The Illusion of Irrationality: Free Is Fun

A friend loaned me his copy of Predictably Irrational, by Dan Ariely. Ariely's a behavior economist, exploring all the ways people don't react in quite the same ways theory predicts. It's a fascinating area of research, a blending of economics and psychology. The book itself is well written and the content makes you think. But it goes way too far.

Because people don't act as theory predicts, Ariely proclaims they are irrational. In reality, the theory doesn't capture all the elements in play (or Ariely's not acknowledging they do). For example, Ariely dedicates chapter three to how people will get something just because it's free, even if it's not the better deal. They'll choose the free $10 gift certificate over a $20 gift certificate which costs seven dollar (effectively choosing $10 over $13). But people like getting things for free. Even if it's not really free, even if we know it's not really free.

Ironically, Ariely said it best: "FREE! gives us such an emotional charge that we perceive what is being offered as immensely more valuable than it really is." (p54) If it gives us that emotional charge, it really is more valuable. People also gamble though few will think they actually come out ahead. The joy comes from those few times you win. That joy, that emotional charge of getting something for nothing, is valuable to people and they'll gladly pay for it in the form of a lost opportunity.

My theory is easily testable (though expensive). Start by offering the $10 gift certificate versus $20 certificate for $7. Then increase that value from $20 to $30 then $40 then $50, steadily increasing the (opportunity) cost of the indulgent from $3 to $13 to $23 to $33. I'll bet you'll see more people start grabbing for their wallets, rationally determining that the joy of FREE! isn't worth the cost.

Comma Marries And

Writing out lists in writing is rather straight forward, but a simple mistake makes the list confusing. One of the easiest ways to keep it clear is to be consistent with commas. Consider the following sentence:

My favorite types of yogurt are orange creme, pineapple, strawberry and banana and vanilla.

Are there three flavors? Four? Two? Is strawberry and banana one flavor or is banana and vanilla one flavor? It's not clear. It's also awkward because the reader doesn't know when to finish the sentence. Now consider the same sentence with one more comma.

My favorite types of yogurt are orange creme, pineapple, strawberry and banana, and vanilla.

Much clearer, isn't it? A friend of mine once told me that commas separate each idea in a sentence as if they were the gaps between cars of a train. It's a pause to signal a slight change in thought. Don't treat it like a period (i.e. watch sentence length) but use it right in a list.

Questionable Writing

It's natural for people to ask questions in their writing, likely because those very questions are running through the writer's mind as they type. I saw this style many times while grading rough drafts my students submitted last week. It's not inherently bad writing. But like quoting, it should be used sparingly with two rules in mind.

1. If you're going to ask a question, ask only one and then immediately answer it. If it has a long answer (i.e. it introduces a section), then answer it in a way that summarizes the section. Asking a whole bunch of questions at once confuses the reader and wastes her time. It also robs you of authority; the reader might ask "Why is he asking so many questions? Does he not know the answer?"

2. You can also ask several questions to illustrate the extent of the difference of alternatives, alternating between one side and the other. Make sure you summarize at the end, of course. Virigina Postrel does this very well in her book The Future and Its Enemies:

How we feel about the evolving future tells us who we are as individuals and as a civilization: Do we search for stasis--a regulated, engineered world? Or do we embrace dynamism--a world of constant creation, discovery, and competition? Do we value stability and control, or evolution and learning? Do we declare with Appelo that "we're scared of the future" and join Adams in decrying technology as "a killing thing"? Or do we see technology as an expression of human creativity and the future as inviting? Do we think that progress requires a central blueprint, or do we see it as a decentralized, evolutionary process? Do we consider mistakes permanent disasters, or the correctable by-products of experimentation? Do we crave predictability, or relish surprise? These two poles, stasis and dynamism, increasingly define our political, intellectual, and cultural landscape. The central question of our time is what to do about the future. And that question creates a deep divide. (p xiv) [Original Emphasis]

Newsflash: Big Plans Are Complicated

Commerce Secretary Carlos Gutierrez commented on CNBC today arguing if the government loan goes though, the government will only manage the big involving their balance sheet. He insists politicians are capable of doing this well.

What we're talking about here is not the running of the auto company. We're saying someone who can evaluate whether they are making the tough calls and whether they are restructuring and whether the numbers suggest they are making the tough calls...We're talking about a big picture of what needs to be done to restructure these companies based on what the executives will bring forward.

This is a lot like saying "I'm not going to tell you how to drive because I'm not an expert. But I will tell you how to make your Civic do tricks out of a James Bond movie." These big picture changes are immensely complicated, filled with nuanced information no one in Congress or the Commerce Department has. They are precisely the things outsiders should not micromanage.

Quote With Caution: Leading and Following

With my development students feverishly working on their final drafts, I want to take some time passing on some writing advice. Today we discuss quoting.

While I've mentioned it before, it's worth repeating. There's only two reasons to quote: (a) convincing the reader that someone believes something (usually something the quoted may not freely admit) and (b) repeating an idea illustrated so well, you can't possibly say it better.

But knowing when to quote is not the same as knowing how to quote. I've witnessed many papers where the writer will quote without comment. Their lead in will be bland and their follow up will be nonexistent. I read phrases such as "Paul Collier says," "Jared Diamond writes," "William Easterly argues," with barely a hint of what they are going to say.

Instead, try something more tailored. Paraphrase the author's idea in the context of the subject of the paper. Then, indicate to the reader why you are bothering to quote. (i.e. "Friedman said it best: 'If you put the federal government in charge of the Sahara Desert, in 5 years there'd be a shortage of sand.'")

Other times, the writer will quote and simply move on. If you going to bother quoting, add context to the quotation. Comment on it (but don't repeat yourself from the lead in). Reference an idea or phrase from within the quote and connect it back to your paper. Quotes are supposed to complement your writing, not replace it.

Don't Celebrate Yet

A surprising 61% of Americans oppose the Detroit bailout of the big three (Ford, GM, and Chrysler). This is hard to explain, given the populace's distaste for seeing big employers go under.

I wish I could say the results are due to people understanding growth doesn't come from preserving failures. Or a realization that there are some things Americans shouldn't do. But while the big picture's the same, the reasoning's likely much more nuanced. Quick depreciation of American cars, declining sales in SUVs, and the rise of the foreign-made hybrid are everyday examples of a poorly performing sector of the economy. Now if only people would take the essence of the argument and apply it consistently.

Paradoxically, the results are also low. Despite the repeated failures of the auto industry, despite the everyday logic that if something doesn't perform you shouldn't work to preserve it, despite the fundamental reality that letting something go away allows us to do something else, nearly forty percent of Americans are not against a bailout.

And then things make sense again.

The Forgotten Charity

Amity Shlaes recalls the last great act of banker, industrialist, and art collector Andrew Mellon in The Forgotten Man:

By giving largely, generously, completely, and entirely, he would demonstrate that the private man could be as good a servant to the public as the government official was...Mellon's gift would show the value of leaving art--or capital--to accumulate and compound in the shadows, untaxed. The National Gallery would be an object lesson that the high taxers could not forget.

One of the finest collections of Western art in the world, and the main building which houses it, was originally the gift of a "robber baron" who gave so selfishly that it doesn't even bear his name. And so, alongside the monuments to presidents and memorials to wars, among the lawmakers and tourists, in the shadow of the Capitol building, rests a silent dedication to low taxes.

The Siren's Song of Manufacturing

Today on Morning Joe Pat Buchanan mourned the decline of the manufacturing sector, whose members now (supposedly) work at Wal-Mart. Forget that over the past thirty years median individual income rose about 40%. Even if they were becoming nurses and lawyers (and they are), Buchanan still prefers manufacturing cars, toys, and electronics in America, by American firms.

Manufacturing is no more important than farming, customer support, or mining. The key is never one sector. The key to American prosperity (among other things) is trade. Freer trade opens the plethora of human ingenuity to more people at steadily decreasing amounts of effort. Alaskans get bananas year round. Nevadans get free tech support. Indianans get toys under the tree. Just because we can't point to a single area where everyone works doesn't mean they can't find good jobs, obtain consumer goods, or live a fuller life. Freer trade means all these things are more common, not less.

Burn, Baby, Burn

With the world financial system still in turmoil (and Japan joining the recession ranks), governments hear the public cry for action. It's a knee-jerk call with little forethought. People mistaken the current economy as a burning building: clearly, something has to be done. This analogy makes a series of errors, assuming the government could fix the problem, knows how to fix the problem, and wants to fix the problem in a way that actually works (instead of just claiming it works).

If you insist on the analogy, we should wonder if the fire's too hot to suffocate. We should wonder if the buckets contain water or kerosene. We should wonder if the firefighters wish to get burned putting it out or stay away and roast marshmallows. But most of all, we should wonder if if the building should just burn down.

