Saturday, December 29, 2012
Friday, December 28, 2012
It seems to me that having smart, ambitious, hardworking people become lawyers is a huge waste. When Apple and Google compete to produce the best smartphone operating system, consumers win as products improve. But while there's presumably some level of lawyerly incompetence that would be socially problematic, at the margin, big firms getting better and better at suing one other doesn't help anyone.
I think the basic idea is that law is a zero sum game, and more resources spent on lawyering just turns it into an arms race. Party A gets better lawyers so Party B has to get better lawyers and now we are spending more on lawyers, but it is still Party A vs Party B with the same facts and the same law and the same equally good lawyers (if better than the last ones) representing each client. We don't gain anything, just more expensive and subtle legal tricks to get to the same outcome
This way of thinking about the legal profession is breathtakingly stupid.
The basic problem here is that once Party A and Party B get better lawyers, they also might get a different outcome. Maybe Party A was going to win, but there is some subtle and obscure point of law or argument or fact that can only be dug up by great lawyering, so now Party B will win. It doesn't matter that the arms race means they *both* have great lawyers capable of making subtle arguments, once they got there it turned out that the subtle arguments are all in Party B's favor.
This happens. I've seen it. Sometimes, as things get elevated to better and more senior attorneys, someone catches something or writes something or thinks something that worse lawyers missed, and it changes the whole case, without the great lawyers on the other side having their own set of innovative tricks to change things back again. Better lawyers can change outcomes, and that means they can help society in three ways:
1. They Make Better Laws
In our country, courts make law. Better lawyers means better judges (who are normally required to be lawyers) getting better, fuller arguments presented to them by both parties before they make that law. I would guess that smarter judges hearing smarter arguments from smarter lawyers make smarter laws.
2. Our Legal System Can Bear More Complexity
I think there is a dumb idea among non-lawyers that the law is complex because lawyers and judges and legislators make it so. That ain't the case. The law is complex because the world is complex. *Really* complex. It is nice when the legal system can be complex too, because excessively simple rules either lead to 1. Unjust and inefficient outcomes as a mess of complex real world fact patterns are decided with too-simplistic rules not designed to account for them or, 2. A lack of predictability as the rules are made wishy-washy enough to deal with complexities on a case-by-case basis. So, as an example, here's a dude complaining that the world has gotten more complex with the advent of driverless cars, and we desperately need a bunch of complex new law to deal with it. New weird facts have raised uncertainties under the old, general laws, so now people want the law to be more specific and complex. Happens all the time.
But if we want a complex system where outcomes can hinge on subtleties, we need minds that can grasp subtleties to work that system. The basic limits on how complex the law can be without costs becoming unbearable are library sciences and lawyer smarts. The smarter the lawyers, the less we have to trade off flexibility for predictability.
3. It's fairer
There's probably a reason, once we dug up all the best, most subtle arguments, Party B won. When a party wins after the court has been exposed to all the arguments -- subtle and simple -- they are more likely to be the party we want winning then when a party wins after being exposed to only the most obvious arguments.
Anyways, I'm not claiming we should pay lawyers more or less or the same. Obviously the benefits of spending more on lawyering has costs. I'm just saying, the benefits exist in the first place. You can't unthinkingly dismiss the idea that spending a lot on lawyering is socially useful.
Friday, December 21, 2012
1. Policy has no effect. Markets do what they will do, regardless. The market uses the best prediction model, so economists’ macro models can, at best, replicate the market’s implicit model.
2. Policy has an effect, but markets try to anticipate policy. The expected component of policy has no effect. Only policy surprises have an effect.
It seems to me that the market monetarists (e.g., Scott Sumner) believe something closer to (2) than to (1). But (2) can get you into some strange conundrums. Does the Fed have free will? That is, does it have the ability to surprise markets, other than by acting randomly? If its actions are not random, they should be anticipated by markets. If they are anticipated by markets, then they should have no effect. etc.But what is the conundrum? He could just as truly be writing about Congress. Congress can write legislation that effects the market. Congress can effect long-term growth, price to dividend, and interest rates. Does Congress have free will? Does it act randomly?
The same "conundrum" surrounds firms. Only unexpected news about firms moves markets. Does that mean Bill Gates can have no effect on the price of Microsoft's stock? Could he wake up tomorrow and deliberately tank it? In fact, markets are always trying to anticipate what CEOs are doing and evaluate how their actions will change the value of the underlying stock.
So where is the conundrum? Why does thinking about the Fed this way make Kling so uncomfortable?
HT: Scott Sumner (with his own comments)
Monday, December 17, 2012
Update: Noah Smith with comments and links. Scott Sumner also comments. (neither comments are directed to me, just the more general debate).
Sunday, December 16, 2012
Meanwhile, mass shooting deaths are a fraction of a fraction of America's 31,000 plus annual gun deaths, and the relationship between gun control and crime is harder to suss out.
So gun control is about suicides. This is good, because it gets us to a core reason we might need state paternalism -- to protect the mentally ill from their crazy decisions. It has the added benefit of being less condescending to gun owners: "we know you are responsible, we know you can handle your weapon safely, but we are worried that some depressed member of your household is going to use that gun to off themselves when they aren't thinking straight."
And it gets the numbers into a world where severely restricting gun rights makes sense: the economic impact of the firearms industry was about 31 billion dollars last year (by their trade group's estimates), meaning, if we value lives at about $7,000,000 (a standard figure in public policy planning, I think), we only need to save just under 4,500 lives a year to make the complete death of the gun sales industry worthwhile. Not only do I think that is a realistic figure (there are 17,000 plus firearm suicides a year; deterring just a quarter of them from killing themselves would get us there), I think we can stop short of completely ruining all the utility people get out of gun ownership and completely bankrupting the industry (licensing guns to people when need can be shown (security guards, cops, etc), allowing rentals for firing ranges and hunting, perhaps still allowing a tightly regulated collecting hobby, etc).
So passing a restriction on big magazines or assault rifles to prevent mass shootings might be a marginally good idea, but it is going after a really small problem. The problem is suicide. The solution is heavy gun restriction.
If you think that people have an individual right to bear arms in the constitution, the solution is repeal of that right and heavy gun restriction.
