Month: October 2023

On Anomalies

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Yesterday, I had written this:

“Trivia question for econ nerds: what long running series in an academic journal are you reminded of when you read this [Anomalies and Thomas Kuhn]? I’ll answer the question in tomorrow’s post.”

“Sometime after returning to Ithaca from my year in Vancouver, I was at a conference sitting next to the economist Hal Varian, then a well-known theorist who later went on to become the chief economist at Google. Hal was telling me about a new journal that the American Economic Association was starting called the Journal of Economic Perspectives. Hal was an advisory editor. The editorial board was thinking about commissioning regular features for the journal. The clever Barry Nalebuff would write one on economics-based brainteasers and puzzles. Hal and I came up with an idea for a feature that I might write on anomalies.”

That is from Section V of Thaler’s autobiography (an intellectual autobiography, in the sense that it is a book about his career), and the chapter itself is titled (what else) “Anomalies”.

The Anomalies “column” first appeared in the Summer issue of the Journal of Economic Perspectives – Volume 1, Number 1. This was in 1987, and if memory serves me right, it ran for the next three to four years at least.

This feature will report successful searches for disconfirming evidence — economic anomalies. As suggested by Thomas Kuhn, an economic anomaly is a result inconsistent with the present economics paradigm. Economics is distinguished from other social sciences by the belief that most (all?) behavior can be explained by assuming that agents have stable, well-defined preferences and make rational choices consistent with those preferences in markets that (eventually) clear. An empirical result is anomalous if it is difficult to “rationalize,” or if implausible assumptions are necessary to explain it within the paradigm. The first anomaly we will discuss is the “January effect.” Stock prices tend to rise in January, particularly the prices of small firms and firms whose stock price has declined substantially over the past few years. Also, risky stocks earn most of their risk premiums in January.

https://www.aeaweb.org/articles?id=10.1257/jep.1.1.197

I’m happy to report that the Journal of Economic Perspectives is freely available online. You can (and if you are a student of economics, you absolutely should) read all of the issues. But the Anomalies column is that rarest of rare things – a fun column that makes you think about fascinating problems and anomalies in economics. And even rarer still is the fact that a “fun” column was at least partially responsible for a Nobel Prize in economics!

Thaler’s vision for incorporating insights from psychology into economics was first laid out in his 1980 article “Toward a positive theory of consumer choice.” In his well-known “Anomalies” series in the Journal of Economic Perspectives, as well as in many other articles, comments, and books, he continued to document and analyze how economic decisions are influenced by three aspects of human psychology: cognitive limitations (or bounded rationality), self-control problems, and social preferences.

https://www.nobelprize.org/uploads/2018/06/advanced-economicsciences2017-1.pdf

There’s a lotto like about Richard Thaler’s work in economics, but one very important reason to learn more about him and his ideas is that he has fun doing what he does, and it shows. A lot of economic research, even when it is fascinating, is written in dull, stodgy fashion. Now, you can disagree with Thaler’s work (and that is a cottage industry in and of itself), but you can’t accuse him of being a boring writer.

And a wonderful place to begin is with that most anomalous of things: a fun column about economics in a top econ journal.

Enjoy!

Economics as an Inductive Science

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…the development of science is driven, in normal periods of science, by adherence to what Kuhn called a ‘paradigm’. The functions of a paradigm are to supply puzzles for scientists to solve and to provide the tools for their solution. A crisis in science arises when confidence is lost in the ability of the paradigm to solve particularly worrying puzzles called ‘anomalies’.

https://plato.stanford.edu/entries/thomas-kuhn/

(Trivia question for econ nerds: what long running series in an academic journal are you reminded of when you read this? I’ll answer the question in tomorrow’s post.)

I was one half of a very nice conversation we recorded over the weekend for a podcast. The podcast will be out in a couple of weeks or so, and I will write more about it then. But for today, we’re going to talk about a lovely little essay that I read after many, many years. I re-read this essay because it came up in conversation during the podcast.

The title of the essay is “Economics as an Inductive Science“, and it is the Presidential Address that was delivered at the sixty-third annual meeting of the Southern Economic Association, in 1993. It was delivered by Robert Clower. If you’ve read enough macroeconomics in your life, Clower is a name that is bound to come up sooner or later. But this particular essay isn’t necessarily (or exclusively) about Keynesian economics. It is, instead, a rant about where economics seems to be headed. And it is a rant that is worth reading.