The financial sector is really large. Arguably too large. At the very least, many firms made some big errors. Saving the company that's a proven failure is not a recipe for long term growth. Ditto for Detroit, who focused on SUVs while gas prices climbed. The same goes for virtually any struggling industry, especially its old and unimaginative players. They made a mistake, honest or not, and now they're dead weight.

Forest fires occur naturally. As forests age, dry undergrowth covers the ground and old trees block out all light. Nothing new grows. It takes only a bolt of lightning to ignite the old structure and wipe it away in a cruel immolation. This is the only way new life can flourish and the forest can ultimately survive.

Let the ancients burn.

Slipperly Logic

After noting the fall of oil prices, a friend of mine suggests oil companies could have "gotten away" with higher prices longer. When prices rise, it's a conspiracy in the greedy pursuit of profits. When they fall, it's still a greedy pursuit of profits?

Supposedly, prices fall because colluding firms want to assuage calls for regulation and taxes. Anyone even remotely familiar with commercials, advertising low prices, knows how sloppy that argument is. There's no evidence of sustained collusion, because there's no way to enforce such deals. Prices rose due to sudden demand and are falling because this competitive industry is finally catching up.

This is not a new story. From Amity Shlaes' The Forgotten Man. In 1934,

[Harold Ickes] had discovered that at numerous points oil was being extracted clandestinely and illegally, outside his NIRA [National Industrial Recovery Act] production quotas, and sold at prices that undercut the policy to force prices upward. He was outraged and opened a campaign against the oil bootleggers, describing them as possessed of a "sly animal cunning." (p 203)

No wonder oil CEOs are paid so much. It's not fun being the villain no matter what you do.

Google > CDC

The U.S. Centers for Disease Control and Prevention (CDC) publishes flu data, but with a lag to allow for the data to arrive. Google decided to track the searches for flu, and gets numbers similar to the CDC, but only without the lag. Thus if you want to know the current flu situation, you are better off with Google than the CDC.

No, You Can't

Lawmakers from all fifty states are being bombarded with requests for tickets to Obama's inauguration. When the norm is several hundred tickets each, some report several thousand requests. Questions arise as to how to divvy them up. Lottery systems seems most likely. A market does not.

Legislation looms to make scalping these tickets illegal. It seems like we should ensure that everyone should have an equal chance to get them, that we should combat those who would order a dozen, only to sell them for personal profit. But an a world of different preferences, a forced lottery system is more unjust than scalping tickets. The person who's mildly interested has the same chance as the die-hard fan. Without a market, there's no way to correct the randomization if the former wins. (Frankly, I'm surprised they aren't going by first come, first serve basis. That would solve a lot of problems. But part of the issue is the offices don't know how many tickets they are getting.)

Auctioning the tickets is not perfect, either. The curious but wealthy are preferred over the enthusiastic but poor. Without a prohibitively costly interview system, it's not possible to make it perfect. But denying trade makes it strictly worse.

Tyranny of the Electoral System

Missouri's still counting and recounting but the absurdity of our electoral system is still clear. Ignoring the Show Me State, here are the results:

Candidate	% of Popular Vote	% of Electoral Votes
Obama	52.6%	69.3%
McCain	46.1%	30.7%

The spread between Obama and McCain jumps from 6.5 points to almost six times that amount (38.6). A large part of this discrepancy is because the plurality of the state gets all the state's votes. But it brings to bear another strange aspect of the electoral college: Pennsylvania has 25 times as many people as Wyoming, but only 7 times the electoral votes. Iowa has a fourth of the people Illinois has but only a third of the votes. In other words, the system disproportionately favors low populations states. (This was a major issue in 2000, when Gore received the popular vote but lost the election.)

People argue rural areas have to get extra voice. Otherwise the candidates would never pay attention to them and spend all their time in major cities. So what? Majorities always have a greater say than minority opinions. But no one says that gays, immigrants, and Jews should get extra votes. The only difference is these minorities (mostly farmers) are concentrated geographically. I'm sympathetic to the idea of giving the outside opinion extra muscle in order to curb the tyranny of the majority. But it's not clear why that minority has to have their own state before they get such an ability. Because we lack consistency, part of the minority becomes party of the majority and the bullying continues.

We Stand Together, Like It or Not

My mother used to tell me "if you don't vote, you can't complain." When I was younger, I remember nodding in agreement. Now, as an avid nonvoter, I failure to understand her arguments. You could say I've "learned" less over the years if you consider such reasoning knowledge. But it's not.

The fallacy assumes defection is a practical option. If three people vote to go see a movie, and one of them offers no opinion, that person still chooses to see what the others decide. We all recognize if silent Carl goes to High School Musical 3 with his friends, he is in little position to complain about which movie to see. If he didn't want to see it, why did he go? The same could be said of those voters who went along with the decision. If they wanted to see Saw V, we would wonder why they followed the majority.

But our process isn't like seeing a movie. It's more like being trapped in a plane and people voting on the destination. If the choices are between Alaska and the Yukon, and the majority votes for Alaska, we can understand why the Yukoners complain. But we can also understand why those that like the tropics, and don't bother choosing between two bad choices, complain. We would only be surprised if the Alaskaners protested the result once we arrived.

It turns out those with the least credibility to complain are those that voted for the winner, which is usually most of the voters.

First Time Voting

Like Alex Tabarrok, I voted for the first time today. It took about 45 minutes, and my voting precinct is close enough that I jogged there after I woke up. I realize my vote counts for nothing but now when people talk about voting I know what they are talking about.

New Orleans Goes Third World

Earlier this month 20/20 ran a "Politically Incorrect Guide to Politics." This segment stood out:

Students of my class (or those familiar with Hernando de Soto's Mystery of Capital) should see the parallels. He discovered that the reason developing countries have trouble growing is because of a stifling bureaucracy preventing people from establishing legitimate businesses and securing property.

Favorite Quote on the Bailout

I've read a lot about the bailout, but by far my favorite quote is this from Ron Hart:

Is there better irony than an imprudent Washington "investing" about a trillion dollars of debt funded tax money into the banking system and telling them how to run a business?

The same federal government confiscated the Mustang Ranch bordello in Nevada in the 90s and then promptly ran it into bankruptcy. If the feds cannot make a profit in a monopoly business of selling sex and booze, my guess is the complexities of banking will totally perplex them—especially when they have to follow the convoluted regulations they themselves impose.

HT Reason

The Speculators That Can't Be

History's a fickle mistress. It can teach us a great deal about ourselves and what to expect, but it can also delude us. Exceptions (which are always more memorable than the mundane) distort our view of how the world works. Writer David Liss referenced a speculator friend of Alexander Hamilton (the first United States Secretary of the Treasury) who used his inside knowledge to make quick profits. His actions nearly caused a financial catastrophe in the fledgling union. In light of the current crisis, Liss ponders when we will learn our lesson?

Liss paints speculators as wild-eyed children. They have no concept of the future, a strange attribute for people who make a living estimating what will come to pass. Speculators cannot survive as an occupation the way Liss described them. Not only would our current volatility be the norm, Warren Buffet would be broke.

A Debate Worth Watching

Was There Too Much Sex And Profanity In The HBO Presidential Debate?
HT: Mike Mills

Reality Check from Iowa

A friend of mine insists that because of the recent economic turmoil and unpopular bailout, Democrats do not have a chance at maintaining control over Congress this election cycle. Like me, he prefers a divided government over a united one (and since Obama is the likely winner, this lose of control would be an optimistic note). But politics is one of those areas where people indulge in their irrational hopes.

The Iowa Electronic Markets encourage people to stop, think, and rationally weigh the data. It's basically a betting system. You buy an "asset" for a candidate. If the candidate wins, you get a dollar. If he doesn't you get nothing. People bid against one another for these assets and a value emerges. We can use this value to predict outcomes (and very successfully, too).

Consider the market for the presidential campaign, focusing on the winner take all option (based on who gets the most popular votes).

The blue line represents assets that Obama will get the most votes and the red line represents McCain will. Obama runs at about 85 cents. In others, he has an 85% chance of getting the most votes (though because of electoral math, this is not the same thing as saying he will win).

There's no graph for Congress or either of its chambers yet but here are the current bids (all as the average bid for Democratics gaining seats):

Congress: 0.953
House: 0.921
Senate: 0.949

The markets are not perfect (maybe participants have a systematically different knowledge base) but this is the strongest evidence I've seen of what we'll see on election night. And it looks like the Democratic Party across the board.

The Futility of Equality

In Russ Roberts' conversation with William Bernstein about inequality last week, Bernstein argued that largely different salaries harm the less wealthy people. In the pursuit of status, the 2nd, 3rd, 4th, placers stress out about their lives. This stress harms their health and shortens their life span. Thus we should engage in redistribution.

It's a clever argument, but I challenge its conclusions (again...see my previous challenge here). I assume Bernstein searches for something less than full equality (where everyone makes the exact same amount) since that would be prohibitively expensive. The alternative is partial distribution, where a few are poorer and several are wealthier.

