Sunday, March 30, 2008

The Paradox of Control

Eliezer Yudkowsky at Overcoming Bias explained scarcity as psychologists think of it: as something becomes less attainable, you value it more. It's not clear how widely this applies but I can see it function in many areas such as dating, fads, and fashion. While Yudkowsky explains the phenomenon with evolutionary psychology (our ancestors had to grab what was scarce or they'd die out) we can also see it as signaling. If you have something that's hard to get, it suggests you're important, hip, or otherwise exceptional in some way.

Contrast this with Robin Hanson's theory of regulation. If a regulator can require something of a person but doesn't, the person will likely conclude doing what the regulator wants isn't all the important. If you can ban something but don't, then it's not all that dangerous. If you can require something but don't, then it's not all that helpful. A lack of regulation is a signal that tells people that if they made a bad decision, they'd still be alright.

Again, it's not clear how widely this framework applies but we can imagine quite a bit of overlap. Drugs come to mind first. If you ban drugs, people will want to do them more to either suggest they're hip or to get them while they can. If you don't ban drugs, people (possibly the same group, possibly different) will then conclude they're aren't a big deal and use them. In other words, if you don't want anyone in a society to use drugs, there's nothing you can do about it.

Thursday, March 27, 2008

What About the Rest of Us?

There's a Breast Cancer Protection Act currently circulating in Congress to require health insurance companies to cover a minimum 48-hour hospital stay for mastectomy patients. Makes sense that women wouldn't want to be forced out of bed right after surgery, but what's that going to do to the rest of our premiums?

Tuesday, March 25, 2008

Is Wal-Mart A Collective Action Problem?

Wal-Mart gets a lot of criticism from a long list of groups from environmental to protectionist to labor union. People complain it destroys jobs and runs local stores out of business. None of these arguments hold water (environmentalism is about private property, free trade emboldens economies, Wal-Mart only works because people choose to go there, etc) and I have yet to hear the rara avis: an anti-Wal-Mart argument that makes economic sense. On a theoretical level, I think I have one.

Consider a small town. Each of these people value two things: their downtown mom-and-pop stores (that small town feel) and low prices (everyone likes a bargain). Let us also suppose that each person values the small town atmosphere over the prices--in other words they are willing to pay a premium to keep the charm of the hamlet.

Now suppose a Wal-Mart comes to town. Each resident has a choice between shopping downtown (and thus supporting it) or shopping at Wal-Mart (and thus get the lower prices). Since the downtown won't go away if one person "defects" to Wal-Mart, that defector can enjoy low prices and still have that small town feel they love so much. It's strictly better. (Note enjoying that small town feel does not require actually trading with them--they simply walk along Main Street and breathe in the atmosphere.)

Naturally everyone has an incentive to do this, thus everyone goes to Wal-Mart (or a lot do) and the downtown disappears. (Set aside any arguments of downtown revival because people can now afford more stuff.) As an individual, you can choose to end your defection and go downtown, but you, lone patron, will not save the stores. It will only work if everyone (or a lot) of people will work with you. But their personal incentives doesn't lend them to that so no one does. It's a collective action problem.

The downtown atmosphere is what economists call a positive externality--people who aren't paying for it still are able to enjoy it. The town could solve this issue by walling off the downtown and charge a small fee to those who wish to visit it. Taxes to the stores could be reduced by a proportional amount (who could then decrease their prices slightly) and the only difference ends up being that free riders can no longer ride for free. Naturally, the town could also ban Wal-Mart if it turns out internalizing these externalities prove too costly (which it very well might be).

Anti-Wal-Mart groups who wish to use this argument should exercise caution. The assumptions are rather strong (nobody is willing to swap low prices for their downtown) and demonstrating they apply to a given community is difficult. Moreover, the establishment of this argument can quickly be applied to areas the group may not desire. If one can ban Wal-Mart on the grounds that low prices are too expensive, then one can ban Internet access, delivery services, resident mobility, and a host of other options on the grounds that people cannot be tempted by alternatives lest the downtown is abandoned. The line between preventing a collective action problem and outright tyranny is a thin one indeed.

Sunday, March 23, 2008

Gaps In the Logic

A lot of dirt is being thrown at financial institutions lately and lot of it's nonsense. Near the top of that nonsense list are the accusations of racism. True, blacks have a harder time getting a loan; no one is denying that. But gaps in outcome does not imply discrimination. As Thomas Sowell points out in his new book,
[In two studies in the early nineties] whites were denied conventional home mortgages loans more often than Asian Americans. The same reasoning that led to the conclusion that blacks were being discriminated against in favor of whites would lead to the very questionable conclusion that whites were being discriminated against in favor of Asian Americans. But however questionable that conclusion, we cannot simply accept empirical evidence when it supports our preconceptions and reject that same evidence when it goes against those preconceptions...A later study showed that Asian Americans took out expensive subprime loans less frequently than whites did--but again the media focus was on black-white differences in the use of costly subprime loans and again the conclusion was that racial discrimination in access to conventional loans explained the difference.
Reality is always a bit more complicated than we'd like it to be or even expect. In the social sciences controlled experiments dwell past the edge of ethics so we have to rely on the observed data with all its chaos and imperfections. With that in mind, we must then look at as much of it as possible so we can parcel out the truth from the nonsense derived from our preconceptions.

