

I have heard the counter-arguments many times:

“But what if banks need the liquidity?” Easy. They can take out their own loans with those other banks. If bank A finds they need more cashflow, they should absolutely feel free to take out a loan from bank B. They can even point to their projected revenues from the mortgage payments we owe them, as a means of repaying that loan. But they should not be able to involve us in that transaction. If you want to trust HSBC, that’s your business (you’re an idiot, but it’s a free country). But you have no right to force me to trust HSBC.

“But banks might not be willing to make those loans, if they knew they couldn’t sell or securitize them!” THAT’S THE POINT. Banks wouldn’t take on all these ridiculous risks in their lending practices that they did (“NINJA loans” and mortgages with payments larger than their buyers’ annual incomes), if they knew they couldn’t just foist the debt off on some Greater Fool later on. They would only make loans they actually expect to be repaid. Obviously any loan carries some risk, but banks would only take on risks they thought they could bear, as opposed to risks they thought they could convince someone else to bear—which is the definition of moral hazard.

“Homes would be unaffordable if people couldn’t take out large loans!” First of all, I’m not against mortgages—I’m against securitization of mortgages. Yes, of course, people need to be able to take out loans. But they shouldn’t be forced to pay those loans to whoever their bank sees fit. If indeed the loss of subprime securitized mortgages made it harder for people to get homes, that’s a problem; but the solution to that problem was never to make it easier for people to get loans they can’t afford—it is clearly either to reduce the price of homes or increase the incomes of buyers. Subsidized housing construction, public housing, changes in zoning regulation, a basic income, lower property taxes, an expanded earned-income tax credit—these are the sort of policies that one implements to make housing more affordable, not “go ahead and let banks exploit people however they want”.

Remember, a regulation against selling debt would protect the freedom of contract. It would remove a way for private individuals and corporations to violate that freedom, like regulations against fraud, intimidation, and coercion. It should be uncontroversial that no one has any right to force you to do business with someone you would not voluntarily do business with, certainly not in a private transaction between for-profit corporations. Maybe that sort of mandate makes sense in rare circumstances by the government, but even then it should really be implemented as a tax, not a mandate to do business with a particular entity. The right to buy what you choose is the foundation of a free market—and implicit in it is the right not to buy what you do not choose.

There are many regulations on debt that do impose upon freedom of contract: As horrific as payday loans are, if someone really honestly knowingly wants to take on short-term debt at 400% APR I’m not sure it’s my business to stop them. And some people may really be in such dire circumstances that they need money that urgently and no one else will lend to them. Insofar as I want payday loans regulated, it is to ensure that they are really lending in good faith—as many surely are not—and ultimately I want to outcompete them by providing desperate people with more reasonable loan terms. But a ban on securitization is like a ban on fraud; it is the sort of law that protects our rights.

The many varieties of argument “men”

PNRJ core principles, ethics, heuristics and biases , , , , , ,

JDN 2457552

After several long, intense, and very likely controversial posts in a row, I decided to take a break with a post that is short and fun.

You have probably already heard of a “strawman” argument, but I think there are many more “materials” an argument can be made of which would be useful terms to have, so I have proposed a taxonomy of similar argument “men”. Perhaps this will help others in the future to more precisely characterize where arguments have gone wrong and how they should have gone differently.

For examples of each, I’m using a hypothetical argument about the gold standard, based on the actual arguments I refute in my previous post on the subject.

This is an argument actually given by a proponent of the gold standard, upon which my “men” shall be built:

1) A gold standard is key to achieving a period of sustained, 4% real economic growth.

The U.S. dollar was created as a defined weight of gold and silver in 1792. As detailed in the booklet, The 21st Century Gold Standard (available free at http://agoldenage.com), I co-authored with fellow Forbes.com columnist Ralph Benko, a dollar as good as gold endured until 1971 with the relatively brief exceptions of the War of 1812, the Civil War and Reconstruction, and 1933, the year President Franklin Roosevelt suspended dollar/gold convertibility until January 31, 1934 when the dollar/gold link was re-established at $35 an ounce, a 40% devaluation from the prior $20.67 an ounce. Over that entire 179 years, the U.S. economy grew at a 3.9% average annual rate, including all of the panics, wars, industrialization and a myriad other events. During the post World War II Bretton Woods gold standard, the U.S. economy also grew on average 4% a year.

By contrast, during the 40-years since going off gold, U.S. economic growth has averaged an anemic 2.8% a year. The only 40-year periods in which the economic growth was slower were those ending in the Great Depression, from 1930 to 1940.

2) A gold standard reduces the risk of recessions and financial crises.

Critics of the gold standard point out, correctly, that it would prohibit the Federal Reserve from manipulating interest rates and the value of the dollar in hopes of stimulating demand. In fact, the idea that a paper dollar would lead to a more stable economy was one of the key selling points for abandoning the gold standard in 1971.

However, this power has done far more harm than good. Under the paper dollar, recessions have become more severe and financial crises more frequent. During the post World War II gold standard, unemployment averaged less than 5% and never rose above 7% during a calendar year. Since going off gold, unemployment has averaged more than 6%, and has been above 8% now for nearly 3.5 years.

And now, the argument men:

Fallacious (Bad) Argument Men

These argument “men” are harmful and irrational; they are to be avoided, and destroyed wherever they are found. Maybe in some very extreme circumstances they would be justifiable—but only in circumstances where it is justifiable to be dishonest and manipulative. You can use a strawman argument to convince a terrorist to let the hostages go; you can’t use one to convince your uncle not to vote Republican.

Strawman: The familiar fallacy in which instead of trying to address someone else’s argument, you make up your own fake version of that argument which is easier to defeat. The image is of making an effigy of your opponent out of straw and beating on the effigy to avoid confronting the actual opponent.

You can’t possibly think that going to the gold standard would make the financial system perfect! There will still be corrupt bankers, a banking oligopoly, and an unpredictable future. The gold standard would do nothing to remove these deep flaws in the system.

Hitman: An even worse form of the strawman, in which you misrepresent not only your opponent’s argument, but your opponent themselves, using your distortion of their view as an excuse for personal attacks against their character.