Redistributing from the wealthy to the poor still creates that ranking system, only with a smaller variance. Instead of being much wealthier, those "on top" of the status ladder are only slightly wealthier. But according to the status theory, that shouldn't matter. A runner up is still a runner up, whether by a little or a lot. They will be just as stressed out, just as prone to an early death. But society will be less opulent because of the incentive distortions. Bernstein's world is strictly worse.

Keep Your Fallacies Straight

Russ Roberts discussed the bailout on Reason.tv, arguing it'll encourage more risk taking in the future. A commentator, Trumpit, accused Prof. Roberts of circular logic:

You state that the bailout will encourage more imprudent risktaking in the future leading to lower standard of living for the next generation. LOL. That's was the cause/reason for the bailout. I took an upper division math class and on the 1st exam the professor drew a big circle to make fun of my circular proof.

Let's take a moment to remember what circular logic is. Also known as begging the question, it occurs when "its conclusion is among its premises...assuming what it's trying to prove." The argument of the bailout goes like this:

1. The Congressional bailout implies imprudent risk taking is cheaper.
2. The financial sector seeks cheapness.
Thus
3. The financial sector will engage in more imprudent risk taking.

It would be circular if the argument was this:

1. The Congressional bailout implies imprudent risk taking is cheaper.
2. The bailout occurred.
Thus
3. Imprudent risk taking is cheaper.

It's not that circular logic is nonsense, it just doesn't say anything interesting.

Coase and Inequality

This week Russ Roberts interviews William Bernstein on inequality. Bernstein argues that income inequality has ill effects on poorer people's health--they have a lower quality of life because they know they are on "low" end, they're more likely to stress out, etc. Thus, he says, we should engage in income redistribution.

I find the big weakness to the inequality argument is its policy recommendation. I can see how a few people making lots of money makes others upset/jealous (we hear about it all the time in politics, suggesting people like to hear about how evil wealthy people are). I can also see that such anger leads to stress and leads to unfortunate health effects. In other words, I can see how one person's increasing wealth can externalize a cost onto another.

Since transaction costs are high, let's set aside the Coase Theorem. Instead, who's the least cost avoider? (Remove the wealth or remove the sadness and either way we have no problem so what's cheaper to remove?) If we ask the rich to make less money, we would lose those the benefits that the person would contribute to society. If we ask the poor to take a breath and let it slide, we likely lose much less for what we get. In other words the conclusion should not be redistribution but people dealing with it on their own terms. Bernstein should be telling people to pick up yoga, not pick pockets.

Definitions Are Not Clothes; Stop Trying To Change Them

This week's Economist quotes Nicolas Sarkozy in their report on Europe's schadenfreude concerning America's economic woes. "The idea that markets are always right was a mad idea."

A doubly bizarre claim. Sarkozy ignores that American financial markets are hardly laissez-faire as he forgets that no one claims markets are always right. It's really easy to denounce a system when you redefine it to suit your ends. It's doubly easy when you then try to redefine reality, too.

Balance Be Not for Kagame

During class conversation today, I felt it necessary to describe the compensating wage differential (stressful/tedious jobs are paid well and relaxing/rewarding jobs are paid poorly). I then promptly forgot why I brought it up.

I now remember. I described Paul Kagame's (Rwanda's president) desire to turn his country into a sort of Switzerland of Africa, notably a sophisticated banking center. We agreed this was a long shot but it's longer than most think. It reminded me that so many developing countries (and developed countries) wish to jump into the high end sectors. Medical plazas, software companies, financial services--industries that are prestigious and clean. Societies, and thus governments, put so much value on these services, we shouldn't be surprised that they are over supplied (part of the reason the financial sectors have been taking a beating lately).

Thus the wage differential. If a job is cool, lots of people will want to do it, depressing the wages it offers. If a sector is hip, so many will jump into it and shrink its returns. I wish we'd stop treating development (and growth) as if the whole world could get a job as ice cream taste-testers.

Strangest Sentence I've Heard Today

A friend of mine from college told me the following over AIM:

i certainly don't think communism can work on any kind of national scale, but socialized assistance programs, like medicine, education, welfare, and social security, ensure that even the poorest people have access to liveable standard of care - of course, the state has to dedicate itself to making that standard liveable

What is communism on a national scale other than a systematic interference with everyone in a country? You have to admire an intellect that can be so inconsistent and not go crazy.

The Elusive Quest for Price Gouging

Anti-price gouging laws are notoriously vague, a fact Florida reminds us of this week. It issued subpoenas to four gas station companies on the basis of price gouging, or according to Florida state law, "an unjustified increase in price" during a state emergency.

What's "justifiable" in this context is not something laws can determine. If a firm increases its price, that consumers determine if it's reasonable by virtue of their actions (and their continued patronage). If an increase is truly arbitrary, then competitors will keep prices lower to get all the business. This argument doesn't work if there's no competition (and no chance for it) but because Florida issued subpoenas to four companies we don't have that problem here.

Markets are not made up of faceless CEOs and wild-eyed Wall Streeters. Markets are more ephemeral than that. They are composed of the interactions of countless millions, each competing with some to appease others. Markets are ecologies, not dictatorships.

Keep Your Favorites To Yourself

The lack of media coverage over the Paralympics induced NPR to comment why they received so little attention compared to the Olympics. One caller blamed corporations, not the lack of demand. Corporations set the agenda and since they don't sponsor these games, they don't show them even though we want to see them.

If this was true, if we really are empty vessels to be filled, then why don't companies sponsor the Paralympics and then cover it? We'd watch something we want to watch and they'd get more airtime for sponsors. This doesn't happen because what matters most is viewership. This is why if a basketball game runs over, it cuts into sitcoms after it. This is why most shows get canceled after the first season. This is why we have any sort of entertainment at all and not corporations force-feeding us an endless stream of ads.

This caller likely replaced their preferences for the desires of everyone else. Just because your preference isn't popular doesn't mean it's because of some secret cabal is holding you and your brethren back. Maybe you just like unpopular stuff.

Wisdom of the Crowds

RT gives Disaster Movie 0% with 53 critics reporting.

Of Human Design

Mike recently directed me to a blog by a mutual vegetarian friend from college, Adam. The language is harsh: eating meat is oppression and so forth. What lovely serendipity that we covered prehistory in my development class today.

The roots of human civilization lie in what Jared Diamond calls "farmer power," or the development of food stuffs so other people can specialize in non-farming professions (soldiers, inventors, traders, etc). Critical to this was the domestication of animals for purposes of food and labor (the aforementioned oppression). Over generations brain power and survival techniques (such as good eyesight) were severely diminished. In other words, they are not natural in any normal sense of the word. Indeed they are less natural than a wooden table, since at least the wood retains original DNA. Domesticated animals are a new species.

Adam posted a few videos from Waking Life, an independent philosophical film. One character argues "the gap between, say, Plato or Nietzsche and the average human is greater than the gap between that chimpanzee and the average human," a rather strange claim given history. The average human purposefully domesticated plant and animal species, something no other animal has done. That's an astonishingly large leap from a chimpanzee.

A great departure from their wild ancestors, modern farm animals are basically bags of meat with scarcely a glimmer of intellect. They were bred to be property, and non-sentient at that (save for the most encompassing definition of sentient). Even by their cousin's standards they are stupid. Of all the oppressions of the world, meat-eating hardly seems like a worthy one to fight.

Markets in Everything: Cancer Sniffing Dogs

The Economist recently had a story of how doctors have smelled patients breath as a way to test for sickness. It's inprecise and can't detect everything, so Carolyn Willis outsourced the smelling of sickness to dogs.

One of the first practitioners of the field of olfactory diagnosis, Carolyn Willis of Amersham Hospital in Britain, decided to contract the job out to dogs. They, she reckoned, have the necessary nasal apparatus to sniff out illness, and there was already some anecdotal evidence that they could, indeed, smell people with cancer. It worked. For the past four years her sniffer dogs have been diagnosing bladder cancer. She is now training them to detect prostate cancer and skin cancer as well.

Numbers Are Like Fire: Don't Play With Them

I question the potency of the argument put forth by Obama's chief economist (Laura D'Angelo Tyson) on the Colbert Report last night that the economy performs better under a Democratic president than a Republican one. While glancing at the data suggests such a correlation might be there (my analysis program is currently on the fritz so an eyeballing had to do), too many complications render the explanatory power weak.

Variance Within Presidents A party maintains control of the presidency for a minimum span of four years (even if the sitting president resigns of leaves office, his VP maintains the party "dynasty") though several do so for eight, sometimes more. But GDP growth fluctuates a great deal within such a span of time, sometimes going negative. Since our dependent variable doesn't change nearly as much as growth rates do, we lose a lot of our explanatory power.

Policy Variance The Democratic and Republican parties of today aren't constant. This limits our scale of analysis to a much smaller time frame (I went back to the 1930s) and even then there were changes. Also the politics that defined most the difference between the parties were Cold War issues, not economic ones.