Apart from some kickass quotations (“Logic is the art of going wrong with confidence” is the first quote, and it only gets better from there on in), it is an essay that makes you think about how we go about “doing” economics.

Economics (and especially macroeconomics), Clower says, is riddled with Kuhnian anomalies. What are Kuhnian anomalies? That’s why we began with that quote at the top of the blogpost.

But let’s back up for minute. What do we do as economists? We learn principles, theories and models (and some of us even develop some of these principles, theories and models). We then go look at the world. Based on what we see in the world, and based on what we think we know of how the world works, we make certain predictions.

Note that the word prediction doesn’t necessarily mean forecasting the future. “If we see x going up, y should be going down” is a prediction, but not a forecast.

Now, if these predictions turn out to be repeatedly and wildly wrong, we are left with three hypotheses. Either, we should reason, the data we have collected is wrong. Or our theory is wrong. Or both! And then, as “scientists”, we go and take a look at our data collection methodologies. Once we ascertain that we haven’t erred there, we look at the theory. And if the data looks right but the theory ain’t working out… well, then, we have an anomaly.

Collect enough of these anomalies, and you get to challenge theory. And every now and then, we get to update the theory. And so science chugs along, inch after excruciating inch.

If you are looking for a concrete example of how this works in practice, I have a story to tell you. This story consists of a lot of things, including static on your television set, a Nobel prize in physics… and pigeon poop. Yes, really.

“I had a lot of experience fixing practical problems in radio telescopes,” Robert Wilson now says. He and his wife Betsy Wilson still live in Holmdel, New Jersey, not far from hilltop where the tests were run. “We looked for anything in the instrument or in the environment that might be causing the excess antenna noise. Among things, we searched for radiation from the walls of the antenna, especially the throat, which is the small end of the horn. We constructed a whole new throat section and then tested the instrument with it.”
At one point, new suspects emerged. Two pigeons had set up housekeeping inside the guts of the antenna. Maybe their droppings were causing the noise? Wilson and Penzias had the birds trapped and then cleaned the equipment, but the signals continued.
After a year of experiments, the scientists concluded that they’d detected the cosmic background radiation, an echo of the universe at a very early moment after its birth.
“We started out seeking a halo around the Milky Way and we found something else,” notes Dr. Wilson. “When an experiment goes wrong, it’s usually the best thing. The thing we did see was much more important than what we were looking for. This was really the start of modern cosmology.” In fact, Wilson and Penzias were awarded the Nobel Prize in Physics in 1978 for determining that the hiss they were hearing wasn’t pigeon poop at all, but the faint whisper of the Big Bang, or the after glow that astronomers call the cosmic microwave background.

https://www.smithsonianmag.com/smithsonian-institution/how-scientists-confirmed-big-bang-theory-owe-it-all-to-a-pigeon-trap-180949741/

You set up an experiment, and you expect to see x. “Expect” to see x? That’s the current theory!

But hey, you don’t see x, you see y instead. Well, maybe we’re seeing y because there’s some problem with our data gathering apparatus. That is, we’re sticking to our guns when it comes to our theory, and we’re going to see if our data collection strategy is off. But if you eliminate every single source of data contamination (including pigeon poop!), then it is finally time to challenge established theory and update it – and win a Nobel Prize to boot.

Cool, huh?

Well it is, except for the fact that Clower is really telling us that this doesn’t happen enough in economics. Consider this quote from Einstein, cited in the speech we are talking about today:

“Science is the attempt to make the chaotic diversity of our sense-experience correspond to a logically uniform system of thought. [ … ] The sense experiences are the given subject matter, but the theory that shall interpret them is man-made. It is the result of an extremely laborious process of adaptation: hypothetical, never completely final, always subject to question and doubt”

Clower is making the point that our theories have become completely final, and are not subject to question and doubt. Read in particular Clower’s descriptions of his set of stylized facts (pp5), and the facts as assumed by our paradigmatic model (pp6).

As economists, we have two choices:

We can keep searching for the pigeon poop, even though it may not exist. Or we can ask if our theory needs to be updated. And maybe, Clower suggests, we should work on updating our theories a bit.

And while doing so, he suggests keeping three things in mind.

While doing inductive science, he says, one’s motto ought to be that “If it isn’t common sense, it’s probably wrong.”

Second, a direct quotation from the speech: “If we are ever to be taken seriously as scientists we would be well advised to proceed with this task as most practitioners of other inductive sciences have proceeded – by taking a hard look at the world around us in a serious effort to lend intellectual order to the “chaos” that strikes our eyes at first sight”

And finally, an admonition of sorts. We should remember, he says, that inductive sciences deal with plausible inference, not with demonstrative reasoning.