Oh, you would favor the gold standard, wouldn’t you? A rich, middle-aged White man, presumably straight and nominally Christian? You have all the privileges in life, so you don’t care if you take away the protections that less-fortunate people depend upon. You don’t care if other people become unemployed, so long as you don’t have to bear inflation reducing the real value of your precious capital assets.

Conman: An argument for your own view which you don’t actually believe, but expect to be easier to explain or more persuasive to this particular audience than the true reasons for your beliefs.

Back when we were on the gold standard, it was the era of “Robber Barons”. Poverty was rampant. If we go back to that system, it will just mean handing over all the hard-earned money of working people to billionaire capitalists.

Vaporman: Not even an argument, just a forceful assertion of your view that takes the place or shape of an argument.

The gold standard is madness! It makes no sense at all! How can you even think of going back to such a ridiculous monetary system?

Honest (Acceptable) Argument Men

These argument “men” are perfectly acceptable, and should be the normal expectation in honest discourse.

Woodman: The actual argument your opponent made, addressed and refuted honestly using sound evidence.

There is very little evidence that going back to the gold standard would in any way improve the stability of the currency or the financial system. While long-run inflation was very low under the gold standard, this fact obscures the volatility of inflation, which was extremely high; bouts of inflation were followed by bouts of deflation, swinging the value of the dollar up or down as much as 15% in a single year. Nor is there any evidence that the gold standard prevented financial crises, as dozens of financial crises occurred under the gold standard, if anything more often than they have since the full-fiat monetary system established in 1971.

Bananaman: An actual argument your opponent made that you honestly refute, which nonetheless is so ridiculous that it seems like a strawman, even though it isn’t. Named in “honor” of Ray Comfort’s Banana Argument. Of course, some bananas are squishier than others, and the only one I could find here was at least relatively woody–though still recognizable as a banana:

You said “A gold standard is key to achieving a period of sustained, 4% real economic growth.” based on several distorted, misunderstood, or outright false historical examples. The 4% annual growth in total GDP during the early part of the United States was due primarily to population growth, not a rise in real standard of living, while the rapid growth during WW2 was obviously due to the enormous and unprecedented surge in government spending (and by the way, we weren’t even really on the gold standard during that period). In a blatant No True Scotsman fallacy, you specifically exclude the Great Depression from the “true gold standard” so that you don’t have to admit that the gold standard contributed significantly to the severity of the depression.

Middleman: An argument that synthesizes your view and your opponent’s view, in an attempt to find a compromise position that may be acceptable, if not preferred, by all.

Unlike the classical gold standard, the Bretton Woods gold standard in place from 1945 to 1971 was not obviously disastrous. If you want to go back to a system of international exchange rates fixed by gold similar to Bretton Woods, I would consider that a reasonable position to take.

Virtuous (Good) Argument Men

These argument “men” go above and beyond the call of duty; rather than simply seek to win arguments honestly, they actively seek the truth behind the veil of opposing arguments. These cannot be expected in all circumstances, but they are to be aspired to, and commended when found.

Ironman: Your opponent’s actual argument, but improved, with some of its flaws shored up. The same basic thinking as your opponent, but done more carefully, filling in the proper gaps.

The gold standard might not reduce short-run inflation, but it would reduce long–run inflation, making our currency more stable over long periods of time. We would be able to track long-term price trends in goods such as housing and technology much more easily, and people would have an easier time psychologically grasping the real prices of goods as they change during their lifetime. No longer would we hear people complain, “How can you want a minimum wage of $15? As a teenager in 1955, I got paid $3 an hour and I was happy with that!” when that $3 in 1955, adjusted for inflation, is $26.78 in today’s money.

Steelman: Not the argument your opponent made, but the one they should have made. The best possible argument you are aware of that would militate in favor of their view, the one that sometimes gives you pause about your own opinions, the real and tangible downside of what you believe in.

Tying currency to gold or any other commodity may not be very useful directly, but it could serve one potentially vital function, which is as a commitment mechanism to prevent the central bank from manipulating the currency to enrich themselves or special interests. It may not be the optimal commitment mechanism, but it is a psychologically appealing one for many people, and is also relatively easy to define and keep track of. It is also not subject to as much manipulation as something like nominal GDP targeting or a Taylor Rule, which could be fudged by corrupt statisticians. And while it might cause moderate volatility, it can also protect against the most extreme forms of volatility such as hyperinflation. In countries with very corrupt governments, a gold standard might actually be a good idea, if you could actually enforce it, because it would at least limit the damage that can be done by corrupt central bank officials. Had such a system been in place in Zimbabwe in the 1990s, the hyperinflation might have been prevented. The US is not nearly as corrupt as Zimbabwe, so we probably do not need a gold standard; but it may be wise to recommend the use of gold standards or similar fixed-exchange currencies in Third World countries so that corrupt leaders cannot abuse the monetary system to gain at the expense of their people.

Moral responsibility does not inherit across generations

PNRJ cognitive science, core principles, ethics, public policy, Uncategorized , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,

JDN 2457548

In last week’s post I made a sharp distinction between believing in human progress and believing that colonialism was justified. To make this argument, I relied upon a moral assumption that seems to me perfectly obvious, and probably would to most ethicists as well: Moral responsibility does not inherit across generations, and people are only responsible for their individual actions.

But is in fact this principle is not uncontroversial in many circles. When I read utterly nonsensical arguments like this one from the aptly-named Race Baitr saying that White people have no role to play in the liberation of Black people apparently because our blood is somehow tainted by the crimes our ancestors, it becomes apparent to me that this principle is not obvious to everyone, and therefore is worth defending. Indeed, many applications of the concept of “White Privilege” seem to ignore this principle, speaking as though racism is not something one does or participates in, but something that one is simply by being born with less melanin. Here’s a Salon interview specifically rejecting the proposition that racism is something one does:

For white people, their identities rest on the idea of racism as about good or bad people, about moral or immoral singular acts, and if we’re good, moral people we can’t be racist – we don’t engage in those acts. This is one of the most effective adaptations of racism over time—that we can think of racism as only something that individuals either are or are not “doing.”