Measurement Issues I used real GDP growth to analyze the relationship; Tyson no doubt used similar data. But this data is flawed because it treats government spending as growth, even when that spending is simply a transfer payment (such as Social Security). I'm currently looking for non-government numbers.

Lag Issues Colbert joked about this but there really are lags in policies, sometimes reaching ten years. Since the presidency oscillated between parties for a while, lagging the variables could result in the opposite conclusion.

Causation Issues Perhaps people are more willing to vote for a Democratic president when times are good. Since more government spending has been a staple of Democrats since FDR (Republicans play a similar game, of course, but to a lesser extent), the public might simply be buying a normal good. Wealthier people are more willing to buy feel-good government programs.

The Theory This is likely the biggest problem with the story. What's the explanation for why a Democratic presidency would fair better for the economy than a Republican one? The one I hear the most is that they help the "little guy", but it's not clear how paying someone because they are poor will incentivize them to be wealthier. Moral hazard issues abound. Their preference to cutting taxes for the non-rich helps, but it's usually paired with a tax increase for the wealthy. Unless you believe the richest tend to only buy and invest in each other, this story doesn't get you far. Income mobility remains quite high in the US, repeating the incentive issues that crop up in "helping the poor."

Cogs In the Machine

Economists are often scoffed at our "dismal" view of the world, that people respond to incentives first and foremost. There are no saviors, no heroes, no Santa Claus. There is no romance to politics except for what we wish was there. Politicians respond based on the choices they have, a constant as universal as gravity. Mr. Obama is not immune to such failings nor does Mr. McCain's "insider" status make him a shadow of Mr. Bush. While they have wishes and goals their actions will always be different than their speeches, a reality long recognized but rarely applied.

There are no good guys and bad guys. There are only people responding to incentives. Mr. Obama wants everyone to believe he'll be an engine of change, a Santa Claus figure that will make everything alright, and he'll surely offer token alterations to convince the populace of exactly that. But we have this world because that's the one that rewards decision makers. The fundamentals won't change because no desire to risk losing office. Only changing the rules of the game will change how the government work and Mr. Obama mentions nothing of such alterations. Believe the stereotype of the two-faced politician because there is nothing new in this election cycle.

How to not vote and show you care

The Onion has a good video on how to not vote and still make it look like you did, in case you want to follow Tullock and not vote but don't want others to know.

Fallacies of Fallacy

Naming a fallacy is very powerful. It signals that not only is something logically incorrect, but so many get it wrong it's worth naming. But like so many powerful things, it's misused. I found this list of "7 Economic Fallacies" written by Tejvan Richard Pettinger, a teacher at Cherwell College, Oxford. Of the seven, three are not fallacies.

Tax Cuts make people work harder.

When you work you are really swapping one valuable resource (time) for another (money). Cutting taxes (which is the equivalent of a pay raise) could mean the person spends more time to get much more money. It could also mean they spend less time to get the same amount of money. It depends on their preferences. As Pettinger implies by his explanation this is an empirical question, not a fallacy.

A Current Account deficit [also known as the trade deficit] doesn’t matter.

That happens to be true. Many of his explanations for why the trade deficit is a problem happen to have logical fallacies, though. Concerns of an "unbalanced economy" are inconsistent with a lack of concern about trade flows between cities; concerns of capital flows ignore that the current account is the mirror image of the capital flow, by definition; concerns that a current account deficit means more foreign liabilities ignores that the trade deficit is not debt (when two people trade, no debt is created). That Pettinger acknowledges "some economists" don't think the trade deficit matters demonstrates that this is not a fallacy.

Tax Cuts will boost the Economy.

The reasoning behind this supposed fallacy is that of increasing consumption, a straw man since in the strict mathematical sense this won't change anything. (Government spends less and consumption plus investment increases by an equal amount.) The logic behind the argument is in how the funds are spent. Money in the hands of private citizen is more likely to be used more efficiently than money in the hands of political agents (for the normal incentive reasons). Thus tax cuts could easily better efficiency and thus the economy. Granted, Pettinger is correct that borrowing in response to a tax cut does little (it only shifts the spending burden to later generations while crowding out the investments today) but the other way to balance of the budget, cutting spending, won't have such adverse effects.

Popular opinions of economics are filled with blatant nonsense. There are so many, we don't need to the lower the bar and paint differing opinions as something so flawed as a fallacy.

The Emperor's New Grub

LA central planners, lead by Jan Perry, put a moratorium on new fast food outlets in south LA (one of LA's poorest neighborhoods). The policy is to encourage more grocery stores and sit-down restaurants. She cites health reasons and claims there simply aren't a lot of choices in that part of the city.

What she really means to say is that she doesn't like what the poor eats and they should be forced to choose what she wants. It clearly never occurred to Perry that this poor (little money to eat at nice restaurants), working (no time to prepare their own food) neighborhood of LA enjoys fast food for a good reason. Forcing them to swap their preferences for hers is ghastly arrogant and morally reprehensible.

If Jan Perry wants more food choices in South LA she should start a restaurant, not ban others.

HT: Jon Cell

Their Relevance, Our Traffic Jams

People who move to Washington quickly notice two things about the area: traffic is nasty and housing is high. Many reasons exist for this, but our small-stature downtown is clearly one of them. Where smaller cities sport several skyscrapers, the district sports no such space savers (or very limited versions thereof). Amity Shlaes in The Forgotten Man explains why. In the early 1900s,

...the federal government was a pygmy. Its size was less than 2 percent of the national economy, smaller even than that of state and city governments. Lawmakers of their generation constantly feared that the fast-growing private sector might further diminish their already questionable relevance. Back in 1910, word of the rise of the skyscraper in New York had panicked congressmen, who promptly zoned height limits for buildings in the District of Columbia, so that no private building could ever overshadow the Capitol.

Obama Calls for a Rise in Gas Prices

Barack Obama's latest YouTube ad calls for a windfall tax on so called "big oil," as if they are the reason prices are high. But no matter who market critics blame--the Middle East, spectators, or a handful of companies--their answer will always be incomplete. Oil price rise because of all of us.

This is not merely because so we choose to use oil (making Obama's painting of us as victims all the more absurd). We also choose not to supply oil. And why should we? It's hard. It's complicated. It's takes a lot of start up capital. The rewards have to be pretty high to get us to try. If oil was going for $10,000 a barrel, you see me looking for ways to supply energy.

These current profits do the same job (though on a smaller scale). People are more interested than ever in supplying gas. It takes time to refine it and pump it and find it. But they are looking (which is why we've seen oil futures stumble a bit). But Obama's plan dulls those incentives. Tax profits and people are less willing to enter.

The market reality of oil (or any product) should remind us of one of the great lessons of economics. The surest way to get low prices is to allow people to charge high ones.

Knowing Is Half the Battle

Asymmetric information is a phrase economists use to describe scenarios when one party has more information than another. Examples are abound: actors know more about the quality of movie they're selling than movie goers; workers know more about how they spend their time than their bosses; borrowers know better than banks how likely they will pay back the loan.

One of the problems that erupt in asymmetric information is adverse selection: when someone chooses something that started off being a bad idea, such as eating a sandwich that the waiter dropped on the floor. But because the customer doesn't have the same information the waiter does, they take a bite. Hence the name--people will select something that isn't in their interest to select.

Many of my students, however, read this as when people choose things that are bad for them, such as driving drunk or smoking. In this latest homework assignment, people would even mention "everyone knows that such and such is bad for you." Then it's not asymmetric information and adverse selection doesn't apply. If you know smoking's bad for you and you still smoke, you are including the health risk as a cost. People might regret this choice later in life, but it's still not adverse selection. Just because you don't agree with their choice doesn't mean its a problem.

The other major issue from asymmetric information appears after the choice is made: moral hazard. When people make an agreement and then one of them figures they can take the other for a ride, that's moral hazard. There's an element of treachery here hence the name: deciding to take advantage of another's trust presents an ethical quandary for the person to overcome. National health care is a classic example. If you give free health care to everyone, you can bet people will visit the doctor a lot more even if it's unnecessary. They'll be less careful, too. More people would smoke.

It's sometimes hard to tell the difference between adverse selection and moral hazard: was this person planning on betraying me or did it just occur to them after I stuck me neck out? But they are real issues that occur in your everyday life and economists have noted several ways people mitigate these problems (especially when hiring and lending). Hopefully, with just five hours before their final, my students understand their application as well.

Decrees from the Bishop

Bill Bishop on The Daily Show tonight frets over people choosing to live with like-minded people or read like-minded sources. Bishop is missing the bigger picture: this "Big Sort" is the product of a wealthier people choosing to live the life they've always wanted to. Past generations didn't like their personal beliefs challenged by their neighbors; they just couldn't afford to move away because of something so small.

It would be nicer if people were interested in challenging values they dare not challenge. But being wrong is a cost they shoulder alone. Unless, of course, they vote: a problem that decreases as the scale of government retreats. Go ahead and be irrational. Just don't make me be irrational with you.