Saturday, December 15, 2012
Friday, December 14, 2012
1. I would not have set any numerical thresholds at all. I didn't like specifying the calendar dates either. I thought that was bad policy if it was a commitment, and bad policy if it wasn't a commitment.
2. Generally, I think there's no substitute for taking a particular action at a point in time, and then carefully articulating why you are doing it. No need to map out the future. Once everyone understands how the state of the world maps into policy actions, we've reached bliss. No point in trying to describe how you map the state of the world into actions, as that will only confuse people, as we see here.
3. "At least now we have some idea of what they want to do..." No we don't. All we know is that they will raise the policy rate, if every, at some date after we cross the 6.5% threshold. When does QE end? When will the policy rate rise? Who knows?
I still find the position strange. He wants lots of transparency for the Fed's decision right now, but no information about the Fed's expectation for policy in the future.
He really doesn't like forward guidance:
The Fed says it is trying to get more leverage from its policy by being more explicit. But in its struggle to do that, it is not increasing the information content at all; if anything it is telling us less.I find it really hard to make sense of how providing more information can really be providing less information. If the new information was worthless, market participants can just ignore it and it does not harm.
On forecasting inflation, the monetary circumstances are so unusual now that there is a huge amount of risk in anyone's inflation forecast, including what you can infer from market prices. So risk is a problem, and its also a problem that the Fed gets to choose the inflation forecast that determines its policy actions.It's a fair point that forecasting inflation is hard. I think forecasting future stock prices is much, much harder, but I still think current stock prices have lots of valuable information about the future prospects of firms and the economy.
I wish he'd flesh out his views more on his blog. I'd like to understand his position better, as it seems very far from my ideal position.
Wednesday, December 12, 2012
You can back out the breakeven rate here. Potentially, looking at the five year rate is misleading as this could have been a bigger short term move (say the one year rose 15 bps and the four year forward 1 year rate hardly moved). I honestly don't know how to find those rates, though I hope to spend some time with a Bloomberg terminal and do my best to figure it out some time soon.
Saturday, December 8, 2012
Wednesday, December 5, 2012
A libertarian will exaggerate the extent to which a practice represents coercion. They are fond of saying, “If you don’t comply with xyz policy, men with guns will come and take you to prison.” I understand this argument and I generally take it as valid. However, I can also understand how someone with a different point of view might argue that when they pay taxes what they get in return is a fair deal.
That's characteristically open minded of him, since I think he mostly identifies with the libertarian position. But sadly, I think it rings false to anyone who has argued with libertarians. Maybe it's just me, but I most see libertarians exaggerating the extent to which human behavior is dominated by rational economic forces, both in terms of morality (what's really important here is material goods) and human behavior (people default to engaging in a series of mostly rational economic transactions). So take selling yourself into slavery: most people immediately dismiss the idea that that should be legal. But to a lot of libertarians, this just looks like an economic transaction -- a long term employment contract, of sorts. So the libertarian community has big arguments about whether this sort of thing should be allowed.
The point isn't that all libertarians endorse indentured servitude (most don't, I think, including King) or even that the ones who do endorse it are wrong. It's just that libertarians tend to see the world in terms of fair, rational, arms-length bargaining, to a super exaggerated extent when compared to other people. To pick a hyperbolic example, if, in the state of nature, a big man with a club meets a little man with a prosperous farm, in the libertarian world the little man is about to hire the big man as a body guard.
Errata (I am not good at short blog posts, but maybe I can get good at separating the stray observations from the main point. Feel free to stop reading here):
1. Of course, it isn't a bad thing for people to see the world in different ways, as King makes clear. Sometimes people do act like rational economic actors and libertarians figure it out before the rest of us and make good policy proposals, so go them.
2. Just for the record, I oppose letting people sell themselves into slavery, for a variety of reasons. If anyone cares I can make a blog post about it.
3. This makes libertarians sort of the anti-liberal/conservatives. If conservatives are constantly fearing barbarism and liberals constantly fearing oppression, libertarians are constantly pretty confident that everything will work out fine if we just give people the right incentives. This is even true of their big bugaboo, government. You hear the "men with guns will rob you" argument, yes, but in the main libertarians are surprisingly willing to ascribe what they see as bad government conduct to public choice problems. They very rarely think the government is a bad actor simply because it is full of oppressive barbarians, though historically some governments are.
4. Seeing the world mostly in terms of rational economic forces also explains King's argument about susan rice:
If you look at the biography of UN Ambassador Susan Rice, she apparently both inherited and married into wealth, received an elite education, worked for McKinsey, and now has a net worth of over $20 million. Yet people on the left describe her as oppressed, because she is African-American and female. I want to say, “Really?”
I don't know if Susan Rice is oppressed, but I know, "Went to a good school and is rich" does not equal "not oppressed," since society has important, non-economic/educational dimensions along which someone can be flexed with. You can imagine an American Jew in the 30's who went to Harvard, was born into money, and has a good job, but who is still dealing with very real oppression thanks to antisemitism (IE, can't join the clubs he wants, make the friends he wants, loses out on some business opportunities, etc. More importantly, all those real slights add up to living in a society that constantly reminds you you are an outsider, which has a real psychological cost). I'd add that you should not count a person un-opressed until they are dead: that same jew, were he Polish rather than American, would, in ten years, face clear and brutal oppression. Just so, Susan Rice may yet pay some sort of real consequence for her gender and race (lose her job?). Or not. Again, my criticism is more with the argument than with the underlying point.
Tuesday, December 4, 2012
First, Public Policy Polling found that 39 percent of voters have a view, pro or con, about Simpson-Bowles. Not bad, you might think. But a quarter of voters also had views on Panetta-Burns, a plan that as it happens doesn’t exist.
Meanwhile, another poll – internet-based, but by a firm with a good record — finds that, by a margin of almost four to one, people think that going over the fiscal cliff will cause the deficit to increase.
Greg, The “principle of charity” suggests you might want to read what I actually said:i.e. “I’m not quite sure why”, before setting off on one of your typical mindless rants. It seems that you are agreeing with me, i.e. I was not quite sure why, if what you say is correct. BTW, If you and your fellow Austrians want to go through life with your own private language that no one else understands, you’ll have about as much success as language purists who insist on calling happy people “gay.” Good luck.