If racism isn’t something one does, then what in the world is it? It’s all well and good to talk about systems and social institutions, but ultimately systems and social institutions are made of human behaviors. If you think most White people aren’t doing enough to combat racism (which sounds about right to me!), say that—don’t make some bizarre accusation that simply by existing we are inherently racist. (Also: We? I’m only 75% White, so am I only 75% inherently racist?) And please, stop redefining the word “racism” to mean something other than what everyone uses it to mean; “White people are snakes” is in fact a racist sentiment (and yes, one I’ve actually heard–indeed, here is the late Muhammad Ali comparing all White people to rattlesnakes, and Huffington Post fawning over him for it).

Racism is clearly more common and typically worse when performed by White people against Black people—but contrary to the claims of some social justice activists the White perpetrator and Black victim are not part of the definition of racism. Similarly, sexism is more common and more severe committed by men against women, but that doesn’t mean that “men are pigs” is not a sexist statement (and don’t tell me you haven’t heard that one). I don’t have a good word for bigotry by gay people against straight people (“heterophobia”?) but it clearly does happen on occasion, and similarly cannot be defined out of existence.

I wouldn’t care so much that you make this distinction between “racism” and “racial prejudice”, except that it’s not the normal usage of the word “racism” and therefore confuses people, and also this redefinition clearly is meant to serve a political purpose that is quite insidious, namely making excuses for the most extreme and hateful prejudice as long as it’s committed by people of the appropriate color. If “White people are snakes” is not racism, then the word has no meaning.

Not all discussions of “White Privilege” are like this, of course; this article from Occupy Wall Street actually does a fairly good job of making “White Privilege” into a sensible concept, albeit still not a terribly useful one in my opinion. I think the useful concept is oppression—the problem here is not how we are treating White people, but how we are treating everyone else. “What privilege gives you is the freedom to be who you are.”? Shouldn’t everyone have that?

Almost all the so-called “benefits” or “perks” associated with “privilege” are actually forgone harms—they are not good things done to you, but bad things not done to you. “But benefitting from racist systems doesn’t mean that everything is magically easy for us. It just means that as hard as things are, they could always be worse.” No, that is not what the word “benefit” means. The word “benefit” means you would be worse off without it—and in most cases that simply isn’t true. Many White people obviously think that it is true—which is probably a big reason why so many White people fight so hard to defend racism, you know; you’ve convinced them it is in their self-interest. But, with rare exceptions, it is not; most racial discrimination has literally zero long-run benefit. It’s just bad. Maybe if we helped people appreciate that more, they would be less resistant to fighting racism!

The only features of “privilege” that really make sense as benefits are those that occur in a state of competition—like being more likely to be hired for a job or get a loan—but one of the most important insights of economics is that competition is nonzero-sum, and fairer competition ultimately means a more efficient economy and thus more prosperity for everyone.

But okay, let’s set that aside and talk about this core question of what sort of responsibility we bear for the acts of our ancestors. Many White people clearly do feel deep shame about what their ancestors (or people the same color as their ancestors!) did hundreds of years ago. The psychological reactance to that shame may actually be what makes so many White people deny that racism even exists (or exists anymore)—though a majority of Americans of all races do believe that racism is still widespread.

We also apply some sense of moral responsibility applied to whole races quite frequently. We speak of a policy “benefiting White people” or “harming Black people” and quickly elide the distinction between harming specific people who are Black, and somehow harming “Black people” as a group. The former happens all the time—the latter is utterly nonsensical. Similarly, we speak of a “debt owed by White people to Black people” (which might actually make sense in the very narrow sense of economic reparations, because people do inherit money! They probably shouldn’t, that is literally feudalist, but in the existing system they in fact do), which makes about as much sense as a debt owed by tall people to short people. As Walter Michaels pointed out in The Trouble with Diversity (which I highly recommend), because of this bizarre sense of responsibility we are often in the habit of “apologizing for something you didn’t do to people to whom you didn’t do it (indeed to whom it wasn’t done)”. It is my responsibility to condemn colonialism (which I indeed do), to fight to ensure that it never happens again; it is not my responsibility to apologize for colonialism.

This makes some sense in evolutionary terms; it’s part of the all-encompassing tribal paradigm, wherein human beings come to identify themselves with groups and treat those groups as the meaningful moral agents. It’s much easier to maintain the cohesion of a tribe against the slings and arrows (sometimes quite literal) of outrageous fortune if everyone believes that the tribe is one moral agent worthy of ultimate concern.

This concept of racial responsibility is clearly deeply ingrained in human minds, for it appears in some of our oldest texts, including the Bible: “You shall not bow down to them or worship them; for I, the Lord your God, am a jealous God, punishing the children for the sin of the parents to the third and fourth generation of those who hate me,” (Exodus 20:5)

Why is inheritance of moral responsibility across generations nonsensical? Any number of reasons, take your pick. The economist in me leaps to “Ancestry cannot be incentivized.” There’s no point in holding people responsible for things they can’t control, because in doing so you will not in any way alter behavior. The Stanford Encyclopedia of Philosophy article on moral responsibility takes it as so obvious that people are only responsible for actions they themselves did that they don’t even bother to mention it as an assumption. (Their big question is how to reconcile moral responsibility with determinism, which turns out to be not all that difficult.)

An interesting counter-argument might be that descent can be incentivized: You could use rewards and punishments applied to future generations to motivate current actions. But this is actually one of the ways that incentives clearly depart from moral responsibilities; you could incentivize me to do something by threatening to murder 1,000 children in China if I don’t, but even if it was in fact something I ought to do, it wouldn’t be those children’s fault if I didn’t do it. They wouldn’t deserve punishment for my inaction—I might, and you certainly would for using such a cruel incentive.