Knowledge is Disperse

This week's Economist notes

And just 6% [of Americans] view the economy positively. Yet many Americans combine despondency about the big picture with personal contentment. More than 80% say they are satisfied with their own circumstances. Even more are satisfied with their jobs.

In other words, the concerns about the economy are overblown.

Skeptics of the positive outlook should tread carefully. One of the core rules of economics--knowledge is disperse--tells us to trust the local claim over the big picture perception. What is an individual more likely to accurately estimate: their personal circumstances or the budgets and incomes of millions of strangers?

Coase on the Coast

Russ Roberts muses about applying Coase to traffic accidents while he's in California. Pedestrians, he notes, run wild in a way they wouldn't in DC because in traffic accidents the driver of the car is usually to blame. What a wonderful coincidence that we covered Coase on Monday in my principles of microeconomics course.

Coase notes the problem is not (in the case of traffic accidents) the car when it hits the pedestrian. The problem is that both the pedestrian and the car tried to occupy the same space at the same time. Remove one of these elements and you remove the problem (like all externality issues).

In brief, the question we should focus on is who is the least cost avoider--who is in the better position to avoid a collusion? Given the car extends well beyond what most grew up maneuvering in (ie, their body) and cars move much faster than people, pedestrians are the least cost avoider. The legal action should be to make pedestrians liable for being hit by cars.

This is not, of course, meant to be a hard fast rule. If you're hit while on the sidewalk or curb or crosswalk, that would still be the drivers fault. Again, the least cost avoider holds: it's less costly for drivers to stay in the street and watch lights than for pedestrians to be forever vigilant about where every car in the vicinity is. But in cases where a pedestrian crosses the street without warning, blame should lie with them.

Remember, economics is not about good guys and bad guys. It's about a bunch of people facing costs and benefits.

Have You Hugged a Spectator Today?

A student once asked me if I thought lower gas prices would help the economy. "Not inherently," I said. "So what should they be?" I responded: "They should be at the price that accurately reflects the conditions of the market."

Economists know genuine growth doesn't come from high wages or cheap oil. It lies in efficiency because that allows us to do more with less. And the best way to get efficiency is to get everyone acting appropriately based on the conditions of the market. Thus the importance of accurate prices.

As Megan McArdle explains, this is where speculators come in. Because they believe gasoline is going to be more expensive, the price of oil today is higher than it would be and the price of oil later is lower than it would be. This allows us to better prepare for the future and adapt more smoothly than we otherwise would.

Speculators aren't "gambling." They aren't even "guessing," as McArdle suggests they are. They're estimating. They're smart people working very hard to get reality right--that's how they get paid--and they've independently agreed that prices are just going to get higher. Thank your spectator because now you'll more smoothly consume gas and you won't be caught off guard by a sudden jump in prices. Now you can plan.

HT: Mike Mills

The Island of Doctor Hayek

For the third homework assignment I asked my principle of microeconomics students the following question:

Suppose anyone could legally practice medicine regardless of their educational background. Keeping the ideas of emergent order in mind, explain the implications of such a change. Would this change be desirable or undesirable? Explain why or why not.

The vast majority (about 70%) claimed this would be, "of course," disastrous. It reminded me of F.A. Hayek's observation:

Much of the opposition to a system of freedom under general laws arises from the inability to conceive of an effective co-ordination of human activities without deliberate organization by a commanding intelligence.

To see what I mean, here's a sampling of the responses:

...there would be a significant decline due to a lack of knowledge ad resources to apply appropriate medical treatment. This would cause a decrease in recovery, trust in the medical professionals, an increase in malpractice suits, and inappropriate treatment...

The quality of healthcare would plummet. The doctors [sic] offices would be jam packed with people who may not even need medical attention.

Without medical schools people would learn how to practice medicine directly from other doctors....without the proper tests and knowledge from medical school many doctors may be ill-informed and overall perform more poorly than they would of if they learned all the rules and regulations from medical school.

There's no doubt, as I mentioned to the class, that decentralized order is messy. In this case, people will surely suffer and even die by the hand of someone with less knowledge than a typical doctor. But so much of the chaos mentioned here wouldn't happen. The danger of medical malpractice and the desire to get a good doctor will make true quacks few and far between. A "jam packed" waiting room would encourage entry or prices would increase. Medical schools would still exist and, because good doctors are still in demand, people would still attend. More might attend because you don't need to finish to practice medicine.

Most of the reasons people go to a doctor are routine concerns. Do you really need a veteran doctor to give you a physical? Or tell you that you have the flu? You're either wasting his time or spending too much on him. As Arnold Kling argues, this "Crisis of Abundance" is one of the big reasons health care costs are so high. You don't need experts on every little cough and sneeze.

Yet students rarely mentioned any benefits such deregulation would bring and some mentioned the lower salary of doctors as a negative (though in reality only the bad doctors would see their wages fall, as per the compensating wage differential, a concept that was covered in the question right before this one).

It's not obvious if this institutional change is desirable or undesirable. But the relative metric is comparing the costs of the risk and additional suffering thanks to quacks with the benefits of getting the same job done for less. And since the costs are temporary and rare (bad doctors don't last long) and the benefits are permanent, I personally lean to the favorable interpretation.

Think Before you Blame

Richard Bitner appeared on The Daily Show tonight promoting his new book, Confessions of a Subprime Lender. Jon Stewart wondered why the people who have the toughest time paying a mortgage are charged the highest rates. Bitner's reply--that they are riskier--is correct but unsatisfying.

We want it to be higher for them. High payments discourage those who have little chance of paying them back. It not only reduces default risk, it generates the incentive for banks to offer these loans in the first place.

America's financial system is not perfect, but it makes a lot more sense than it appears when you take a moment to think about it.

The Joker's Lesson on Free Trade

When I saw the midnight showing of The Dark Knight I doubt my fellow moviegoers were learning something about free trade. I didn't see the lesson at first but once I noticed it, it became painfully obvious.

***Spoiler Alert***

At the climax of the movie the Joker scares the population of Gotham to evacuate, leading to two ferries packed with people trying to escape the city. The Joker places a bomb on each ferry and then gives the two captains the detonation device for the other bomb. Ferry A can blow up Ferry B and vice versa. They have fifteen minutes to decide what to do or the Joker will blow them both up.

This is obviously a prisoner's dilemma game with the standard Nash equilibrium (the captains pull the triggers at the same time, killing each other). But that's not what happened. Each crew was overwhelming in favor of blowing the other up (confirmed by a vote), but no one was willing to actually do the deed. In other words, there's a very real morality cost that altered the payoffs. People would rather die than kill someone but they would rather have someone else kill than die.

If you look at polls Americans are mostly against free trade. (Last week's Economist cited only 33% of Americans think free trade is good for the economy.) Yet that's not how they act at the market. A choice between a cheap import and a more expensive domestic leads to people favoring the import. We don't of course need government action to limit free trade--people could just refuse to buy imports. But, as in the ferries, no one is willing to shoulder the cost of doing it themselves. They want someone else to do the deed.

Bryan Caplan notes there's a big difference between voting and buying. In buying you internalize all the costs and benefits of your actions. In voting such considerations are externalized onto someone else. Your gut feelings of xenophobia, survival, or old ideas are a lot easier to hold on to. But when faced with the true costs of your action, revealed preferences are quite different than the cheap talk from a voting booth.

Inferiority Complex

Upon grading principles of microeconomics homework I come across too many students (ie more zero) incorrectly identify an inferior good as a low quality good. This is emphatically not always true (though a correlation probably exists). An inferior good sees fewer buyers as incomes rise. Here's a few examples of inferior goods that are not low quality:

-Bikes. There's a lot of high quality bikes out there, but, as China reminds us, increasing incomes sees fewer bikes bought.

-Personal education. Most of the time people go to school to get a degree so they can earn more money. Of course if you're already making a lot you're less likely to hit the books. Bill Gates never did finish his undergraduate degree but I doubt I'll see him in class. (Note this is personal education. The opposite it true for the education of, say, your kids.)

-Studio apartments. There's nothing inherently low quality about a studio apartment. Indeed the amenties and location could be tremdously nice (in the middle of downtown, hardwood floors, new appliances).

Quality is a relative concept, of course. This makes refering to "low quality" items in an absolute context sloppy thinking. A 42-inch television is low quality compared to a 50-inch but no one's saying the 42-inch is an inferior good. An inferior good is not "good" or "bad."

In of World of Constant Opportunity Costs....

After grading the first homework of the semester semester, I thought I should take some time to clarify a bit about our old friend, opportunity costs. Most, I'm pleased to say, understood the concept (at least so far as the question is concerned). But most is not all.

Here's the question:

People often claim that hurricanes are good for the economy they affect because it creates a great deal of economic activity. While citing (and defining) opportunity costs, offer a challenge to this argument.

Opportunity cost occurs in two ways in these disaster scenarios: was the disaster economically beneficial and is it worth cleaning up?

