The Economics of Bigotry

Conventionally, profit-seeking and bigotry are contradictions in terms. A company that constrains who can be an employee interferes with the ability to get the best employee and thus interferes with profits. A company which limits its customer base affects its bottom line. The same logic can be applied to personal relationships: if you refuse to make friends with people of different ethnicity, genders, religions, sexual orientations, etc, then you limit the pool of potential friends. Since people are so diverse in their interests, bigotry can make you very lonely. Incentives discourage bigotry.

If it was that simple, the Supreme Court ruling on the Voting Rights Act would be inconsequential and we could safely say anti-discrimination laws have no place in a libertarian government. Economic incentives (which we know are very powerful) would discourage bigotry so much, such laws would serve no purpose. But it is not so simple.

The person who hires is not always the same as the person who profits from that hiring. In fact, it is very common that the manager is not the owner of the store she manages. While a manager's salary and job security are tied to the division he manages, it's an indirect tie. The likelihood he'll get full credit for good performance diminishes the farther the manager is removed from the owner(s). Knowing this, a manager (particularly a low-level manager) faces a very low cost to be a bigot. She gives up little (a small, small chance to get credit for good sales) compared to the owner so she indulges in bigotry more than the owner would. The demand curve slopes down.

This is a real concern for owners who naturally want the very best performers, but it is virtually impossible to get around. Refusing to hire the best person due to bigotry is hard to detect; there is no obvious error the owner can point to (unlike hiring a stupid or lazy person, where there is a record of complaints and poor performance).

What makes matters worse is that sometimes the best performers (or customers) are bigots themselves. Even if a manager isn't a bigot, he may be encouraged to avoid certain traits others  unjustly find offensive. This concern, real or imagined, might be more prominent than we may be willing to admit: the desire to be around people who look like you is a strong one, one probably hard-wired into our DNA.

This instinct increases the benefits of bigotry. In the FX series Justified, the main character is a deputy U.S. Marshal in eastern Kentucky. While not a racist himself, he's found it advantageous to his job to feign some racist attitudes. More people are willing to talk to him if they feel like he's "one of them." It's an extreme example, but it highlights an important point. We not only like to be around people who look like us, we like being around people who think like us. The more people who have foolish views of those who are not like them, the greater incentive to engage in those views (or least, not challenge your primitive instincts). Bigotry becomes self-sustaining.

This is what makes the ruling on the VRA so disturbing. Even though the South had issues with racism "a long ago" (half a century ago), that certainly doesn't mean many of those attitudes are gone. As the recent decision by students to resegregate a South African school demonstrates, old habits die hard.

How Food Stamps Can Send You To Hawaii

PolitiFact rated Gingrich's claim that food stamps can send people to Hawaii as "Pants on Fire," it was so wrong. Food stamps can only be used for food.

Yes, that's true, but that doesn't mean getting food stamps can't result in you being able to afford going to Hawaii. (I doubt that's what Gingrich meant, but it is true nonetheless). Food stamps are basically gift certificates. If I give you a $1,000 gift certificate to Wal-Mart, it will assuredly result in you buying more goods that don't come from Wal-Mart. You will substitute money you would spend at America's biggest retailer and instead spend it on other things. If you get food stamps, the effect is the same. So yes, food stamps can send you to Hawaii, though not directly.

No Philip, There Are Rational Expectations

Philip Pilkington at Naked Capitalism has an article which might as well be titled "Watch Me Confuse Theory with Reality." The complaints are familiar: neoclassical economists assume people are perfectly rational and they have all the needed information to make a decision but its possible to think of times when that's not true so the whole idea is stupid. Advertising is often used as a counterpoint and this article is no more original in that regard. It also has particular problems with rational expectations which predicts that people will try to minimize their error when they are trying to forecast the future.

The fundamental point here is that people – be they consumers or producers, investors or forecasters – often act in an almost wholly irrational manner; one that is quite open to manipulation. And once we allow for this the very premise upon which rational expectations theory rests upon falls to pieces.