Moreover, there’s a problem with dynamic consistency here: Once the action is already done, what’s the sense in carrying out the punishment? This is why a moral theory of punishment can’t merely be based on deterrence—the fact that you could deter a bad action by some other less-bad action doesn’t make the less-bad action necessarily a deserved punishment, particularly if it is applied to someone who wasn’t responsible for the action you sought to deter. In any case, people aren’t thinking that we should threaten to punish future generations if people are racist today; they are feeling guilty that their ancestors were racist generations ago. That doesn’t make any sense even on this deterrence theory.

There’s another problem with trying to inherit moral responsibility: People have lots of ancestors. Some of my ancestors were most likely rapists and murderers; most were ordinary folk; a few may have been great heroes—and this is true of just about anyone anywhere. We all have bad ancestors, great ancestors, and, mostly, pretty good ancestors. 75% of my ancestors are European, but 25% are Native American; so if I am to apologize for colonialism, should I be apologizing to myself? (Only 75%, perhaps?) If you go back enough generations, literally everyone is related—and you may only have to go back about 4,000 years. That’s historical time.

Of course, we wouldn’t be different colors in the first place if there weren’t some differences in ancestry, but there is a huge amount of gene flow between different human populations. The US is a particularly mixed place; because most Black Americans are quite genetically mixed, it is about as likely that any randomly-selected Black person in the US is descended from a slaveowner as it is that any randomly-selected White person is. (Especially since there were a large number of Black slaveowners in Africa and even some in the United States.) What moral significance does this have? Basically none! That’s the whole point; your ancestors don’t define who you are.

If these facts do have any moral significance, it is to undermine the sense most people seem to have that there are well-defined groups called “races” that exist in reality, to which culture responds. No; races were created by culture. I’ve said this before, but it bears repeating: The “races” we hold most dear in the US, White and Black, are in fact the most nonsensical. “Asian” and “Native American” at least almost make sense as categories, though Chippewa are more closely related to Ainu than Ainu are to Papuans. “Latino” isn’t utterly incoherent, though it includes as much Aztec as it does Iberian. But “White” is a club one can join or be kicked out of, while “Black” is the majority of genetic diversity.

Sex is a real thing—while there are intermediate cases of course, broadly speaking humans, like most metazoa, are sexually dimorphic and come in “male” and “female” varieties. So sexism took a real phenomenon and applied cultural dynamics to it; but that’s not what happened with racism. Insofar as there was a real phenomenon, it was extremely superficial—quite literally skin deep. In that respect, race is more like class—a categorization that is itself the result of social institutions.

To be clear: Does the fact that we don’t inherit moral responsibility from our ancestors absolve us from doing anything to rectify the inequities of racism? Absolutely not. Not only is there plenty of present discrimination going on we should be fighting, there are also inherited inequities due to the way that assets and skills are passed on from one generation to the next. If my grandfather stole a painting from your grandfather and both our grandfathers are dead but I am now hanging that painting in my den, I don’t owe you an apology—but I damn well owe you a painting.

The further we become from the past discrimination the harder it gets to make reparations, but all hope is not lost; we still have the option of trying to reset everyone’s status to the same at birth and maintaining equality of opportunity from there. Of course we’ll never achieve total equality of opportunity—but we can get much closer than we presently are.

We could start by establishing an extremely high estate tax—on the order of 99%—because no one has a right to be born rich. Free public education is another good way of equalizing the distribution of “human capital” that would otherwise be concentrated in particular families, and expanding it to higher education would make it that much better. It even makes sense, at least in the short run, to establish some affirmative action policies that are race-conscious and sex-conscious, because there are so many biases in the opposite direction that sometimes you must fight bias with bias.

Actually what I think we should do in hiring, for example, is assemble a pool of applicants based on demographic quotas to ensure a representative sample, and then anonymize the applications and assess them on merit. This way we do ensure representation and reduce bias, but don’t ever end up hiring anyone other than the most qualified candidate. But nowhere should we think that this is something that White men “owe” to women or Black people; it’s something that people should do in order to correct the biases that otherwise exist in our society. Similarly with regard to sexism: Women exhibit just as much unconscious bias against other women as men do. This is not “men” hurting “women”—this is a set of unconscious biases found in almost everywhere and social structures almost everywhere that systematically discriminate against people because they are women.

Perhaps by understanding that this is not about which “team” you’re on (which tribe you’re in), but what policy we should have, we can finally make these biases disappear, or at least fade so small that they are negligible.

The unending madness of the gold standard

PNRJ cognitive science, heuristics and biases, macroeconomics, public policy , , , , , , , , , , , , , ,

JDN 2457545

If you work in economics in any capacity (much like “How is the economy doing?” you don’t even really need to be in macroeconomics), you will encounter many people who believe in the gold standard. Many of these people will be otherwise quite intelligent and educated; they often understand economics better than most people (not that this is saying a whole lot). Yet somehow they continue to hold—and fiercely defend—this incredibly bizarre and anachronistic view of macroeconomics.

They even bring it up at the oddest times; I recently encountered someone who wrote a long and rambling post arguing for drug legalization (which I largely agree with, by the way) and concluded it with #EndTheFed, not seeming to grasp the total and utter irrelevance of this juxtaposition. It seems like it was just a conditioned response, or maybe the sort of irrelevant but consistent coda originally perfected by Cato and his “Carthago delenda est.” “Foederale Reservatum delendum est. Hey, maybe that’s why they’re called the Cato Institute.

So just how bizarre is the gold standard? Well, let’s look at what sort of arguments they use to defend it. I’ll use Charles Kadlic, prominent Libertarian blogger on Forbes, as an example, with his “Top Ten Reasons That You Should Support the ‘Gold Commission’”:

  1. A gold standard is key to achieving a period of sustained, 4% real economic growth.
  2. A gold standard reduces the risk of recessions and financial crises.
  3. A gold standard would restore rising living standards to the middle-class.
  4. A gold standard would restore long-term price stability.
  5. A gold standard would stop the rise in energy prices.
  6. A gold standard would be a powerful force for restoring fiscal balance to federal state and local governments.
  7. A gold standard would help save Medicare and Social Security.
  8. A gold standard would empower Main Street over Wall Street.
  9. A gold standard would increase the liberty of the American people.
  10. Creation of a gold commission will provide the forum to chart a prudent path toward a 21st century gold standard.