The first question should always be answered with a no. If the disaster did not happen, infrastructure would still be intact and people would still have their lives and health. Thus resources spent to replace items or mitigate pain would instead be used to enrich an existing society. It's strictly better. Instead of losing a house and paying to rebuild it, you can keep the house and pay to expand on it (or buy a boat, or send a kid to college, or whatever).

The second question's answer is less certain. Perhaps it's not worth rebuilding. If a tornado destroys an obscure ancestral home and restoring it would benefit us by $1 million, but we could build a new school that would bring a benefit of $10 million, restoration is clearly not worth it even if we would be better off had not the building been destroyed. Just because it was worth having does not mean it is worth replacing.

People understand this distinction all the time. If a board game is destroyed in a flood, the family will certainly count it as a loss (having a game is better than not having one, all other things equal). But we wouldn't be surprised if they don't leap to replace it with the same game. They might buy a different game or buy something else entirely.

This distinction--the opportunity cost of a disaster and the opportunity cost of fixing--resolves the seeming paradox of why economists sometimes regret destruction while simultaneously refusing to repair damage. If we can stop disasters cheaply, that's great. But they are almost as unavoidable as opportunity costs and letting ruins stand is not always bad.

The Ethics of Greed

The Economist reports this week that CompartamosBanco, a Mexican bank, is making a killing in micro finance. Trail blazed by Nobel Peace Prize winners Muhammad Yunus and his Grameen Bank, micro credit loans very small amounts (a few hundred dollars) to entrepreneurs in developing countries. Usually done by nonprofits, CompartamosBanco is a notable exception.

Lending to those in developing countries is expensive because the social, legal, and physical infrastructure is so lacking. The Mexican bank spends about a $152 a year per client. No wonder its interest rates run 79%--usury to most developed countries. But the customers gladly accept the rate. CompartamosBanco has nearly one million borrowers--a far cry from Grameen Bank's seven million but impressive nonetheless.

CompartamosBanco's success encourages new entrants risking their own money (seven new competitors in Mexico alone) while Grameen continues to rely on subsidies and donations. As the economy of scales takes into effect, interest rates fall (seven years ago it used to be 115%) and yet more people rise out of poverty. Not only is this yet another example of how profit seeking helps us all, it reminds us of one of the strange lessons of economics: the only way to get low prices is to allow people to charge high ones.

In Praise of Spectators

Diane Rehm agreed with a caller today that speculators are to blame for rising oil prices. Her guests (J. Robinson West, Athan Manuel, Stephen Power, Chris Oynes) offered no serious dissent and often repeated the concerns that these investors are acting irrationally, irresponsibly, and at the expense of the people.

Yet we should celebrate their acts. By pushing oil up now rather than later, we sooner get an accurate price meaning we sooner get adaptation to that price. As everyone on today's show recognized it takes a long time to move oil from the ground to the pump. Without spectators oil would move up slowly and sometimes dip down, making investments in production far less likely.

It is the job of an investor to gather all the information from all over the world (including places you wouldn't expect) and come up with an unbiased prediction. It's how they earn their livelihoods. That doesn't mean they never panic or are subject to emotions. We're all human after all. But their irrationality is much more rare than the uninformed panic of the voting public.

Pillsbury ND: Where the Marginal Vote Matters

Pillsbury North Dakota is a small town. So small that in a recent election for mayor no one voted, not even the candidates. Here is a case where voting definitely would have changed the election, although it might not have changed the outcome of the town rule:

The council meets about five times a year, Brudevold said. Members are each paid $48 annually, and a good portion of that goes for doughnuts at the meetings or gas to get there, he said.

Pachelbel For the Modern Rocker

Art Carden wonders if this is art. I bet it is, but I ultimately don't care. It rocks.

Welcome To the Jungle

Paul Krugman argues America's food quality is what it was a century in the time of Upton Sinclair's The Jungle. A lax FDA (and its industry cohorts) is to blame for the recent "tainted spinach, poisonous peanut butter and, currently, the attack of the killer tomatoes."

Economics is a strange discipline because it really just requires people to take lessons they follow in their everyday life and apply them consistently. The lesson here is that we don't want zero risk when it comes to food. Do you boil every glass of water that comes your way? Demand tests on meat that you get in a restaurant? Grow your own food? Avoid eating at authentic restaurants abroad? Failure to do these things puts us at risk but we gladly accept it. Avoiding that risk is too costly: zero risk is not optimal.

Ensuring consistency does a lot for a good argument. Krugman scoffs at the free-market argument against the FDA--that "private companies would avoid taking risks with public health to safeguard their reputations and to avoid damaging class-action lawsuits." And yet he warns that a lack of regulation for ensuring solid food safety is not "just bad for consumers, it’s bad for business." So firms won't ensure safety on their own because they are too greedy but if the food quality is poor then it's bad for business? I bet he doesn't take a UV light to restaurants, either.

People Are Not Passive

Are there limits to growth? That's what people tell me while citing higher food prices, a planet of 6.7 billion, and cities often exceeding ten million. "There are too many people," they say. What nonsense.

Eleven years ago, Nobel Prize winner Norman Borlaug wrote that with current technology we could feed 10 billion people (a population we're not going to reach until around 2050). With 21st century technology we can surely feed more. Alex Tabarrok reminds us that US land use for crops has been steady from the late 1930s to the late 1980s, a trend likely continuing right now.

Whenever people make note of the resource usage of developed countries or the "carrying capacity" of the planet, they always ignore that people are not passive. We are not infants, sucking thoughtlessly away at the tit of the world. We create more than we consume. Our inventions exceed our immolations (at least in today's world). For every mouth to feed there is a mind to think, hands to work, and feet to move. We cherish our lives, our wealth, and our hope for a better future and we will lash out with every appendage to maintain our true and steady course.

Are there limits to growth? Probably, but we're not going to encounter then in our lifetime. Or even in our grandchildren's grandchildren's lifetime. History is replete with doomsayers and prophecies of cataclysm. And as seductive as their wild-eyed claims are, as invincible as they seem, they're always wrong. Never forget that.

When To Recycle and When To Not

There are four plastic bags near the front door of my parents' house each stuffed with a few weeks worth of newspaper bags. This is my mom's latest attempt to save the world. In her infinite foresight she's gathering these bags to "keep them out of the landfill." She plans to send them back to the newspaper company so they can reuse them. I somehow doubt they will.

Plastic bags are tremendously cheap, evidence in that are giving them away to customers. They still cost the company something but I doubt it'll be worth sorting through the bags to reuse them. Recycling's expensive and often not worth the time and effort. Though in some cases, like recycling cans, it is. People are willing to pay for the savings it brings. Note soda cans are one of the few places you are paid to recycle.

Recycling reduces space used in a landfill but so what? Is landfill space really so scarce that this is worth it? If it is, why aren't we charged per bag or per pound thrown out? Part of this is due to the city-run industry but the a bigger factor is that landfills aren't hurting for space, particularly out here in Iowa.

If you're not being charged to throw it out and if no one's willing to compensate you for your time it's not worth recycling. See a past post on this subject here.

Asbestosis Gone Wild

A court in New Jersey recently ruled Spanish citizens can now sue Owens-Illinois and other asbestosis-related firms based on exposure from U.S. ships. This does not have to translate into actual harm from the exposure. Like most asbestosis litigation, post hoc ergo propter hoc works just fine in the court of law. Indeed, the even possibility of harm is enough to cost Owens-Illinois. To punish firms so overwhelming cheapens our society in two ways.

First we get too little asbestosis. Asbestosis is not evil and its optimal amount is not zero. It's useful and safe in many areas of our society. (Indeed, its wide application is why asbestosis litigation never seems to go away.)

Second we lose good ideas in the process. This is not limited to opportunity costs coming from litigation-related expenses. The possibility of similar attacks can destroy a development before it even starts. If asbestosis litigation can completely ruin an industry, companies are less willing to engage in ideas that they think could be twisted down that same route. Sometimes this is good but the level of asbestosis litigation likely makes firms so risk averse that the net effect is undesirable.

This second issue is critical but often ignored because this lost opportunity is never seen (be definition). It makes it difficult to estimate the true cost of asbestos litigation. But if the technological and economic progress in the past few decades is any indication, that cost is a lot higher than most people might think.

Order At A Bargain

This week on EconTalk Allan Meltzer poetically reminded us that

A country that won't experience a small recession will end up having a big one.

Free markets are messy things and it won't be perfect all the time. Nothing will be perfect all the time. We must remember that slowdowns and corrective recessions are the price we pay for the benifits of a dynamic and enriching society. And we're getting a damn good deal.

If You Build It, They Will Ride

Paul Krugman claims Americans face a paradox as we adapt to higher oil prices and away from our suburbia lifestyle.

Public transit, in particular, faces a chicken-and-egg problem: it’s hard to justify transit systems unless there’s sufficient population density, yet it’s hard to persuade people to live in denser neighborhoods unless they come with the advantage of transit access.