Greg Ransom, I really can’t figure out if it’s all an act on your part, a big joke, or if you are just completely delusional. Sincerity? Charitable reading? I don’t think I’ve ever come across a less charitable commenter in my life, except for MF of course. I’m just going to assume you are joking and leave it at that. The alternative is too depressing.
This is from someone so patient he answers virtually all his thousands and thousand of commenters! I imagine the only counter-tactic is ignoring the troll, which I noticed seems to be the strategy of this latest post. Yet, there seem trolls he's already ignoring, and they are still trolling strong. Sometimes the trolls troll each other. I am no expert on troll behavior or troll avoidance, but I'd bet my co-blogger has more insight into troll dynamics.
PS. - Scott's comments are still an excellent source of information. I find an excellent way to skim them is just looking for his (ssumner) responses. If he says something interesting, you can go back and check the original comment.
PPS - At least 50% of our commenters so far are top economists.
PPPS. - This PPPS. and the previous PPS. and PS. are homages to Scott.
Sunday, December 2, 2012
So the common law makes a lot of use of a concept called "reasonableness." I think lawyers like to pretend that this is a very precise term of art with different, clear meanings in different situations, but the fact is that is crap. There's been manful work in trying to convert "reasonable" into a more objective standard -- several federal appellate judges have tried to make "reasonable," in the context of the tort of negligence, mean something like "cognizant of the cost-justified level of risk," for example -- but the fact of the matter is we frequently throw jury instructions to people that basically say, "Do you think the defendant acted reasonably? Reasonable means acting in a manner that is..." followed by vague bullshit.
And that's all fine. The law is never going to produce outcomes with mechanical certainty, there is plenty of room for vague concepts. But why this vague concept? Is it unique? What are the outlines of this "reasonableness?" Well, we can all agree that there is behavior the bulk of people think is reasonable, there is behavior a majority of people think is reasonable, there is behavior people disagree about, and there is behavior a large or small majority of people think is unreasonable. For most actions (most things that are done, I mean, not most kinds of actions), there is probably majority agreement about whether the action is reasonable (in a single society, anyway). And there are probably a lot of cultural, factual, random, and very human factors going into that judgment. So great.
The problem is, that seems very similar to a lot of human concepts: compare thinking about whether stuff is "reasonable" to thinking about whether it is disgusting, funny, sexy, etc. But the law is really loathe to use those concepts.
Take funny. Funny comes up in the law. Whether something is satire matters for copyright purposes. Whether someone is joking could matter for contract purposes (IE, did he make an offer to contract or was it just a joke). But the law normally avoids engaging the question of humor directly: it just asks whether a reasonable person would have interpreted it as a joke or contract offer, it defines satire without reference to whether it is *successful* satire, etc.
More interestingly, we could use "funny" as a concept by which to judge actions, like we do "reasonable." We don't actually care if someone saw a tortfeasor commit an act of negligence and thought it was reasonable. We only care whether his actions were, in some objective sense, reasonable. It's an "objective" standard.
So take the video of the naked wizard with a micro-penis prancing around a music festival until cops tase him. Was that reasonable force? I don't know! But let's propose another standard: police are justified in using as much force as is reasonable or hilarious. I think reasonable minds could disagree about whether the cops acted in a way that was reasonable, but they clearly acted in a way that was hilarious. If you don't think a naked wizard with a micropenis being tased is funny then you, sir or madame, are a stick in the mud. And maybe we can throw on another check, and get a law like: "force is justified when it is reasonable. If it isn't clear whether it is reasonable, it is justified if it is hilarious. If it still isn't clear, it is not justified if it is horrifying." etc. Rather than trying to parse close cases of reasonableness, we can set up a hierarchy of vague notions our society cares about and go down the list until it isn't a close case anymore. I care more about living in a society where cops can't do things that are horrifying than I do living in a society where cops do things that are marginally reasonable to a random collection of jurors.
This may be a really dumb idea.
The final line for me to cross in complete alienation from the right was my recognition that Obama is not a leftist. In fact, he’s barely a liberal—and only because the political spectrum has moved so far to the right that moderate Republicans from the past are now considered hardcore leftists by right-wing standards today. Viewed in historical context, I see Obama as actually being on the center-right.Tell most Republicans this and there evidence against will be a health care plan that was first floated by Heritage.
It still isn't widely appreciated how many of the best ideas from the right (and in particular from neoliberalism and neoclassical economics) have bee co-opted by the left. Every wonk's preferred climate solution is Cap and Trade or gas taxes, not regulation. When Obama attacked Hillary Clinton on trade, he had his chief economic adviser call Canada to reassure them that we don't really believe this stuff. Remember Romney's plan to limit tax deductions, that was Obama's idea first.
Listening to Free to Choose debates, Milton Friedman sounds like Matt Yglesias: stop restrictive zoning, fight poverty with the earned income tax credit, increase immigration...
In a better world, the political parties would be separating Bruce Bartlett and Matt Yglesias. In many ways, the wonk spectrum is divided that way. Unfortunately, the public is not.
Saturday, December 1, 2012
I was hoping Russ would press him on one point I can't comprehend, which is central to Cochrane's argument. First, we agree that insurance should be long-lived and guaranteed renewable. Meaning, if a person gets sick, the insurance company can't drop them or raise their premiums. This makes perfect sense to me. The reason we buy insurance is to insure ourselves from risk. In this case, the risk of getting really sick in a way that will cost a ton of money for care. If I buy insurance that only lasts one year and I get cancer, I'll get the benefit for one year, but the next year when I try to renew my premiums will go sky high. What good is that? The answer is obvious. I need to buy "insurance insurance." I need insurance against the risk that my premiums rise. Of course, if insurance insurance isn't long lived, I'll need to insure the risk my insurance insurance premiums rise and this rabbit hole goes on and on. It's turtles all the way down. This logic leads to the idea that insurance should be long lived. Rather than buying an infinite number of insurance contracts, I can buy on contract that never expires.
What I can't figure out is this statement?