Number 10 can be safely ignored, as clearly Kadlic just ran out of reasons and to make a round number tacked on the implicit assumption of the entire article, namely that this ‘gold commission’ would actually realistically lead us toward a gold standard. (Without it, the other 9 reasons are just non sequitur.)

So let’s look at the other 9, shall we? Literally none of them are true. Several are outright backward.

You know a policy is bad when even one of its most prominent advocates can’t even think of a single real benefit it would have. A lot of quite bad policies do have perfectly real benefits, they’re just totally outweighed by their costs: For example, cutting the top income tax rate to 20% probably would actually contribute something to economic growth. Not a lot, and it would cut a swath through the federal budget and dramatically increase inequality—but it’s not all downside. Yet Kadlic couldn’t actually even think of one benefit of the gold standard that actually holds up. (I actually can do his work for him: I do know of one benefit of the gold standard, but as I’ll get to momentarily it’s quite small and can easily be achieved in better ways.)

First of all, it’s quite clear that the gold standard did not increase economic growth. If you cherry-pick your years properly, you can make it seem like Nixon leaving the gold standard hurt growth, but if you look at the real long-run trends in economic growth it’s clear that we had really erratic growth up until about the 1910s (the surge of government spending in WW1 and the establishment of the Federal Reserve), at which point went through a temporary surge recovering from the Great Depression and then during WW2, and finally, if you smooth out the business cycle, our growth rates have slowly trended downward as growth in productivity has gradually slowed down.

Here’s GDP growth from 1800 to 1900, when we were on the classical gold standard:

US_GDP_growth_1800s

Here’s GDP growth from 1929 to today, using data from the Bureau of Economic Analysis:

US_GDP_growth_BEA

Also, both of these are total GDP growth (because that is what Kadlic said), which means that part of what you’re seeing here is population growth rather than growth in income per person. Here’s GDP per person in the 1800s:

US_GDP_growth_1800s

If you didn’t already know, I bet you can’t guess where on those graphs we left the gold standard, which you’d clearly be able to do if the gold standard had this dramatic “double your GDP growth” kind of effect. I can’t immediately rule out some small benefit to the gold standard just from this data, but don’t worry; more thorough economic studies have done that. Indeed, it is the mainstream consensus among economists today that the gold standard is what caused the Great Depression.

Indeed, there’s a whole subfield of historical economics research that basically amounts to “What were they thinking?” trying to explain why countries stayed on the gold standard for so long when it clearly wasn’t working. Here’s a paper trying to argue it was a costly signal of your “rectitude” in global bond markets, but I find much more compelling the argument that it was psychological: Their belief in the gold standard was simply too strong, so confirmation bias kept holding them back from what needed to be done. They were like my aforementioned #EndTheFed acquaintance.

Then we get to Kadlic’s second point: Does the gold standard reduce the risk of financial crises? Let’s also address point 4, which is closely related: Does the gold standard improve price stability? Tell that to 1929.

In fact, financial crises were more common on the classical gold standard; the period of pure fiat monetary policy was so stable that it was called the Great Moderation, until the crash in 2008 screwed it all up—and that crash occurred essentially outside the standard monetary system, in the “shadow banking system” of unregulated and virtually unlimited derivatives. Had we actually forced banks to stay within the light of the standard banking system, the Great Moderation might have continued indefinitely.

As for “price stability”, that’s sort of true if you look at the long run, because prices were as likely to go down as they were to go up. But that isn’t what we mean by “price stability”. A system with good price stability will have a low but positive and steady level of inflation, and will therefore exhibit some long-run increases in price levels; it won’t have prices jump up and down erratically and end up on average the same.

For jump up and down is what prices did on the gold standard, as you can see from FRED:

US_inflation_longrun

This is something we could have predicted in advance; the price of any given product jumps up and down over time, and gold is just one product among many. Tying prices to gold makes no more sense than tying them to any other commodity.

As for stopping the rise in energy prices, energy prices aren’t rising. Even if they were (and they could at some point), the only way the gold standard would stop that is by triggering deflation (and therefore recession) in the rest of the economy.

Regarding number 6, I don’t see how the fiscal balance of federal and state governments is improved by periodic bouts of deflation that make their debt unpayable.

As for number 7, saving Medicare and Social Security, their payments out are tied to inflation and their payments in are tied to nominal GDP, so overall inflation has very little effect on their long-term stability. In any case, the problem with Medicare is spiraling medical costs (which Obamacare has done a lot to fix), and the problem with Social Security is just the stupid arbitrary cap on the income subject to payroll tax; the gold standard would do very little to solve either of those problems, though I guess it would make the nominal income cap less binding by triggering deflation, which is just about the worst way to avoid a price ceiling I’ve ever heard.

Regarding 8 and 9, I don’t even understand why Kadlic thinks that going to a gold standard would empower individuals over banks (does it seem like individuals were empowered over banks in the “Robber Baron Era”?), or what in the world it has to do with giving people more liberty (all that… freedom… you lose… when the Fed… stabilizes… prices?), so I don’t even know where to begin on those assertions. You know what empowers people over banks? The Consumer Financial Protection Bureau. You know what would enhance liberty? Ending mass incarceration. Libertarians fight tooth and nail against the former; sometimes they get behind the latter, but sometimes they don’t; Gary Johnson for some bizarre reason believes in privatization of prisons, which are directly linked to the surge in US incarceration.

The only benefit I’ve been able to come up with for the gold standard is as a commitment mechanism, something the Federal Reserve could do to guarantee its future behavior and thereby reduce the fear that it will suddenly change course on its past promises. This would make forward guidance a lot more effective at changing long-term interest rates, because people would have reason to believe that the Fed means what it says when it projects its decisions 30 years out.

But there are much simpler and better commitment mechanisms the Fed could use. They could commit to a Taylor Rule or nominal GDP targeting, both of which mainstream economists have been clamoring for for decades. There are some definite downsides to both proposals, but also some important upsides; and in any case they’re both obviously better than the gold standard and serve the same forward guidance function.