This is not really a big problem if you remember your marginalism. Extend a single rail line through a residential area. If oil prices are as high as everyone says they are, people will move to that area. Apartment buildings will replace townhouses (and if you're smart, you bought some of that land around the rail before the construction was announced).

Firms solve this problem all the time. Wal-Mart constructs its stores in the middle of no where. It doesn't fret about the low population density (it prefers it, actually) because it knows people will come to it. Same goes with any large scale project that people will want. Assuming, of course, they want what you're building.

All Bad Stuff Isn't Worth Avoiding

As the semester closes, a student came in to collect his final and we got to talking about immigration. He's concerned about illegal immigration, largely for security reasons. Keep out the illegal immigrants and you'll to keep out the terrorists. It only takes one to make a disaster, after all.

But the optimal amount of terrorism (or pollution, accidents, illiteracy) is not zero. It might seem so because we really don't like seeing bad things happen (terrorist attacks being some of the most tragic) but complete prevention is a very costly thing to do.

Reducing terrorism requires the command of a vast amount of resources. Thus increasing security reduces the amount of things we can do (workers are busy patrolling borders). This "opportunity cost" is can actually cost lives: doctors tend soldiers with heat stroke instead of citizens with heart attacks. Terrorism reduction through border control also reduces the number of people who peacefully work in the US (the vast majority of them) so our opportunity cost deepens. We not only have fewer people producing other things, we have fewer people producing at all.

The cost of terrorism reduction increases faster than it falls. Picking out the obvious amateur is pretty easy, but once all the easy guys are caught, tracking down the elusive expert is much harder. For each percentage point closer to zero we get, that single point costs more and more. Our "increasing marginal cost" puts a tremendous amount of strain on our economy without obvious benefit beyond that one more person captured.

Preventing terrorism in the U.S. is particularly expensive. The country's size makes it that much harder to find terrorists. Its decentralization means any terrorist attack will have a small impact on the functionality of the country. Its productivity means that we are giving up so much more when we wander the desert looking for illegals. The accounting costs are very high. The opportunity costs are very high. The benefits are pretty low. Zero is not the optimum.

Playing with Statistics

Bill Moyers appeared on The Daily Show tonight and fretted over the rising gap between "the rich" and "the poor." That these terms are arbitrary and vague didn't seem to bother him. Nor did he seem to mind that the numbers are useless. Comparing a gap now and a gap twenty, ten, or even five years ago assumes nothing else has changed.

But lots of things have changed, including the people the numbers are looking at. People are moving higher up in incomes and starting at lower incomes (because of immigration, more schooling, etc). This is a great scenario but Moyers' naive examination of it would suggest disaster. When we follow the individuals (which we don't do enough of so the data is a little old), "....the bottom 20% in 1975 were also in the top 40% at some time in the 16 years follow." (Sowell, p135) Here's a table from Steve Horwitz's page that gives us a more complete picture:

Income Mobility 1975 to 1991 (UM Data)
	Bottom 20% (1991)	Fourth 20%	Middle 20%	Second 20%	Top 20%
Bottom 20% (1975)	5.1	14.6	21.0	30.3	29.0
Fourth 20%	4.2	23.5	20.3	25.2	26.8
Middle 20%	3.3	19.3	28.3	30.1	19.0
Second 20%	1.9	9.3	18.8	32.6	37.4
Top 20%	0.9	2.8	10.2	23.6	62.5

Why Are There No CEO Assassins?

My newly found of love of Burn Notice reminds me of a question Robin Hanson posed to use a few weeks ago. Why don't firms assassinate the CEOs of their competitors? It seems pretty strange but industrial sabotages is an old practice and a highly paid CEO is the lynchpin of the company.

It's not like it would be that difficult to get away with it given the resources these firms have at their disposal. Besides, most murders don't get solved if they are done halfway smart and pulled off by someone not in the system. Mob families have contract killings all the time (using "all the time" in a loose sense). So why aren't CEOs dropping like third world dictators? Here's a few theories.

Rule of law. This is a bit of hand-waving but it's worth noting that my above examples of common assassinations (mobs and developing nations) take place in contexts where the rule of law is precarious at best.

Externalized benefits. Your gain is your third party's gain. But she's also your rival and didn't have to pay for the hit. Even if just two firms are the biggest boys on the block by far, the threat of a new competition (which would surely arise) could get you to shrug your shoulders. Why off the CEO of Pepsi when that will allow another Pepsi to rise up? Meanwhile, Pepsi's still there and now you have two rivals.

Retaliation. This is how mob bosses (and some nations) keep the peace. A CEO is less willing to off his counterpart if he believes they'll respond in kind.

Built in redundancy. In a weird way, every firm large enough to make the risk worth it is prepared for it. It's likely not explicit, but every shareholder knows their CEO could have a heart attack or die in a car accident. If the CEO is worth his salary (and the economic analysis suggests he is), then he's worth taking out an insurance policy for. This means there are other guys who know just as much about the firm and are probably almost as good as the guy in charge. True lynch pins (such as Steve Jobs and Warren Buffet) are rare. Ok sure, you could just take out the back ups, but how do you know who they are? And more than one mysterious death will raise attention--the chance of getting caught rises pretty quickly with each additional dead body.

Shhhhhhh. Of course for all we know CEOs are killed, but we just know them as heart attacks and horrible accidents. Remember the whole idea is not getting caught.

Upcoming Final Exam

I hope my money and banking students can answer the following:

Select one of the methods we discussed on how expansionary monetary policy increases GDP (there were five in total, from lecture 19) in the short run. Detail the logic (i.e. the series of causation) of why this avenue of monetary expansion increases GDP. Why won’t this work in the long run? At what point in the causation does the method you selected stop working? Why?

Why Banks Hate Foreclosures

In the mess of the sub-prime collapse, you occasionally hear that the banks purposely lent to people they knew couldn't pay back the loan. This why they get the loan money and keep the house. Seems like a pretty good deal. Why don't banks do this all the time?

Banks are a business--they don't really want the house, they want the money. You can't pay your workers with bits of a home. You can't use it to invest. You can really only use it to live in, but all the management staff has a place to live already. Homes are what economists call "illiquid" assets--assets that can't turn into other things easily. Banks prefer liquid assets such as bonds, futures contracts, stocks, and cold hard cash.

Can't the bank just sell the house it forecloses? That is what they try to do, but each day it takes costs the bank money in the form of lost opportunities. CNN reported that people who gave up the home to the bank tend to trash the home. They rip out piping, steal toilets, take out cabinetry, lay claim to fixtures, and punch holes in the wall. One family grabbed a pair of decorative columns from a home. Homes like these have to sold at a discount or the bank pays to fix them up. And then they have to pay to keep the house from accumulating additional damage while it sells. It all adds up to time and money down the hole in the floor where the toilet used to be. And banks don't like it.

There Is No Peak of Progress

James Howard Kunstler appeared on the Colbert Report today promoting his new novel about a world without oil. Kunstler claimed we have hit the peak of oil and now we must get off of oil and abandon our Wal-Mart suburbia ways.

Kunstler is mistaking economics with physics. There's a finite amount of oil, but that's not what we care about. We care about energy. As the price of oil rises we find new sources of electricity. We improve wind, solar, nuclear, coal, geothermal, and oil efficiency. We find new deposits, including things we never considered oil before. Someday we will not use oil, but it will be phased out, not ripped away. Kunstler imagines the oil wells "drying up" will come as a surprise--a paradox concerning that's what everyone talks about. Assuming ignorance on the part of the oil companies (who's fortunes are made on the stuff) is patently absurd.

Colbert wisely (though I doubt he meant it this way) brought up the terror of Y2K, asking "When's that going to hit?" I remember the scares of the millennium bug vividly, the concern that planes will fall out of the sky and the world will suddenly end. It didn't. No one wanted to go back to the Stone Age so programmers fixed the problem. Now we are better off than we were eight years ago, and the Y2K scare a distance and quaint memory. Kunstler's novel will surely follow the same path.

Worlds Within Worlds

Bill Maher fretted to Jeffery Sachs Friday that if all people of the world consumed like Americans we would need five Earths to supply the resources. Yet a hundred years ago, we could tell a similar story using Europe as a baseline instead of the States. How can I make this claim?

What Maher and Sachs are ignoring (as too many people do) is that if the people of the world used more resources, they would be able to produce more of them. More creativity, more inventions, more ideas, more productivity, more investment, more hands at work, more active minds. The history of the world is replete with scares of shortages and the panics never hold out to the adaptive world of free markets.

Increasing Returns and Life

A few days ago Arnold Kling applied the law of diminishing returns to everyday life. In other words, he explained how doing the same things get boring and where in our life can we avoid this trap.

According to Kling, people do it an awful lot. They read books by the same author. They stay forever in the same organization. They're hesitant to change jobs. On a personal note, the only fiction my mom seems to read are murder mysteries and I sometimes wonder if she ever gets bored with them or can guess the guilty sooner.