I like to keep my blog posts short so let me set aside a few issues: the area of imperfect information is a big field in economics, neoclassical or otherwise; advertising has useful functions such as signalling quality (you spend more on ads to demonstrate you're putting a lot behind a product) and conveying information; and rationality in economics is a very low bar (you do what makes you happiest given your constraints and desires).

More fundamentally, rationality is a general guideline which explains the vast majority of the average person's behavior very well. Precisely because it works so well, we don't notice it because errors are more memorable than successes (and for good reason since making an error suggests we need to re-evaluate how we make a decision in that sphere of our life). For example, today I bought a bagel sandwich for breakfast. I've bought such sandwiches many times in my life and enjoyed them so I rationally believed I would enjoy this one. I was right. I also bought it on a banana nut bagel. I've never had such a bagel before but I like bananas, nuts, and the combination of banana and nut so I believed, again recalling my previous experiences, that I would like this. I was right. I also bought a Diet Coke with my bagel sandwich, a drink I've consumed many, many times before. Again, it was enjoyable. Had I not read Naked Capitalism's article, I never would have given my purchases today a second thought.

Do me a favor and think of all the things you bought today. I'm not just talking about your morning coffee or the toll you might have had to pay to get to work. What about the water that came out of your shower? Electricity? Gas? Trash bags? Internet service? Phone service? Netflix account? (Note some of these things you bought earlier so you could use them later, including today.) Most of these things you don't think about and you probably don't know the price for many of them off the top of your head. You might say this violates rationality and that if people behaved like economists say they do, The Price Is Right would be a very easy game show. You'd be wrong.

We don't know these prices, or think about the purchases, precisely because we are rational. For the vast majority of us, what we are willing to pay (our reservation price) is far greater than what these things cost to purchase (the market price). In other words, there is no question we want to buy them. If there is no benefit to contemplating something but a definite cost (as there is contemplating how happy we are with our phone service or the precise price of water), we don't do it. And that leads us to forget how rational we are.

The advertising argument deserves special mention, since I hear it so often. It is the stock response to the rationality skeptic. Let's consider it carefully. If it were true that people are constantly misled by advertising, if we waste billions each year mindlessly pursuing images of sex and stature, then there would be no product development. Indeed, there would be no products. Everything we buy would be empty boxes with pretty pictures on them. Yes, this is absurd but pointing out the logical extreme highlights just how far away we are from this. Advertising takes up a small portion of a company's budget. Macy's spends 5% of its sales on advertising and that's quite a bit for retail. Wal-Mart spends closer to 0.4% and, of course, Wal-Mart's much larger than Macy's. Packaged goods (whatever that means) can get as high as 10%. Product design and development easily hit the same percent in sales (here's some numbers from Canadian companies) with some sectors such as aerospace and computers reaching well over 15%.

Remember, history's awashed with failed products that had lots of advertising. Several blockbusters and dozens more TV shows utterly fail each year. New Coke also comes to mind. One estimate claims 65% of new products fail (some estimates put it as high as 95% but those tend to come from "how to improve your product" websites so take that with a grain of salt). Yes, many of those products suffered from a lack of advertising but some of them were just bad. Let's not forget Borders recently shut down.

Again, our brain can fool us on such minor issues: we remember the purchases we regret (and by no means does neoclassical econ suggest people make zero mistakes) but there are many, many products we see ads for but don't succumb to. I was in Abercrombie and Finch the other day. Its walls were covered with half naked models. Its aisle filled with attractive salespeople. Its shelved filled with $80 pants. As usual, I bought nothing.

Obama Is a Secret...Oh Who Cares?

Matthew Yglesias suggests that an increasing share of Americans (18%, up from 11% in March 2009) believing Pres. Obama's a Muslim derives from poor economic conditions.

My best guess is that we can just chalk this up to the general dynamic of recession-induced suspicion and incumbent unpopularity.