Now, the “adverse selection” phenomenon, that sick people are more likely to buy insurance, and healthy people forego it, is a big problem. But the insurance company charges the same rate, not because it can’t tell who is sick – a fundamental, technological, and intractable information asymmetry. The insurance company charges the same rate because law and regulation force it not to use all the information it has. If anything, we have the opposite information problem: insurers know too much.As best I can tell by following his links, health status insurance is the insurance insurance I just discussed. So John's big idea is the asymmetric information isn't a big deal, the real problem is that insurance companies can't charge sick people higher premiums.
This source of adverse selection is a legal and regulatory problem, not an information problem, and easily solved. If insurance were freely rated, nobody would be denied. Sick people would pay more, but “Health status” insurance shows how to solve that.
Suppose that two parents have a kid that is covered on their insurance, until he's twenty-five. Then he has to go to the market and buy his own insurance. Now suppose when he's twenty-four, he gets cancer. In John's world his premiums should skyrocket. I think he would argue that the parents should buy "insurance insurance" for the kid. The parents need to buy insurance against the kid's future high premiums, before he gets sick. Obviously, they can't do that after he's diagnosed. The "insurance insurance" would be too expensive. They need to do it earlier. Perhaps, when he is born. Though what if we find he has complications? Perhaps, when he's conceived? But what if the parents have genetic predispositions to certain diseases? The kid is more likely to become sick, thus the insurance on his future premiums must be higher. Maybe they'd be high enough that the two parents wouldn't get married, because of the possible complications. Oh no, two people who love each other can't get married. What if the grandparents stepped in and helped out? They could buy "insurance insurance insurance," they could hedge the risk that their son or daughter grew up wanting to marry someone who wasn't as genetically compatible.
Maybe this sounds convoluted, but I'm trying to get to the notion of complete markets. Complete markets means that all risk that can be insured is insured. Since we are risk averse, complete markets make us all better off. If one of our houses burns down, we'll all chip in $100 bucks to get us back on your feet. The Amish did it literally, but nowadays we do it through insurance companies. The premium on home insurance is just the $100 bucks that goes to some unlucky person that just watched their home go up in flames.
But in a truly complete market, ALL risk is insurable. I could insure against a risk, before I was ever born, before I ever had a medical history. In a truly complete market, we insure all risks at "time zero," before we even exist. I picture a random soul in heaven, just like all other souls. One of the risks those souls want to insure against is sickness. Maybe being born sick. Maybe being sick later in life. Basically, they don't know when it will or if it will happen, but there's some risk they'll get sick. So they get with all the other souls and agree, we'll all put money aside, and whoever gets sick gets the money. That's insurance. My question is how much would each put in. Well, it's obvious they'd all pay the same. They are exactly alike in every way. It's only fair.
The point I'm trying to make is that in John's system, no matter how you slice it, there will be some choke point along the way. What if we switched from our system to John's tomorrow? A lot of healthy people would buy guaranteed renewable insurance, but a lot of sick people would be out of luck and face exorbitant premiums. If we are in a system where everyone is paying a different price for insurance, then we can't possibly be at the complete markets case. If we aren't at the complete markets case, either John's policy is suboptimal or there is some friction that prevents us from getting to the complete markets case. So what is it?
The wrench that I haven't thrown in yet is incentives. If I have guaranteed insurance before I am born, I'm much less incentivized to put effort into maintaining my health. I may drink like a fish or eat too much. I may smoke or do drugs. Maybe I just won't sleep enough. We make decisions that affect our health. This is a "friction." This is a reason that the complete markets case may not work (as if the having to buy insurance before your born wasn't enough). Maybe this is the sort of important friction John has in mind, because for conditioning on pre-existing conditons he gives these examples in the podcast, "Fat people don't pay more than thin people; smokers don't pay more than non-smokers. All sorts of things they don't condition on." Russ corrects him that they can condition on smoking, which in my understanding isn't that big of a bump in premium. I don't have a problem with insurance companies conditioning on smoking or charging a higher premium on people like me that eat and drink too much. It's the all sorts of other things I don't want. What about something simple like being female? Women have to pay higher insurance premiums, because women have babies. In a complete market, women would pay the same premium as everyone else. They'd buy their insurance before they had a gender (or even parents) and pay the same price as everyone else.
Conditioning on effort is fine to the extent that an insurance company can do it. But what they really want to do is condition on how sick we are. People with cancer pay more, and I don't see John distancing from that. I can't imagine by pre-existing condition he really means "big sweet tooth."
I thought I found a lot to like in the essay. I think there are lots of regulations that make health care more expensive and that the health care market should be more competitive. But I was really jarred by this statement, "Romney was pushed on what he was going to do, he said: Well, but of course we can't let insurance companies discriminate on pre-existing conditions. Well, once you've done that, you've swallowed the fly--the old lady that swallowed the fly...And once you do that, you've got most of the ACA." He's really arguing that my disagreement is irreconcilable with his preferred health care solution. Which makes sense, if my story is correct then charging everyone the same price and mandating everyone buy insurance sounds pretty close to the preferred solution. Since in a truly compete market, we'd all pay the same health care premiums. His preferred solution must be a market frictions story, but its a story I can't understand and he spends a good deal of the podcast and paper dismissing frictions in the health care market. If there is a well-formed second best model there, I'd love to know it.
Friday, November 30, 2012
In Part I, we defined the Efficient Markets Hypothesis and introduced the joint hypothesis problem. I don't want to primarily post on zombie debates, but John Quiggin's book gives me a chance to discuss a little bit about what a lot of modern finance is built on, before I start blogging about whether or not stochastic volatility is a risk factor in a linear factor model (stay tuned!).
I'll let Quiggin start us off with his view:
“But as a string of philosophers of science, being with the late Karl Popper, have shown, a theory that can’t be refuted by any conceivable evidence isn’t really a theory at all…The global financial crisis, along with the earlier dotcom crisis has shown that, on any ordinary understanding of its terms, the efficient markets hypothesis can’t be right…So supporters of the efficient markets hypothesis have sought a redefinition that would make it invulnerable to refutation…This argument in one form or another has been put forward by all the leading defenders of the EMH, notably including Eugene Fama and John Cochrane of Chicago and Scott Sumner of Bentley University.”