The Economist on the Iraqi Bank Heist

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Mike Sowden on Wikipedia

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Oldie, but a goodie. And it is 2023, therefore very relevant.

In Praise of Randomness

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In fact, this blogpost will not be enough. Randomness needs an entire book, maybe more.

This post is a reflection on Tim Harford’s excellent column titled “Sometimes a random solution is best“.

Here is the opening paragraph:

Just over a decade ago, Egypt’s Coptic Christians chose their new pope. The names of three favoured candidates were placed in a glass bowl, then a blindfolded boy selected from the trio at random. Religious people can appeal to the idea that the outcome wasn’t truly random; God himself decided on Tawadros II. Yet it is a seemingly unsettling way to deal with a serious decision.

https://timharford.com/2023/10/sometimes-a-random-solution-is-best/

As always, read the whole thing. Lots of advantages to random solutions, and here are the ones that Tim lists out:

  1. It promotes efficiency. Take grants, for example. If the amount of the grant isn’t that large, evaluating the grant can often cost more than the grant that is awarded! So long as everybody who is on a list has met some criteria, allocate grants randomly among these applications.
  2. Implicit in this, of course, is the point that the money that has been saved when it comes to detailed evaluations can be put to other uses. Maybe award twelve grants instead of ten? We have, in other words, increased the (potential) supply of grants.
  3. It incentivizes applications from diverse backgrounds. Folks from ethnic minorities (to use Tim’s own example) are more likely to apply if the process is randomized (can you guess why?). In other words, we have increased the (potential) demand for grants.
  4. Think about it: the market for grants has been made more efficient by making the process more random. Huh.
  5. Sometimes, Tim tells us, a randomized solution is better than listening to the experts, and he points us to the arrhythmia case study from the 1980’s.

Particularly in the case of entrance examinations in India, there is another benefit to applying randomized solutions. Rather than give the seats in a college to the highest rankers in an entrance examination, why not give admission randomly, so long as a minimum cutoff has been met?

Examinations in India, particularly the entrance variety, usually optimize for speed while solving a lot of fairly basic questions. That is, the highest scores tend to belong to those students who are unusually quick at solving a lot of not-very-difficult problems very quickly. The degree of difficulty for these questions varies a bit in the case of different universities, sure, but I would think what I have described here ought not to be too controversial.

But how is optimizing for the ability to quickly solve how far Rahul has walked if he turns right then left then right then left and so on a good measure of your ability to read and understand The Wealth of Nations? It might not hurt, sure, but hey – it might not help either! In fact, I would be much more comfortable with a hypothesis that said it is likely to not help. It has been a while since I read The Wealth of Nations, alas, but not once did I have to rely on my ability to do algebra very quickly in my head. I had to rely, instead, on my ability to persevere.

Would you agree that our entrance exams don’t optimize for perseverance?

What else do they not optimize for?

So, so long as a certain minimum benchmark is met, why not randomize admissions, and see if the cohort that comes in is better than the previous cohorts? And if so, along which dimensions?

It is unlikely that such a system will be adopted anytime soon, because of a variety of reasons. But all I’m saying is that there are, indeed, benefits to being random.

No?

Innovative Pedagogical Approaches to Teaching Economics

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I was invited recently to give a workshop on this topic. I’ll be honest, workshops like these fill me with foreboding and horror. They conjure up images of musty meeting rooms in sleepy departments. Participants unlucky enough to have to attend sessions such as these look forward to being able to catch a quick nap in the post lunch session – that is the best one can hope for!

But I paint with too broad a brush, of course. Not all sessions are all bad, and when done well, there is a non-zero chance that learning outcomes for students will improve down the road. And isn’t that the whole point?

But there are three things that such a workshop ought to focus upon, in my opinion, and I wanted to run these three things past you in today’s blogpost. Two reasons for doing so – do you agree with each of these three? Any points that are more important, in your opinion, than these three? Please do let me know.