Indeed, it’s really quite baffling that so many people believe in the gold standard. It cries out for some sort of psychological explanation, as to just what cognitive heuristic is failing when otherwise-intelligent and highly-educated people get monetary policy so deeply, deeply wrong. A lot of them don’t even to seem grasp when or how we left the gold standard; it really happened when FDR suspended gold convertibility in 1933. After that on the Bretton Woods system only national governments could exchange money for gold, and the Nixon shock that people normally think of as “ending the gold standard” was just the final nail in the coffin, and clearly necessary since inflation was rapidly eating through our gold reserves.

A lot of it seems to come down to a deep distrust of government, especially federal government (I still do not grok why the likes of Ron Paul think state governments are so much more trustworthy than the federal government); the Federal Reserve is a government agency (sort of) and is therefore not to be trusted—and look, it has federal right there in the name.

But why do people hate government so much? Why do they think politicians are much less honest than they actually are? Part of it could have to do with the terrifying expansion of surveillance and weakening of civil liberties in the face of any perceived outside threat (Sedition Act, PATRIOT ACT, basically the same thing), but often the same people defending those programs are the ones who otherwise constantly complain about Big Government. Why do polls consistently show that people don’t trust the government, but want it to do more?

I think a lot of this comes down to the vague meaning of the word “government” and the associations we make with particular questions about it. When I ask “Do you trust the government?” you think of the NSA and the Vietnam War and Watergate, and you answer “No.” But when I ask “Do you want the government to do more?” you think of the failure at Katrina, the refusal to expand Medicaid, the pitiful attempts at reducing carbon emissions, and you answer “Yes.” When I ask if you like the military, your conditioned reaction is to say the patriotic thing, “Yes.” But if I ask whether you like the wars we’ve been fighting lately, you think about the hundreds of thousands of people killed and the wanton destruction to achieve no apparent actual objective, and you say “No.” Most people don’t come to these polls with thought-out opinions they want to express; the questions evoke emotional responses in them and they answer accordingly. You can also evoke different responses by asking “Should we cut government spending?” (People say “Yes.”) versus asking “Should we cut military spending, Social Security, or Medicare?” (People say “No.”) The former evokes a sense of abstract government taking your tax money; the latter evokes the realization that this money is used for public services you value.

So, the gold standard has acquired positive emotional vibes, and the Fed has acquired negative emotional vibes.

The former is fairly easy to explain: “good as gold” is an ancient saying, and “the gold standard” is even a saying we use in general to describe the right way of doing something (“the gold standard in prostate cancer treatment”). Humans have always had a weird relationship with gold; something about its timeless and noncorroding shine mesmerizes us. That’s why you occasionally get proposals for a silver standard, but no one ever seems to advocate an oil standard, an iron standard, or a lumber standard, which would make about as much sense.

The latter is a bit more difficult to explain: What did the Fed ever do to you? But I think it might have something to do with the complexity of sound monetary policy, and the resulting air of technocratic mystery surrounding it. Moreover, the Fed actively cultivates this image, by using “open-market operations” and “quantitative easing” to “target interest rates”, instead of just saying, “We’re printing money.” There may be some good reasons to do it this way, but a lot of it really does seem to be intended to obscure the truth from the uninitiated and perpetuate the myth that they are almost superhuman. “It’s all very complicated, you see; you wouldn’t understand.” People are hoarding their money, so there’s not enough money in circulation, so prices are falling, so you’re printing more money and trying to get it into circulation. That’s really not that complicated. Indeed, if it were, we wouldn’t be able to write a simple equation like a Taylor Rule or nominal GDP targeting in order to automate it!

The reason so many people become gold bugs after taking a couple of undergraduate courses in economics, then, is that this teaches them enough that they feel they have seen through the veil; the curtain has been pulled open and the all-powerful Wizard revealed to be an ordinary man at a control panel. (Spoilers? The movie came out in 1939. Actually, it was kind of about the gold standard.) “What? You’ve just been printing money all this time? But that is surely madness!” They don’t actually understand why printing money is actually a perfectly sensible thing to do on many occasions, and it feels to them a lot like what would happen if they just went around printing money (counterfeiting) or what a sufficiently corrupt government could do if they printed unlimited amounts (which is why they keep bringing up Zimbabwe). They now grasp what is happening, but not why. A little learning is a dangerous thing.

Now as for why Paul Volcker wants to go back to Bretton Woods? That, I cannot say. He’s definitely got more than a little learning. At least he doesn’t want to go back to the classical gold standard.

Believing in civilization without believing in colonialism

PNRJ core principles, development economics, ethics , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,

JDN 2457541

In a post last week I presented some of the overwhelming evidence that society has been getting better over time, particularly since the start of the Industrial Revolution. I focused mainly on infant mortality rates—babies not dying—but there are lots of other measures you could use as well. Despite popular belief, poverty is rapidly declining, and is now the lowest it’s ever been. War is rapidly declining. Crime is rapidly declining in First World countries, and to the best of our knowledge crime rates are stable worldwide. Public health is rapidly improving. Lifespans are getting longer. And so on, and so on. It’s not quite true to say that every indicator of human progress is on an upward trend, but the vast majority of really important indicators are.

Moreover, there is every reason to believe that this great progress is largely the result of what we call “civilization”, even Western civilization: Stable, centralized governments, strong national defense, representative democracy, free markets, openness to global trade, investment in infrastructure, science and technology, secularism, a culture that values innovation, and freedom of speech and the press. We did not get here by Marxism, nor agragrian socialism, nor primitivism, nor anarcho-capitalism. We did not get here by fascism, nor theocracy, nor monarchy. This progress was built by the center-left welfare state, “social democracy”, “modified capitalism”, the system where free, open markets are coupled with a strong democratic government to protect and steer them.

This fact is basically beyond dispute; the evidence is overwhelming. The serious debate in development economics is over which parts of the Western welfare state are most conducive to raising human well-being, and which parts of the package are more optional. And even then, some things are fairly obvious: Stable government is clearly necessary, while speaking English is clearly optional.