Quiggin argues in the chapter that trying to squirm out of irrefutable evidence EMH defenders have changed the theory over time to render it useless. That narrative is completely false. Here is Eugene Fama in 1970 in a seminal paper on the EMH, before he was the “father of modern finance” and was just a young professor trying to sort out the theory, “the theory of efficient markets is concerned with whether prices at any point in time "fully reflect" available information. The theory only has empirical content, however, within the context of a more specific model of market equilibrium, that is, a model that specifies the nature of market equilibrium when prices "fully reflect" available information.”
It’s not nearly as elegantly stated as it is in the previously linked podcast, but that's the joint hypothesis problem in its first formulation in 1970. I am really surprised it isn’t front and center in Quiggin’s account of EMH, because it is certainly front and center in any finance course discussing the testing of EMH. The joint hypothesis problem isn't new, and it isn't something that proponents of EMH have been hiding for the last forty-two years.
Is this a sham? In finance, It's pretty humbling to try to create the "right" theory for prices. The world is complicated and modeling that is hard. How many essential types of risk are there? Can I really model them all? Even the most important ones? What about cash flows? Am I certain I can predict how the growth of the internet and technology will effect firm's various business activities? Is it possible to imagine a world where the dotcom bust doesn't happen, a world with a few more Amazon's, a world where the biotech boom that was so desired actually pays the dividends we dreamed about? Believe me, I'm open to the idea that bubbles can occur. Here is a really good case that the dotcom crash was a classic bubble/mania, but let's admit that the endeavor of diagnosing a bubble even ex post is not simple, much less ex ante. We only observe one outcome of many possible futures.
So I've argued that Quiggin's narrative is wrong. Testing EMH may be impossible, but that isn't something Quiggin discovered. Academics have been discussing the joint hypothesis problem, since the EMH's inception, rather than stuck in a self-erected cell built by constant squirming from critics. In part 3, I'll try to argue all is not lost, if the EMH isn't testable.
Thursday, November 29, 2012
John Quiggin, author of Zombie Economics, graciously engages this post I made in response to his book in the comments. He also points to an interesting and easy to read paper he wrote on the equity premium puzzle. My real critique is that the equity premium puzzle isn't an EMH puzzle it's a macroeconomics puzzle. Let me try to explain the difference.
In Quiggin's book and definition of EMH he is confounding two ideas:
Efficient Markets Hypothesis - prices fully reflect all available information.
Market Efficiency - a well functioning market will allocate all resources in the best possible way
The second idea is often strictly defined as the First Fundamental Welfare theorem, which basically says that if you make a bunch of assumptions (that aren't true) like markets are perfectly competitive, markets are complete, no externalities and perfect information, then the market outcome is efficient. In this case, efficient means pareto efficient, a weak notion that means we can't make one person better off without hurting anyone else.
This confusion explains a lot of odd statements he makes, like, "The Efficient Markets Hypothesis implies that governments can never outperform well-informed financial markets."
The first fundamental theorem does say that (under very restrictive assumptions) and if our notion of improvement is limited to pareto efficiency, but the EMH just says markets adjust in the background. Let's say there is an negative externality called pollution. A government may be able to enact a policy to limit pollution and make everyone better off, say a tax on gasoline. The EMH just says that stocks will adjust to that new policy. The tax on gasoline will limit the amount of gasoline consumed, so companies like Exxon and BP will see their profits decrease. People will probably drive less, so Ford's stock will go down. The EMH just says that security prices will reflect all available information.
The EMH is still not a weak hypothesis. If we imagine that the government is deciding on whether or not to enact the policy, the market prices must be constantly adjusting to the updating chances that the knew policy will be enacted. The prices must be the best guess for the properly discounted value of future dividends for every stock in the market, even stocks that will only be barely affected by the law, like a theme park that will lose profits, because it is far out of town and a few less people will want to make the drive.
Wednesday, November 28, 2012
So for a long time Rome's legal system had these people called the jurists. If you were in a lawsuit you would go to a jurist and tell him about your case. Then he'd write a legal opinion applying the law to your facts (normally favorably), tell you exactly what to plead, etc. He wouldn't actually argue the case -- advocates like Cicero were for that -- but he'd come up with smart reasons for why you should win, and would grapple in smart ways with any novelties or tough questions of law your case presented.
If a Jurist was particularly smart, his decisions would sort of take on an air of gospel truth, and eventually become law. And this worked great. Over time the Romans developed the most important legal system in world history, still the basis of the law in dozens of countries, exactly this way. But as time dragged on more and more jurists kept writing. By the middle of the empire, when jurists stopped being a thing, there was a *lot* of gospel truth out there, written by a *lot* of well respected jurists.
So it became a library sciences problem. And, as they have so often in the past, the library sciences failed civilization. Romans just didn't have the publishing industry or the filing skills to make sure anyone -- much less hick lawyers out in the provinces -- had access to what every jurist said ever. So some lawyer in northern France would go on vacation in Spain and come back with a bunch of books he found (authentic? who knows!) from famous jurists. Suddenly, he's throwing out established legal "facts" no one in the entire province had ever heard before. Big problem!
So the emperor Justinian fixed all that. First, he basically pruned the list of people whose writings were considered "canon." Then, he went through the writings of the people who were left, cutting and pasting, arranging by topic, and throwing a lot of stuff out. Only what he left in counted as law. That became the digest, and it's the most important legal work ever in the history of animals.
So what can we learn from all this? Well, sometimes perfectly good methods for generating law, if left on too long, generate too much law. And sometimes going through all that big mess of law and throwing out the bad stuff and keeping the good stuff works wonders.
This has a huge bearing on our society. We don't have jurists, but we do have the common law, and the most unique characteristic of common law legal systems is that judges can make law. Full stop. When Americans talk about "the law," they aren't just talking about all the bills passed in all the legislatures, they're talking about every word every appellate judge has said since the 1700's. And that's a lot of law!
Fortunately, library science has kept up -- who knows where we would be without computers -- but while we are physically capable of managing all that law, you can't help but wonder if all the expense is worth it. When you hire a lawyer you are paying for him to subscribe to a service that collects and annotates all those cases, paying for him to search through all those cases, and paying for him to try to make sense of all of them and how they affect you. It ain't cheap! Multiply that by hundreds of thousands of lawyers and you get a lot of money being thrown after this stuff.