  1. Learning should be more participatory: learning economics shouldn’t be about passive listening. It should be about learning by doing. Not always, and not in every single class. But participating in a oral double auction is one thing, and taking notes about it is entirely another. Playing the prisoner’s dilemma will help it stick much better in your head than will drawing a 2×2 matrix. Students are much more likely to remember experiences than they are a lecture, and we don’t provide enough of memorable experiences. An economist would be hard pressed to find a reason to swing a wrecking ball in front of their own face, but we could always run a Vickrey auction in class.
  2. Use technology: don’t teach students the Monty Hall problem, ask them to build it. Don’t teach students what the central limit theorem is, show it to them. Don’t write down the equation for the Cobb-Douglas function on the board, build a working model in Microsoft Excel. We live in the age of AI, and “but I don’t know how to code” doesn’t cut it anymore. It has been years since I did any serious coding, but I can get by just fine – and so can you.
  3. Economics is only part of the answer: will imposing fines for littering lead to cleaner streets? Will the answer change depending upon who imposes the fine, on whom, and in which country? An economist will say “yes” in response to the first question and will reluctantly say “yes” in response to the second. Sociology, anthropology, politics, religious beliefs and many other factors are also at play in the real world, and the ivory tower model doesn’t play well in reality. Understanding that this is a feature, and not a bug – that economic models need to be placed in the context of lived realities in different parts of the world – is something that every student of economics needs to go through.

Get students to do economics, not just learn it | Use more technology | Learn to be multi-disciplinary

That’s what I would want to focus on in a workshop where I teach folks how to get better at teaching economics. I hope you disagree, and I hope you tell me why you disagree.

Bring it on, please – and thank you in advance.

Health in America (and Goodhart’s Law)

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Is it better to spend a lot of money on healthcare, and not get great results, or it is better to not spend a lot of money on healthcare, and not get great results?

The United States of America tries to generate data that answers at least the first half of that question:

The country spends about $4.3trn a year on keeping citizens in good nick. That is equivalent to 17% of GDP, twice as much as the average in other rich economies. And yet American adults live shorter lives and American infants die more often than in similarly affluent places.

https://www.economist.com/business/2023/10/08/who-profits-most-from-americas-baffling-health-care-system

And if you are even remotely interested in the question of healthcare and how to get it to work for a country, you know, of course, about pharmaceutical firms and hospitals in America. But in a fascinating article, The Economist tells us about the middlemen in America’s healthcare system.

https://www.economist.com/business/2023/10/08/who-profits-most-from-americas-baffling-health-care-system

What do middlemen do? At their best, they can literally create markets. They can provide useful information to market participants, they can make markets more efficient by reducing search and transaction costs, they can lower risk and they can provide additional services. Has AirBnB made travel easier because of all of these factors? That’s what a middleman can do. So both this post and The Economist article aren’t a complaint about middlemen.

But that being said, the dose does make the poison. If middlemen make the markets more efficient, their revenue expressed as a percentage of national health expenditure shouldn’t be going up much, right? It certainly shouldn’t be nearly doubling!

So what’s going on?