Possibly. I have another, complementary, theory: no one cares.

When there's a lot going on in your life and you're stressed about losing your job or finding another one and the bills are piling up, you don't care what religion the President is. Spending time caring/screaming about irrelevant facts is a normal good for some: it rises as income rises. In the early days of the recession, when some thought it might be a small blip, people cared about this. They were willing to listen beyond the occasional yelp that he's a secret Muslim, sometimes onto more reasonable people that correctly point out he's Christian. But now they hear those screams, brought up again surely because of the midterms and because commentators know people aren't going to look into it as hard, and accept it. Because double-checking is a pain, thinking hurts, and they have better things to do.

Rational Crime

I used to be surprised whenever news came out about a wealthy person committing insider trading or a priestly sex scandal or a congressional scam. These individuals are already at the top of their game with seemingly great jobs. Why risk it, why risk jail? The standard explanation is arrogance or greed. These people think they can do whatever they want and they get stupid.

That's a pretty sloppy explanation and I've come to the conclusion that the real reason is far darker: it actually happens all the time and you rarely get caught (or are rarely prosecuted). Indeed, Congress spends an average of $1 million a year for settlements of congressional employees. That's all taxpayer money, by the way.

The Paradox of Happiness

Disciplines are always most interesting when they cross with other disciplines and the economics of happiness is no exception. Talking to some of my friends the other day (one versed in anthropology and another in psychology), we noted how much people value a sense of genuine accomplishment and is probably why, in some cases, wealthy people aren't as happy as less wealthy people. (Setting aside the lower mortality rates in poorer societies.)

For example, the people of the indigenous tribe that must work every day to get a meal are going to be happier (assuming they are successful) than the middle management who, while isn't concerned about getting his next meal, has no sense of accomplishment and feels as though his life is wasted. (This, by the way, is how many mid-life crises take root.) Indeed, people who have the option to leave their tribe in favor of modern life tend not to take it (I know this is very common among the Amish, and I'm sure a similar story can be told for other groups).

However, I argue that the wealthier, accomplished person will be happier than the less wealthy accomplished person ("accomplished" being defined as the standard of the society...for example, getting a book published in the wealthier society versus bringing home a kill in the less wealthy one). Some expressed doubt to the claim, so here's my reasoning.

First definitions: p (probability of achieving an accomplishment); S (happiness from achieving survival); s (happiness from surviving); A (happiness from achieving something else); and a (happiness from that something else). This draws the distinction, for example, between the sense of achievement from a book published and the royalties received from getting a book published. Note I'm also assuming it's equally likely to achieve something in a rich society and in a poorer society. This is primarily to make the math easier.

A person would be indifferent between two societies if:

p(S+s) = p(A+a)+s,
where the right-handed side is the wealthier society (they get the benefits of survival without trying) and the left-handed side is the indigenous society. Simplifying reveals:

S-A = a+((1-p)/p)s
In other words, there must be a larger sense of accomplishment from surviving than from other accomplishments to make a person indifferent. To make a person prefer the less wealthy societies (which I strongly doubt), the premium (S-A) would have to be greater than a+((1-p)/p)s, which I doubt since both values are positive and a might well be quite large.

Now consider the scenario when p=1, or when you are comparing people in each society who have made achievements (either in survival or in something else). The equation becomes:

S-A = a
If we think of such individuals in each society as sharing common traits (intelligence, drive, etc), then this means that more capable people are less likely to prefer modern society compared to less capable people--it all depends on the additional satisfaction derived from achieving survival versus achieving something else. While I imagine this premium to be quite small, the fact that this (simple) model predicts "stronger" people are more likely to prefer an environment that is more dangerous seems to be quite the paradox.

Information on the Margin

According to a study, New York City's new laws requiring calorie counts on fast food restaurants doesn't appearing to be having any net effect on food purchases. One would think this law would get people to steer clear of fast food, but it's easy to see why, in practice, this doesn't make any bit of difference.