People are cognizant of this I think, though it's hard to separate complaints that the law is too complicated (in this complex a society, probably inevitable) from the complaint that there is just too much of the damn stuff. But even though people are aware of it, you almost never hear anyone propose Justinian's solution: let's just throw out a lot of the common law. People have codified the common law before, but that process, while radical, normally clarifies that anything not intentionally changed in the common law still matters, and normally allows for past common law to interpret the new code, so it's not as radical as what I am suggesting: put together some panels, decide what cases count and what don't, and move on, the vast bulk of American common law gutted from the system. Will it be a political process? Probably. Will it run into due process and contract clause problems if it tries to be retroactive? Yup. Is it still worth doing? I don't know! But it's worth thinking about.
I suspect your opinion on the indeterminacy of the law -- how capable the law if of "forcing" outcomes to legal cases on judges and juries -- affects how you think about the Justinian solution. If you think the law is pretty indeterminate, then all that common law floating around doesn't do much but complicate the process of judges making pragmatic policy decisions. If you think the law forces decisions on judges, then all that common law floating out there should make decisions more automatic and easy, since so many cases have already been addressed.
Short blogging, I an't good at it.
Lucas is not the straw man he's sometimes made out to be.
My favorite bits:
"But the term "Lucas critique" has survived, long after that original context has disappeared. It has a life of its own and means different things to different people. Sometimes it is used like a cross you are supposed to use to hold off vampires: Just waving it it an opponent defeats him. Too much of this, no matter what side you are on, becomes just name calling."
Defending New Keynesian models?
If we accept any version of the Quantity Theory of Money then it seems clear that it does not hold at high frequencies (which is what I think price stickiness means). If we don't accept the Quantity Theory of Money at low frequencies then I guess we should just close up shop. There are some hard unresolved problems to be faced.
Causes of business cycles. This is the first time I've heard any macroeconomist say this explicitly, but it is also my view:
I drew from this the idea that all cycles are probably driven the same kind of shocks. Since I was convinced by Friedman and Schwartz that the 1929-33 down turn was induced by monetary factors (declined is money and velocity both) I concluded that a good starting point for theory would be the working hypothesis that all depressions are mainly monetary in origin.
Ed Prescott was skeptical about this strategy from the beginning...He also thought we needed to have some kind of benchmark theoretical model to give us a start...
As I have written elsewhere, I now believe that the evidence on post-war recessions (up to but not including the one we are now in) overwhelmingly supports the dominant importance of real shocks. But I remain convinced of the importance of financial shocks in the 1930s and the years after 2008. Of course, this means I have to renounce the view that business cycles are all alike!
This is beautiful.
Q: If the economy is currently in an unusual state, do micro-foundations still have a role to play?
Lucas: "Micro-foundations"? We know we can write down internally consistent equilibrium models where people have risk aversion parameters of 200 or where a 20% decrease in the monetary base results in a 20% decline in all prices and has no other effects. The "foundations" of these models don't guarantee empirical success or policy usefulness.
What is important---and this is straight out of Kydland and Prescott---is that if a model is formulated so that its parameters are economically-interpretable they will have implications for many different data sets... This kind of cross-validation (or invalidation!) is only possible with models that have clear underlying economics: micro-foundations...This is bread-and-butter stuff in the hard sciences. You try to estimate a given parameter in as many ways as you can..."Unusual state"? Is that what we call it when our favorite models don't deliver what we had hoped? I would call that our usual state.
Tuesday, November 27, 2012
After reading this feisty exchange between Stephen Williamson and John Quiggin, I wanted to address an argument Quiggin raises against the Efficient Markets Hypothesis (EMH). I read the EMH chapter in his book, Zombie Economics, first, just to make sure I was really seeing the strongest form of his point and not some watered down blog version. While there is much in the book I disagree with, I think Quiggin attempts to grapple with his opponents’ strongest arguments. And he’s a first rate economist (top 1% according to this ranking).
What is the Efficient Markets Hypothesis?
Quiggin gives this definition, “financial markets are the best possible guide to the value of economic assets and therefore to decisions about investment and production. This requires not only that financial markets make the most efficient possible use of information, but that they are sufficiently well-developed to encompass all economically relevant sources of risk.” I honestly don’t know what that means. What is an economic asset? Are there non-economic assets? “Best possible guide for who”? Encompassing all risk sounds like a notion of market completeness, but that isn’t a requirement of market efficiency. Market completeness is just the notion that any risk I have can be insured. This is obviously not true; for instance, I think I'll get a PhD, but I might not. I could flunk out. I'd love to buy insurance against that possibility, but I can't. Does that mean IBM’s stock isn’t fairly priced?
I’m going to use a simple definition given by Eugene Fama in this podcast and seminal paper, and since Fama is one of the major foils in the book, that seems especially appropriate. EMH says, “prices reflect all available information.” This obviously leads to the question, what is the “available information”? Fama broke the EMH into three forms, in order to try to encompass the types of tests people were doing at the time (he regrets this, btw). The forms are weak – the relevant information is past prices, semi-strong – the relevant information is all publically available data (financial statements, earnings announcements…), or strong all public and private data. Quiggin is mostly talking about the semi-strong form, which is standard.
We just have to cover the “prices reflect” part and this is really the crux of the issue. Quiggin argues that EMH implies that prices generated by markets are “right” (scare quotes in the original). The only distinction Fama would make is that they are the best guess, but not necessarily correct. Otherwise they would agree on this statement by Quiggin, “the value of an asset is determined by the flow of income it generates over the period for which it is held and its disposal value. This stream of payments can be converted into a current value by a discounting procedure: [at the] “right” discount rate.” I like this statement. To know what the price should be, we need to know its future cash flows and we need to know what rate to discount the flows.
Here is the crux of the issue. In order to know if the market prices are right we need some theory to tell us what the cash flows will be and more importantly, how to discount them. But how do we know if our theory is correct? In order to test our theory, we have to assume markets are efficient and see if our theory matches market prices. This is called the joint hypothesis problem and has been taught in finance courses for a long time.
This problem really should have been central to the chapter (as it is in Finance courses), because every one of the reasons Quiggin gives in refutation of the EMH is subject to the joint hypothesis problems. Stock prices are too volatile. How volatile should prices be? We need some theory. Is the theory wrong or EMH? Quiggin places great weight on the recent financial crisis, and after every market crash there is always lots of clamoring against EMH. But what theory says markets can’t crash?