Yet many people are resistant to this conclusion, or even offended by it, and I think I know why: They are confusing the results of civilization with the methods by which it was established.

The results of civilization are indisputably positive: Everything I just named above, especially babies not dying.

But the methods by which civilization was established are not; indeed, some of the greatest atrocities in human history are attributable at least in part to attempts to “spread civilization” to “primitive” or “savage” people.
It is therefore vital to distinguish between the result, civilization, and the processes by which it was effected, such as colonialism and imperialism.

First, it’s important not to overstate the link between civilization and colonialism.

We tend to associate colonialism and imperialism with White people from Western European cultures conquering other people in other cultures; but in fact colonialism and imperialism are basically universal to any human culture that attains sufficient size and centralization. India engaged in colonialism, Persia engaged in imperialism, China engaged in imperialism, the Mongols were of course major imperialists, and don’t forget the Ottoman Empire; and did you realize that Tibet and Mali were at one time imperialists as well? And of course there are a whole bunch of empires you’ve probably never heard of, like the Parthians and the Ghaznavids and the Ummayyads. Even many of the people we’re accustoming to thinking of as innocent victims of colonialism were themselves imperialists—the Aztecs certainly were (they even sold people into slavery and used them for human sacrifice!), as were the Pequot, and the Iroquois may not have outright conquered anyone but were definitely at least “soft imperialists” the way that the US is today, spreading their influence around and using economic and sometimes military pressure to absorb other cultures into their own.

Of course, those were all civilizations, at least in the broadest sense of the word; but before that, it’s not that there wasn’t violence, it just wasn’t organized enough to be worthy of being called “imperialism”. The more general concept of intertribal warfare is a human universal, and some hunter-gatherer tribes actually engage in an essentially constant state of warfare we call “endemic warfare”. People have been grouping together to kill other people they perceived as different for at least as long as there have been people to do so.

This is of course not to excuse what European colonial powers did when they set up bases on other continents and exploited, enslaved, or even murdered the indigenous population. And the absolute numbers of people enslaved or killed are typically larger under European colonialism, mainly because European cultures became so powerful and conquered almost the entire world. Even if European societies were not uniquely predisposed to be violent (and I see no evidence to say that they were—humans are pretty much humans), they were more successful in their violent conquering, and so more people suffered and died. It’s also a first-mover effect: If the Ming Dynasty had supported Zheng He more in his colonial ambitions, I’d probably be writing this post in Mandarin and reflecting on why Asian cultures have engaged in so much colonial oppression.

While there is a deeply condescending paternalism (and often post-hoc rationalization of your own self-interested exploitation) involved in saying that you are conquering other people in order to civilize them, humans are also perfectly capable of committing atrocities for far less noble-sounding motives. There are holy wars such as the Crusades and ethnic genocides like in Rwanda, and the Arab slave trade was purely for profit and didn’t even have the pretense of civilizing people (not that the Atlantic slave trade was ever really about that anyway).

Indeed, I think it’s important to distinguish between colonialists who really did make some effort at civilizing the populations they conquered (like Britain, and also the Mongols actually) and those that clearly were just using that as an excuse to rape and pillage (like Spain and Portugal). This is similar to but not quite the same thing as the distinction between settler colonialism, where you send colonists to live there and build up the country, and exploitation colonialism, where you send military forces to take control of the existing population and exploit them to get their resources. Countries that experienced settler colonialism (such as the US and Australia) have fared a lot better in the long run than countries that experienced exploitation colonialism (such as Haiti and Zimbabwe).

The worst consequences of colonialism weren’t even really anyone’s fault, actually. The reason something like 98% of all Native Americans died as a result of European colonization was not that Europeans killed them—they did kill thousands of course, and I hope it goes without saying that that’s terrible, but it was a small fraction of the total deaths. The reason such a huge number died and whole cultures were depopulated was disease, and the inability of medical technology in any culture at that time to handle such a catastrophic plague. The primary cause was therefore accidental, and not really foreseeable given the state of scientific knowledge at the time. (I therefore think it’s wrong to consider it genocide—maybe democide.) Indeed, what really would have saved these people would be if Europe had advanced even faster into industrial capitalism and modern science, or else waited to colonize until they had; and then they could have distributed vaccines and antibiotics when they arrived. (Of course, there is evidence that a few European colonists used the diseases intentionally as biological weapons, which no amount of vaccine technology would prevent—and that is indeed genocide. But again, this was a small fraction of the total deaths.)

However, even with all those caveats, I hope we can all agree that colonialism and imperialism were morally wrong. No nation has the right to invade and conquer other nations; no one has the right to enslave people; no one has the right to kill people based on their culture or ethnicity.

My point is that it is entirely possible to recognize that and still appreciate that Western civilization has dramatically improved the standard of human life over the last few centuries. It simply doesn’t follow from the fact that British government and culture were more advanced and pluralistic that British soldiers can just go around taking over other people’s countries and planting their own flag (follow the link if you need some comic relief from this dark topic). That was the moral failing of colonialism; not that they thought their society was better—for in many ways it was—but that they thought that gave them the right to terrorize, slaughter, enslave, and conquer people.

Indeed, the “justification” of colonialism is a lot like that bizarre pseudo-utilitarianism I mentioned in my post on torture, where the mere presence of some benefit is taken to justify any possible action toward achieving that benefit. No, that’s not how morality works. You can’t justify unlimited evil by any good—it has to be a greater good, as in actually greater.

So let’s suppose that you do find yourself encountering another culture which is clearly more primitive than yours; their inferior technology results in them living in poverty and having very high rates of disease and death, especially among infants and children. What, if anything, are you justified in doing to intervene to improve their condition?

One idea would be to hold to the Prime Directive: No intervention, no sir, not ever. This is clearly what Gene Roddenberry thought of imperialism, hence why he built it into the Federation’s core principles.