Like smoking, the unhealthiness of fast food is common knowledge. Telling them exactly how many calories are in X, Y, and Z change anything because they're not seen as relevant (ignoring that a high calorie count isn't the same thing as being unhealthy). If you already know a Big Mac is bad for you, knowing it has 576, not 500, calories isn't going to change your decision.

It's too costly to calculate everything down to such fine nuance. Instead, people think in broad categories. Now, if estimated calorie count was off by a factor of 2 or 10, we'd see some real movement. But, on the margin, this information adds virtually nothing. People are good at estimating calories by themselves.

Voting Three Times A Day

Robert Kenner's new movie, Food, Inc., argues that food is too cheap and, thanks to health-related issues from diabetes, will end up being more expensive in the long run. While Kenner is lacking in his rationality (it's hard to make the argument that it's bad to give people more options in the form of cheaper food) he recognizes that consumers are the key to the problem. When he appeared on The Daily Show last week, he reminded Jon Stewart that the consumer "votes three times a day." If consumers want healthier food, they will demand it and producers will provide. They will have to if they want to stay in business. But most Americans aren't demanding these things, even those who know all the messy origins. At the end of the day, people vote for fat and that's their choice.

How Obama Got People to Be Less Afraid of Being Republican

Robin Hanson proposes that Obama's election makes the public more conservative. No, the story isn't that Americans are secretly racist and have suddenly come to terms with their racism. Quote psychology experiments,

People were more willing to express potentially prejudiced attitudes when their past behavior had given them a bit of credentials as a nonpredjudiced person.

Bizarrely, Hanson cites recent polls that Americans are more in favor of gun control, less in favor of legalized abortion, and fewer people believing global warming is the result of human activity as evidence of this theory. What does racial issues such as affirmative action have to do with climatology?

People care what others think of them, even if those others are strangers. We care about it so much, we say we believe things we don't believe. If we value the truth on an issue low enough, ewe even fool ourselves into believing things we'd normally conclude are false. (Bryan Caplan calls this rationally irrationality.) In essence, we are paid (in the form of social capital) to conform.

The reason why we care so much about we others think of us is that we care what others think. We like to associate with people who are like us, a trend easily seen in grade school, high school, college, and beyond. This isn't merely shared interest but political opinion and values; constantly arguing with someone about politics gets exhausting for most people. It also makes it easier to talk to people since there's more common ground and you don't have to police your offhand comments or jokes.

There are lots of issues, though, and it's inefficient to list off your opinion on all of them. This is why we use labels (to the annoyance of some), such as Democratic, Republican, Libertarian, Populist, Christian, Muslim, Atheist, Jew, Protectionist, Free-trader, etc. In a single word, we convey a body of opinions to potential friends or mates. This is why it is normal for dating sites to post a person's political affiliation: it's a cheap way to convey important information.

But it's not perfect. Some issues are more important to some people than others and individuals are more diverse than the label's official or perceived hierarchy of priorities. We want to connect with people that share what we care about, starting with top priorities. People will then adopt most of the views of one group, including views they don't believe, to signal that they believe things that they find very important and distinguish themselves from the group that seems (rightly or wrongly) to disagree with them, even if they secretly agree with that group on less important issues. When an event convinces people that most agree with what you find to be really important, you will more accurately express your view of the less important things since you are less afraid of being mistaken for some other group.

To illustrate, consider two parties: D (Democratic) and R (Republican). Also consider two issues: A (being for racial equality) and B (being for less gun control). ~A means, then, that a group is perceived as being against racial equality and ~B means that a group is perceived as being against less gun control (or in favor for more gun control). Before Obama, one could argue that the public views the parties as so:

D (A, ~B)
R (~A, B)

Consider a person who has the preference of (A, B), but cares much more about A than B. In other words, he'd rather spend time with a person who's restricting gun ownership and is racially tolerate than a racist gun nut. U(A, ~B) > U(~A, B) (U stands for utility, economic lingo for satisfaction.) Thus, he will adopt policies of both racial tolerance and gun control to better signal that he's a Democrat, making it more likely he'll spend time with his preferred type of person. He might even start believing B, since he'll have to argue the point at parties and it's easier to argue something if you fool yourself into believing it's true. (This is where the rational irrationality comes in.)