Quiggin argues that EMH has been redefined in response to criticism to make it unfalsifiable. As such it isn’t science, but a new sham hoisted on you by the finance community. In Part II, I’ll argue at the very least, it’s an old sham :-). And that maybe there is some hope.
Lots of problems with that, but the biggest is that campaign spending had very little to do with the fall of the Roman Republic. The decades before the empire are largely a story of private armies fighting civil wars: First Marius raised a private army loyal to himself and dominated politics, than Sulla did, then Caesar and Pompey did, then they fought with their private armies and Caesar won, then Marc Antony and Augustus took Caesar's private army and killed the people who killed him, then they fought each other. Finis rei publicae. And those were just the big names, plenty of other people tried this "raise an army and take over" shtick. For example, the article mentions Cicero as a dude who hypocritically fought for less campaign spending. Which I guess he did? But his most important act as Consul was to put down the Catalinarian conspiracy, a plot to -- you guessed it -- raise a private army and take over Rome.
The Republic fell for a lot of reasons, and I don't want to oversimplify this. Roman politics at that time was an eddy of factionalism, ambition, and ideology as aristocrats fought demagogues (the optimates vs the populares) provincials fought citizens (the social wars), and patronage networks fought for dominance (see Cicero's entire legal career). But at the end of the day the Republic fell because individuals kept raising armies, starting civil wars, and seizing power. It's just not a story about messy political campaigns --Caesar and the senate didn't fall out over a super PAC-- it's a story about powerful generals with access to loyal veterans and large fortunes jockeying for power. Unless you have a much lower opinion of our officer corps than the average American, that is not going to be a problem here any time soon.
Saturday, November 24, 2012
Advocates of the rule see it as an obviously correct workplace safety regulation: unprotected sex is dangerous, these people are having unprotected sex on the job, let's protect them.
Except that's not fully convincing. Some jobs are dangerous -- fishing off the coast of Alaska, building a house, repairing broadcast towers. People die doing this stuff. But we let them because our society is not all about maximizing safety.
In life there are risks and there are rewards, and generally we trust tort law and the free market to sort that out. If someone wants to pay you to do something dangerous, he'll have to pay you more. If someone is negligent or lies to you to put you in a dangerous situation you can sue them. When do we depart from that rule? Do any of those exceptions apply here? Let's find out!
Reasons for regulating health and safety:
1. Information overload: Consumers gotta consume, and in the modern economy they are faced with a lot of options. Of the thousands of restaurants in your city, which are safe? Which brand of toothpaste is safest? Is the escalator in this mall dangerous? Tough to say! In situations like that, where there are big information asymmetries some people think it makes sense to protect the ignorant party. Rather than being paralyzed having to research a hundred restaurants you can just show up and be pretty confident some official has inspected the kitchen. Score.
This doesn't really apply in this case. The porn stars aren't random people who wandered onto a set, this is their profession. They're aware of the safety precautions that have been taken (mandatory testing), the safety precautions that haven't been taken (no condoms), are comfortable with that mix.
2. Tough Bosses: The "let's just let the free market work it out" rule implies that employees and workers will negotiate the "correct" mix of safety and danger. A lot of people aren't comfortable with that, and think that employers have some coercive power over employees, maybe because of transactional costs (hard for employees to unite and negotiate as one), maybe because of the market just not being a magical cure-all, whatever. So the workers want a safety railing and the evil plutocrat says "no!" Society passes regulations to get them that railing.
This certainly doesn't apply in this case: it's for situations where management and labor are fighting, but teh porn stars oppose this regulation as heartily as the owners.
3. Human Rights: Some things are just wrong and people shouldn't be allowed to do them. Lots of people think you shouldn't be able to sell yourself into slavery, or work an 11 year old for 12 hours a day in a factory, or whatever.
I don't think this applies here. Lots of people think you shouldn't be able to sell sex, but no one thinks you shouldn't be able to have sex without wearing a condom. Condom-less sex is not the sort of act so insulting to human dignity that we want to ban it.
4. Externalities: Management and labor agree that they are causing the right amount of pollution, but maybe the dude downstream for where they are dumping the toxic waste disagrees. We impose regulations on things that could be seen from a worker-safety perspective -- handling toxic waste -- because we are actually worried about other people -- the civilians downstream.
I don't think this applies here. Yes, people who have condom-less sex risk contracting and spreading disease. But that's true of people who are doing it professionally and people who aren't. If this regulation isn't targeted at protecting porn starts, its protecting everyone, everyone should be willing to live by the same rule (IE, condom-less sex should be banned society wide).
So of all the traditional reasons I can think of for workplace safety regulation, none of them seem to apply here. This looks a lot more like "I know this is a risky job, but it's not crazy risky ("porn star" is not the most dangerous job in America, by a long shot), my boss is taking some reasonable precautions and I'm getting paid a premium for the danger. Let's do this." And in a free market society, that's pretty much how we apportion risk.
Did I miss something?
Basically the dispute is safe sex advocates on one side and the porn industry (and, crucially, the porn stars themselves) on the other. It's a pretty simple argument: "This is basic workplace safety stuff, and promotes safe sex besides." vs "We already have a vigorous STI testing program that keeps performers safe. We don't want to go further since using condoms hurts profits, both because dudes are dumb and don't like watching condom-porn and because it increases production costs, since condoms chafe a bit, especially over the super-long sex sessions used on a shoot, and actors and actresses need to spend more time on a shoot resting when they are used." I strongly suspect the pornographers are right on this one, and I'm going to do a series of blogs explaining why. I am planning on three posts: why it's a bad idea as workplace safety regulation, why it's a bad idea from a first amendment point of view, and why it's a bad idea from a privacy rights point of view (there should be a better term for the kind of rights I am talking about, but the courts call them privacy rights so I will to).
Crucially, I won't be doing a close cost-benefits analysis of how much this will cost the industry vs. how many people it will save from STIs. I think that's the most relevant kind of way to figure out the right solution here, but that sort of thing is hard to do. Suffice to say there are real costs (Vivid pictures tried to go all condom and was losing so much money they had to stop) and real benefits (people won't get sick, duh) involved here.