Yet we also have to recognize there are increasing returns. If what you experienced in initial consumption can be carried forth (in part) to future consumption, then the time time you engage in that activity, your change in satisfaction can higher than what it was before. For example, the first time you tell a joke won't be as good as the second time. The learning experience you gained from the first time enhances your telling for the next time. You might be a little bored of the joke because it's in your recent memory, but the smoothness of the execution of the punchline more than makes up for it. But it doesn't have to be educational in nature. A little bit of the drama carries from experience to experience. Similar experiences can enhance each other (which is why there are so many people who throw themselves into a TV show).

The same could be said in other areas people specialize in, such as their job, a discipline, or a sport. You can think of it as going to the same amusement park each day in a week. Each time you experience another part of it, but can also avoid the costs of constantly learning how to navigate its paths. Obviously, this can't last forever (not even academics think in terms of the discipline every waking hour) but it does suggest that dabblers may well be served to throw themselves into a discipline instead of constantly moving about. And perhaps it's worth it to visit the Louvre twice in the same visit to Paris--you're surely discover great things most people don't notice.

Earth Day Is Capitalism Day

On this Earth Day, George Mason University's Don Boudreaux celebrates what he calls Capitalism Day:

...far more than any other, has made human lives clean, safe, dignified, and culturally rich. Capitalism is also responsible for giving people the wealth and leisure to permit them to mis-perceive nature as loving and bountiful, and to enjoy nature in a way that few of our pre-industrial ancestors could ever have enjoyed it.

It is this latter point that is often ignored. A wealthier society is a gateway to all other things we value. Wealthier societies not only have more stuff (from Wiis to advanced medicine) and more options (for jobs, living areas, places to travel) they also give us the gift of time.

Time is our most precious resource. Our ability to save time (though greater productivity) is critical to our happiness. We spend time to enjoy the company of others, find love, seek enlightenment, discover our purpose in the world, and enjoy nature. In a lot ways, nature is a really nasty thing. It's a little strange we leave the safety of modern society to visit it. Nature is filled with bugs, dirt, and disease. The sun spews radiation. Some hiking trails are small and uneven, making it easy to get lost and then sprain an ankle. There is no plumbing, no Internet, and no one to gut and cook a fish for you. Poison ivy crops up in unexpected places. Water needs purification tablets and food needs to be hoisted in the air out of the reach of wild animals. Birds scream all the time. And this assumes it doesn't rain.

Few would ever want to live permanently in such a place and most that try don't last long. But all this "roughing it" can be fun if it's temporary; nature is best left as a tourist attraction. But only with the time capitalism awards us can we afford to "get away from it all" for days at a time. Visitors cut themselves off from the world that they rely on for everything they brought out to the wilderness to make sure they don't die. If there was no capitalism, if people were too busy to see how beautiful nature can be, we likely wouldn't have an Earth Day which celebrates the wilderness. Or, worse yet, we'd be out there all the time.

The Nature of Trade

Jeff Faux (Economic Policy Institute, founder) on the Diane Rehm Show argued against NAFTA today, arguing that globalization changed the nature of trade. It's no longer about exchanging goods but about US firms manufacturing abroad and importing back to the States. The trade deficit, he concludes, is a problem.

Mr. Faux should know better. The trade deficit (aka the current account) is an arbitrary distinction between the net flow of goods and the net flow of investment (capital account). By definition, the two add up to zero (the balance of payments or BoP). Americans import goods and in exchange they spread the US dollars that give foreigners the ability to invest in the US economy. As a result, US citizens maintain a very low savings rate without losing the technological and economic progress that investment generates.

Here's a simple graph to drive home the point:

Keep Your Numbers Real

Today CNN commented on the Pope's visit to New York City, arguing it would bring $50 million to businesses in the Big Apple. They compared this to when Pope John Paul II visited the city in 1995 who spent $45 million. They then briefly commented why the Pope might be bringing in more and what's changed in the past twelve years.

But they didn't mention what's definitely changed: the price level. Usually when they bother to adjust for inflation, they mention it. But not today. A simple check reveals that the real value of the last Pope's visit was $62.2 million--over $12 million more. Say what you want about popularity or Pope expenses, but always check for inflation.

The Secret Safety Record of Nuclear Power

When it comes to the environment and electricity there are two basic schools of thought for clean energy: nuclear power versus wind/solar (and occasionally hydroelectric). Nuclear power has the advantage of being reliable (the weather doesn't effect it so it's great for base-line power) and cost effective. Its main problem is that it's scary.

There's only been two major accidents in nuclear power history--Chernobyl and Three Mile Island. Lots of other accidents involving isolated radiation leakage occur, but it's the disaster scenarios that people are scared of. It's very strange, much like how people are afraid of flying because there's been a few big accidents yet don't bat an eye at the thousands of car wrecks a year. If we want to truly judge the safety of nuclear power versus other sources, let's examine how many people die per terawatt-hour. Note these deaths can occur in many ways, such as accidents, pollution, construction and maintenance.

Coal: 32.6
Solar: 0.83
Wind: 0.4
Nuclear: 0.052

The solar rate are based largely on rooftop solar and most of it comes from the danger of installing it (roofing is one of the most dangerous occupations in the States). See this article for more information. I picked up the coal and nuclear numbers from this article.

Granted, it's difficult to tell how dangerous nuclear power is given the long-term effects of radiation and issues regarding nuclear waste. At the same time since nuclear power is so much cheaper its customers could afford other things that they couldn't otherwise such as healthier food or better medical care. The net effect is far from obvious but it seems unlikely to overcome the ten-fold increase in the death rate compared to its clean alternatives. Nuclear power is a lot safer than you think.

Contracts and Adultery

Contracts are great. They let us plan our life with confidence. They secure trust and obligation. Even when informal, they just make everything run smoother. Contracts, in all their forms, are at the heart of a well functioning society.

Marriage is a contract: "I give me life to you so long as you give your life to me" etc etc. Cheat on your spouse and you get what's coming to you. You made a promise; make sure you keep it. It all makes sense. But some have a very strange approach of cheating: they blame the cheating partner just as much as the one they cheated with. They call them home-wreckers, sluts, jerks, and monsters. Sometimes they are threatened with violence. Some are killed. Even if they're not married, they're called adulterers.

This is nonsense. Your spouse is clearly in the wrong, but the other party isn't (unless s/he's married, too), even if they knew about the marriage. They didn't break contract. They may have allowed your spouse to break it, but so did the hotel they stayed in. Third parties made no promises to break.

Suppose Ethan promises Steve to sell him a book for $10. Then James, knowledgeable of the contract, offers Ethan $20 for the book and Ethan takes the deal. It's hard to imagine Steve being angry at anyone other than Ethan, but yet the same logic doesn't apply to marriages. You might say these third parties aren't respecting marriages and that's their flaw, but you could say the same thing about James and contracts. And since marriages are contracts, that doesn't get us far. What's special about marriage?

I have yet to hear a good answer, though married people seem to loathe this position more than single ones. The best explanation I can come up with is that they just don't like the idea of someone they care about cheating on them and they'd rather blame someone other than the one they love. So the lesson today is that if your spouse (or girlfriend, or boyfriend) cheats on you, the problem lies with them and your relationship, not some random person you just want to be angry at.

Listen to Your Mother

I have vivid memories of my mother insisting I wash my hands before dinner. I remember thinking: "What on earth does she think I've been doing that would justify all this hand-washing? I'm eating pasta, not performing surgery." But insist she did and the rule has (somewhat) stuck. I live a pretty quiet life--academia isn't exactly a dirty job.

Doctors are a different story. They expose themselves to dirt and disease with every patient they visit. But for some reason, they rarely wash their hands. Even though washing between each patient is time consuming, using ultraviolet germicidal irradiation (and wearing rubber gloves to mitigate the dangers associated with constant exposure) would cut that time down to a negligible value.

We talked about this issue and others (interns work for 24+ hours, doctors wear "sterile" scrubs to the cafeteria, aspirin before a heart attack is rarely used) during law and economics today. The existence of these deficiencies is a puzzle. They are very easy and effective ways to save lives yet in the avalanche of medical malpractice suits they are rarely employed. More puzzling, they are rarely cited as a cause of negligence--a lack of this or that test is more common.

The latter seems to explain the former (hospital's aren't willing to accommodate because no one's complaining) but that only makes the latter more puzzling. Most people who file a suit don't have a legitimate claim of harm, but surely they could secure a victory if they point out the doctor/hospital didn't take simple steps for avoiding harming. Why are doctors being sued for not ordering an obscure and expensive test and not being sued for being less hygienic than the seventeen-year-old at McDonald's?

My best guess is that people don't want to believe doctors could be so careless. This doesn't quite explain it since you'd think the possibility of infection or death would encourage people to think more carefully (rational irrationality doesn't get us far). Still it is consistent with the fact that of the people who have a legitimate case against their doctor, only about 2% sue. What a strange world we live in.