Wednesday, March 19, 2008

Rick and Uncertainty

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

T/F and explain.

If a payoff is uncertain (not merely risky), then you cannot calculate its expected value.

Saturday, March 15, 2008

Evolutionary Progress

Among the first lesson I teach my money and banking class is Joseph Schumpeter's insight on economic change: creative destruction. It's a strange term but economics is strange itself and sometimes requires language that on the surface doesn't make sense.

Schumpeter understood that economies grow by creating new ideas while simultaneously destroying others. It is not a stationary process but one of constant change. Creating many ideas means society has many options and thus many good innovations. But destruction is equally important. It allows the market process to move resources from bad or obsolete ideas and move them to desirable ones. We not only get the good stuff, we get a lot of it. But that means destroying the bad--or just not as good--options.

People generally recognize the importance of creation. The role of destruction is much harder to grasp. And so it was today when Lou Dobbs once again expressed concern for a loss of manufacturing jobs. He was confused how officials from the U.S. military could defend free trade and building equipment abroad while these jobs are destroyed. But employees are fired, not murdered, and they will go on to do other things. It is from this destruction that breathes new life into the economy and allows the world reinvents itself once more, as it has done before anyone alive today walked the earth.

Thursday, March 13, 2008

"No Lye" but a Lot of "Tomfoolery"

I recently picked up a copy of Tulani Kinard's No Lye, a book promoting "natural hair care" for African American women. Surprise, surprise! State regulation was advocated in the same breath as upholding tradition!

Kinard's argument is straightforward: Age-old African hair care methods are safer, healthier, and self-esteem building. In keeping with these traditions, black women today should braid, loc, and twist their hair.

"Now for the clencher": Increased demand for these traditional hairstyles require legal definitions for the techniques and certified professionals to do them.

Gee, these techniques supposedly survive today because of hundreds of years preservation by women who weren't certified. Why change all of the sudden now?

Saturday, March 08, 2008

Yea, Governator!

I was appalled when I heard about this recent ruling against California's homeschooling families. Considering that many homeschooling parents - like my own - are better educated than our credentialed public school teachers, requiring the former to submit themselves to special training is ridiculous! I'm really happy that the Governor has made a statement against this ruling and the Home School Legal Defense Association (HSLDA) petition has racked up thousands of signers. I'd encourage Californians to contact their state legislators and House representatives about the issue.

Friday, March 07, 2008

First Kentucky and Now Egypt

When I saw this, I nearly fell over laughing. Copyright the pyramids? Ridiculous! The fact that every little kid is amazed by pictures of pyramids in history books is probably the only reason why they later visit Egypt and spend gobs of American money there as tourists. Please tell me that their copyright laws won't hold up here in the US.

Reward Those Who Know

Rep. Patrick McHenry (R-North Carolina) asked CEOs dragged into Congress today of Paulson Credit Opportunities Fund, which made billions betting the housing market would plummet. McHenry spoke in distaste of this success.

The congressman should think before he speaks. If Paulson has a unique insight in the housing market, don't we want his firm to act on it? By rewarding people who act on accurate information, countless others have a reason to search for problems before they become disasters. Offers of $1,000 for every mistake found leads to very accurate textbooks.

Monday, March 03, 2008

Dump The Dumping Laws

Right now, an old friend of mine is awash with paperwork. He works for a company in the Midwest, importing steel from China. Last month his firm received a notice from the Department of Commerce (which insists on call itself "the Department" while abbreviating virtually everything else). They received a petition that my friend's firm (along with several others) are importing at an unfair price. An investigation is now underway.

First the department required that they spend dozens of hours filling out forms that summarize the company's activities with China (which basically means all their business). Then the department used that information and did acomparison study with India to determine their prices were "too low." The report reads why this is a problem:
The Petitioners contend that the industry's injured condition is illustrated by reduced market share, lost sales, reduced production, reduced capacity utilization rate, reduced shipments, underselling and price depressing and suppressing effects, lost revenue, reduced employment, decline in financial performance, and an increase in import penetration.
These are better known as the effects of competition.

The importer must now spend hundreds of man-hours demonstrating they operate in a free market or be hit with massive fines. People often complain that in an unregulated free market, corporations will set prices too high. Strangely, they now
argue that prices are too low because this company isn't in that same uncontrolled environment.