Click here for part 2 of this series, IF YOU ARE MAN ENOUGH. Or woman enough. Or gender-is-a-spectrum enough.
I'd take it one step further: we should support the individuals in the military because they are great, not because they are in the military. Most of the people I know in the military are smart and hard working and funny and thoughtful and conscientious. In most cases, I don't think that's because they are serving, it's just how they are (often I know this, because I knew them before they enlisted or got their commission). The military has been an important road out of poverty for a lot of people I know, but if we gave them a civilian road (better and less costly education options? More use of professional internships for high schoolers, along the German model?) I think they'd be just as well off.
I feel semi-comfortable generalizing my personal experiences, here. It's really hard to make a great person at the age of 18, so it makes sense that most soldiers and sailors and airmen and marines were probably pretty awesome from the get go (albeit needing a bit of maturing). Under this telling, it's more about great people being attracted to a life of service and sacrifice than it is great people being forged by a life of service and sacrifice and fighting lava monsters. So yes, the troops are impressive people doing a great thing and should be thanked and respected for it, but we should recognize that if this was pre-WWII and we didn't have a large standing military, most of them would still be impressive people doing something great and impressive and charitable for their fellow Americans. Or, you know, slaves. Things sucked back then.
Once you separate that, supporting the bad-ass people who are the troops from supporting the troops, two things happen. 1. You are a lot more prepared to encounter the (incredibly small) minority of people serving who suck. 2. The military, as opposed to the troops, looks less unambiguously good. The military isn't what made all these great troops we should support. They were already great. No, the military is what took all these great, hard working, smart, idealistic people out of the economy that builds things and put them in the economy that blows things up.
Maybe we are blowing up the right amount of things, and if we spent less on blowing things up we'd be less safe, less free, and less able to invest and trade. Maybe we are spending too much. But that calculation should be based on how much stuff we want and need to blow up, not on whether we support the troops. Once we start blowing up or preparing to blow up too much stuff, each extra servicewoman assigned to that task is a major waste, a transformation of one of our great creators into a great destroyer. And it doesn't do her many favors besides: giving the individuals in the military a robust economy and lots of alternative careers after military service is the single best way to support them, not wasting trillions on military spending.
So support the troops, they're great and we owe them. But don't let that support affect how you think about military spending. If we cut military spending and lose 5 combat brigades, that's not thousands of troops hurt; it's 1000s of great people who are going to get a chance to do great things for the civilian economy.
And yes, I realize that is a lot stronger argument at full employment than it is now, in an economy where laid of veterans risk unemployment. That's just reason 50000 to wait for the economy to improve before cutting spending, on the military or on anything else.
Wednesday, November 21, 2012
Currently the idea is to cover economic and legal policy. I have no economics training and my legal training ain't any more special than hundreds of thousands of other lawyers, but I can at least promise to keep the racial epithets to a minimum.
Rule of thumb: anyone trying to simultaneously make you scared of both
1. the fiscal cliff and 2. not getting the deficit fixed in the next few years
has a bad underlying model of how the economy works. The "fiscal cliff" is a bunch of tax hikes and spending cuts that get rid of the deficit real fast. Since the "fiscal cliff" is just sharp deficit reduction, if going off the fiscal cliff is a bad idea right now, by definition sharp deficit reduction is a bad idea right now.
You should also be wary of people who oppose stimulus but support the fiscal cliff. If cutting a lot of government spending and raising taxes is a bad idea right now because it will hurt the economy, maybe lowing taxes and raising spending is a good idea because it will stimulate the economy? As near as I can tell, if the fiscal cliff is a bad idea it's a bad idea for pretty Keynesian reasons.
That said, it is possible to be worried about both the deficit and the fiscal cliff, but you should expect those people to talk about the deficit as a long term problem we have some time to fix. If we have to fix it now now now, then the fiscal cliff does that. If we have some time and if we want to keep spending up and taxes low now to stimulate the economy, then the fiscal cliff is too abrupt and should be avoided.
Thursday, September 13, 2012
For those that don't know, kickstarter is a website where artists can propose projects and ask for funding to help make them a reality. Lately, it's become big in the video game industry as a way to get good sized funding for a game. Take the current Homestuck adventure game kickstarter campaign. It's one of the big successes in the history of kickstarter -- 1.2 million funded at this time and still 20 days left to go in the campaign. So hooray, weird niche indie game finds funding!
But it hasn't really found funding. Almost everyone who is contributing "funding" is actually purchasing a copy of the game: everyone who contributes at the lowest level,15 bucks,gets a copy. Higher levels get a copy plus some gewgaw, like a t-shirt or themed deck of cards or whatever. Kickstarter isn't funding the game, it's taking pre-orders.
So 12,100 backers times 15 dollars equals... $181,5000. So how has the game raised over a million dollars? Price discrimination. Price discrimination is the simple idea that even if you make the most money selling widgets for five dollars, you still have rich customers who love widgets and would buy them for six bucks, and there are still poor people out there who would buy your widgets at a still-profitable four dollars. So to capture all those rich people at the higher price level you add some bells and whistles that cost you next to nothing, and sell a DELUXE edition for six dollars. Then you chop off some features, even though it hardly saves you a thing in the costs department, and sell the BASIC version to the poor folks. In the video game industry this has traditionally been done by selling deluxe editions to rich people at launch and by selling gradually cheaper versions of the game as time goes by after launch to capture the poor dude's dollar.
Kickstarter is doing price discrimination in a new way. Even though any of the contributors could get the game for 15 dollars, they get some cheap trinkets if they pay more. More importantly, they get to feel like they are helping in the grand cause of getting this thing they want made. So, for example, a dude contributed 10,000 dollars to the Homestuck kickstarter campaign. What's weird is that video game players are fine with and celebrate kickstarter, but other forms of price discrimination -- blocking out content already in a video game unless customers pay more, for example -- infuriates them. Tell a gamer that if he pays more he will get a trinket and it will go towards the publisher making better product and he gets super excited. Make the exact same proposal but hide the basic nature of the transaction by telling him he's buying downloadable content and he gets furious. Robin Hanson might get excited here about the importance of signaling honesty.