But does that really make sense? Even as Star Trek shows progressed, the writers kept coming up with situations where the Prime Directive really seemed like it should have an exception, and sometimes decided that the honorable crew of Enterprise or Voyager really should intervene in this more primitive society to save them from some terrible fate. And I hope I’m not committing a Fictional Evidence Fallacy when I say that if your fictional universe specifically designed not to let that happen makes that happen, well… maybe it’s something we should be considering.

What if people are dying of a terrible disease that you could easily cure? Should you really deny them access to your medicine to avoid intervening in their society?

What if the primitive culture is ruled by a horrible tyrant that you could easily depose with little or no bloodshed? Should you let him continue to rule with an iron fist?

What if the natives are engaged in slavery, or even their own brand of imperialism against other indigenous cultures? Can you fight imperialism with imperialism?

And then we have to ask, does it really matter whether their babies are being murdered by the tyrant or simply dying from malnutrition and infection? The babies are just as dead, aren’t they? Even if we say that being murdered by a tyrant is worse than dying of malnutrition, it can’t be that much worse, can it? Surely 10 babies dying of malnutrition is at least as bad as 1 baby being murdered?

But then it begins to seem like we have a duty to intervene, and moreover a duty that applies in almost every circumstance! If you are on opposite sides of the technology threshold where infant mortality drops from 30% to 1%, how can you justify not intervening?

I think the best answer here is to keep in mind the very large costs of intervention as well as the potentially large benefits. The answer sounds simple, but is actually perhaps the hardest possible answer to apply in practice: You must do a cost-benefit analysis. Furthermore, you must do it well. We can’t demand perfection, but it must actually be a serious good-faith effort to predict the consequences of different intervention policies.

We know that people tend to resist most outside interventions, especially if you have the intention of toppling their leaders (even if they are indeed tyrannical). Even the simple act of offering people vaccines could be met with resistance, as the native people might think you are poisoning them or somehow trying to control them. But in general, opening contact with with gifts and trade is almost certainly going to trigger less hostility and therefore be more effective than going in guns blazing.

If you do use military force, it must be targeted at the particular leaders who are most harmful, and it must be designed to achieve swift, decisive victory with minimal collateral damage. (Basically I’m talking about just war theory.) If you really have such an advanced civilization, show it by exhibiting total technological dominance and minimizing the number of innocent people you kill. The NATO interventions in Kosovo and Libya mostly got this right. The Vietnam War and Iraq War got it totally wrong.

As you change their society, you should be prepared to bear most of the cost of transition; you are, after all, much richer than they are, and also the ones responsible for effecting the transition. You should not expect to see short-term gains for your own civilization, only long-term gains once their culture has advanced to a level near your own. You can’t bear all the costs of course—transition is just painful, no matter what you do—but at least the fungible economic costs should be borne by you, not by the native population. Examples of doing this wrong include basically all the standard examples of exploitation colonialism: Africa, the Caribbean, South America. Examples of doing this right include West Germany and Japan after WW2, and South Korea after the Korean War—which is to say, the greatest economic successes in the history of the human race. This was us winning development, humanity. Do this again everywhere and we will have not only ended world hunger, but achieved global prosperity.

What happens if we apply these principles to real-world colonialism? It does not fare well. Nor should it, as we’ve already established that most if not all real-world colonialism was morally wrong.

15th and 16th century colonialism fail immediately; they offer no benefit to speak of. Europe’s technological superiority was enough to give them gunpowder but not enough to drop their infant mortality rate. Maybe life was better in 16th century Spain than it was in the Aztec Empire, but honestly not by all that much; and life in the Iroquois Confederacy was in many ways better than life in 15th century England. (Though maybe that justifies some Iroquois imperialism, at least their “soft imperialism”?)

If these principles did justify any real-world imperialism—and I am not convinced that it does—it would only be much later imperialism, like the British Empire in the 19th and 20th century. And even then, it’s not clear that the talk of “civilizing” people and “the White Man’s Burden” was much more than rationalization, an attempt to give a humanitarian justification for what were really acts of self-interested economic exploitation. Even though India and South Africa are probably better off now than they were when the British first took them over, it’s not at all clear that this was really the goal of the British government so much as a side effect, and there are a lot of things the British could have done differently that would obviously have made them better off still—you know, like not implementing the precursors to apartheid, or making India a parliamentary democracy immediately instead of starting with the Raj and only conceding to democracy after decades of protest. What actually happened doesn’t exactly look like Britain cared nothing for actually improving the lives of people in India and South Africa (they did build a lot of schools and railroads, and sought to undermine slavery and the caste system), but it also doesn’t look like that was their only goal; it was more like one goal among several which also included the strategic and economic interests of Britain. It isn’t enough that Britain was a better society or even that they made South Africa and India better societies than they were; if the goal wasn’t really about making people’s lives better where you are intervening, it’s clearly not justified intervention.

And that’s the relatively beneficent imperialism; the really horrific imperialists throughout history made only the barest pretense of spreading civilization and were clearly interested in nothing more than maximizing their own wealth and power. This is probably why we get things like the Prime Directive; we saw how bad it can get, and overreacted a little by saying that intervening in other cultures is always, always wrong, no matter what. It was only a slight overreaction—intervening in other cultures is usually wrong, and almost all historical examples of it were wrong—but it is still an overreaction. There are exceptional cases where intervening in another culture can be not only morally right but obligatory.

Indeed, one underappreciated consequence of colonialism and imperialism is that they have triggered a backlash against real good-faith efforts toward economic development. People in Africa, Asia, and Latin America see economists from the US and the UK (and most of the world’s top economists are in fact educated in the US or the UK) come in and tell them that they need to do this and that to restructure their society for greater prosperity, and they understandably ask: “Why should I trust you this time?” The last two or four or seven batches of people coming from the US and Europe to intervene in their countries exploited them or worse, so why is this time any different?

It is different, of course; UNDP is not the East India Company, not by a longshot. Even for all their faults, the IMF isn’t the East India Company either. Indeed, while these people largely come from the same places as the imperialists, and may be descended from them, they are in fact completely different people, and moral responsibility does not inherit across generations. While the suspicion is understandable, it is ultimately unjustified; whatever happened hundreds of years ago, this time most of us really are trying to help—and it’s working.