But suddenly, Obama is elected president and it starts to look less like ~B is a staple of group R. If so many Americans were racist, it's hard to believe a black man could win (especially since he got 52.9%). Thus, the public perceives racism as being uncommon enough that it isn't a defining attribute of a major political party. At worst, the public's opinion on the stance is uncertain and the perception changes to this:

D (A, ~B)
R (?, B)

Now back to our hypothetical (A, B). No longer concerned with openly believing B will attract ~A people, he expresses his B opinion (or overturns his previous ~B opinion). He is no longer afraid of being mistaken for R.

In practice, there are more than two issues and people might still call themselves Democrats out of habit, fear of losing current friends, or because there's still enough about the party they like. But, in time, more will be willing to. In the meantime, expressing the secondary opinion will be more common. So, here's the punchline: Obama's election made Americans, and by extension moderate Republicans, seem less racist. Thus more people are willing to be seem as (or mistaken for) a Republican.

The Economics of Alien Conquest

My cousin, Brendon, and his girlfriend, Jenna, were in town this weekend. Both of them read my blog and Jenna told me I'm clearly knowledgeable about what I'm talking about, but still wrong. That response in itself deserves a post, which I may or may not get around to. Still, it would be fun to deviate a bit away from controversial topics and I thought of alien invasion. If aliens invaded, what would be their motivation?

Natural resources is a favorite Hollywood staple. Aliens will destroy our planet to take our stuff, likely minerals (Independence Day comes to mind but the physical land might be valuable, too (in The Day the Earth Stood Still, alien invaders attempted to terraformed our planet).

This is quite possibly the least likely reason aliens would go through the trouble of global conquest. The universe is filled with minerals and other resources that no one's using and are much easier to get to than stuff on an occupied planet. Maybe other extraterrestrials make harvesting Vega asteroids difficult, but even in the boundaries of our solar system there's still quite a lot to draw on.

Unless aliens are after biomass (i.e. living things). Perhaps there's some technology or feeding requirement that requires biomass (or they just want us as slaves), and Earth is the best place to get it. Lots of biomass with little ability to defend it. In that case, the best strategy probably wouldn't be a messy mass attack on the resource you're trying to harvest. Aliens would likely be much more insidious with probably a pathogen--killing everyone or knocking us all out while leaving the bodies around for collection later.

Racism is a likely motivation. This pops up in a lot of Sci-Fi television shows (Star Trek, Stargate, Babylon 5). A similar train of thought is a concern for humanity and a fear of what will happen if we're allowed to continue to live. Given many humans mistakenly fall into one of these two categories, I'd like it's a reasonable motivation for aliens to kill us.

Technology is a justification that's rarely explored. This is understandable but not for the reasons you probably think. Most assume that if aliens know how to travel faster than light, they are clearly more advanced than us on all other levels. That is far from certain, especially since an alien brain will probably not be wired the same way as a human one. As Richard Dawkins suggests, it is entirely possible there's a group of extraterrestrial life who intuitively understand the theory of relativity but have difficulties grasping principles of air resistance and other "slow" speed phenomena.

But it would be rather clear that the easiest way to get technology is to trade for it, not to take it by force. If such aliens were interested in our technology, they would more likely be peaceful. The one exception to this rule is if they discover it's easier to kill us than to learn a single human language. That would certainly be a sad state of affairs for us.

Then there's the possibility that aliens need to build a intergalactic superhighway along a path that intersects with Earth's orbit. That's a bit unlikely given how big space is ("Really big," according to Douglas Adams) but it could still be true. And if galactic eminent domain is as potent as our terrestrial version, then considered us conquered.

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.