  1. What does the healthcare market consist of? Doctors and patients, of course. But what connects, enables and facilitates interactions between both sides of the market? That’s the “plumbing” of this market – the middlemen. These are the insurance firms, the chemists, the drug distributors and the pharmacy benefit managers (PBM’s). As The Economist puts it, these entities don’t make drugs, and they don’t treat patients.
  2. And yet, they got to keep about 45% of America’s “health-care bill”. Those must be some fancy pipes!
  3. So here’s what happened. Back in 2010, the American government said to insurers that they could no longer eat away at all those dollars in America’s healthcare system. No more than 15% to 20% of collected premiums can end up in your pockets as profits. A measure (profitability) became a target (market efficiency to be defined by limiting profits).
  4. And in these parts, we know what comes next, correct?
  5. “But it imposed no restrictions on what physicians or other intermediaries can earn. The law created an incentive for insurers to buy clinics, pharmacies and the like, and to steer customers to them rather than rival providers. The strategy channels revenue from the profit-capped insurance business to uncapped subsidiaries, which in theory could let insurers keep more of the premiums paid by patients.”
  6. And well, these middlemen went out and bought these “uncapped subsidiaries” – some $325 billion worth of them. Or a 130 different mergers and acquisitions, if you like more than one metric.
  7. So now your healthcare market looks like this: patients go to get treated by doctors. Patients are “connected” to doctors via the plumbing provided by middlemen. But now, the plumbing “owns” the doctors!
  8. Which is when, as an economist, you should want to use the “i” word. What will be the incentive of the doctor? To give you the best treatment possible, or to reduce costs as much as possible for their corporate structure? If they can choose only one among these, which are they likely to choose?
    “For example, many studies have found that after hospitals acquire physician practices, prices increase but quality of care does not. A health-care company that controls many aspects of patient care could raise prices for rivals wishing to access its network. Some also worry about physicians being nudged towards offering the cheapest treatment to patients, lowering the quality of care.”
  9. One shouldn’t throw around such claims or hypotheses without backing it up with data. Is it actually the case that these middlemen are earning excess returns?
    “America’s health-care intermediaries are indeed unusually profitable. Research by Neeraj Sood of the University of Southern California and colleagues found that intermediaries in the health-care supply chain earned annualised excess returns—defined as the difference between their return on invested capital and their weighted-average cost of capital—of 5.9 percentage points between 2013 and 2018, compared with 3.6 for the S&P 500 as a whole.”
  10. Maybe these excess returns will attract competition, and maybe competition will make markets better? Paging Amazon!
    “Perhaps the biggest disruption to big health could come from Amazon. In 2021 its health-care ambitions suffered a setback owing to the closure of Haven Healthcare, a not-for-profit joint venture with JPMorgan Chase, the biggest bank in America, and Berkshire Hathaway, the biggest investment firm. Haven had aimed to cut health-care costs for the trio’s own staff. But despite Haven’s failure, Amazon is still expanding its health-care business. Last year it paid $3.9bn for One Medical, a primary-care provider. It runs Amazon Clinic, an online service offering virtual consultations, and RxPass, which lets members of its Prime subscription service buy unlimited generic drugs for a small fee. John Love, who heads Amazon’s pharmacy business, believes that the tech giant’s focus on customer experience, combined with its vast logistics network, makes it well-suited to shake up the industry.”
  11. But you’d be surprised at how complex any market can be. And healthcare markets are (trust me on this) a whole other story:
    “The entrenched firms have built their networks of doctors, hospitals, insurers and drugmakers over decades. Replicating that takes time and institutional knowledge. Mr Cuban admits that it is difficult to get drugmakers to list branded drugs on his pharmacy, as they are wary of upsetting the large pbms. And without branded drugs and the support of large health insurers, his firm’s reach remains small. The cap on insurers’ profits makes life tough for upstarts in that business, which struggle to compete against the negotiating power of the integrated giants.”
  12. Designing policy around healthcare markets is, as it turns out, quite the challenge. And it is very likely to be a case of one step forward and two steps back at worst, and two steps forward and one step back at best.
  13. But it is oh-so-important to take those steps, and having taken them, to ask if they are taking us in the right direction. Onwards!

Does The Supply of An Effective Remedy Create Its Own Demand?

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Arnold Kling has an interesting essay in which he attacks… books.

When I finish writing a book review, I will often say to myself, “There! Now nobody has to read the book. I’ve boiled it down for them.” We would be better off if authors did that work themselves.

https://arnoldkling.substack.com/p/the-trouble-with-books

Arnold Kling has read a ton of books, I can guarantee you. He is not saying this because he has always disliked books, or because he dislikes thinking. That, in fact, is what makes this essay worth reading – he is saying this a person who used to love books, and is still in love with what the book represents: knowledge.

But, as any good economist should, he applies his knowledge of economics to the market for consuming books, and tells us that:

  1. Books don’t have that many ideas in them (they are not information dense, to use his phrasing)
  2. Our time today is limited (by which I mean we have a lot of alternate uses for our time)
  3. So either make the books way shorter, or just stop writing them.

If you are someone like me (that is, a book lover), this might fill you with worry. A world without books? What a horrible thought!

Bear in mind that Arnold Kling is talking about non-fiction books, not books in general. And even in such cases, his arguments will not always hold. I don’t read a Bill Bryon non-fiction book to only learn about new ideas, for example. I want Bill Bryson books to contain delightful digressions, delectable diversions and dizzying descriptions. A little spice can liven up even the dullest of subjects, and Bryson is a master in this regard.

But that being said, it is nonetheless true that a book can often be dreadfully dreary. As Arnold Kling says:

But it is hard for a book to be information-dense in terms of ideas. If you have one really important idea, why does it require a whole book? And if you have several important ideas, chances are that readers will miss some of them, or else not remember them. Better to put the ideas into separate essays.

https://wordpress.com/post/econforeverybody.com/13883

A book, like a song from the sixties, is but a vehicle for carrying ideas. The point always was to convey ideas, and lots of them. Inventing the printing press changed humanity for the better, because that allowed for the spread of oh-so-very-many-ideas.

Understanding that electronic screens and artificial intelligence are here to stay will also change humanity for the better, because these will allow for the spread of even more oh-so-very-many-ideas. The supply is already here, who is to say what will happen to demand?

Tyler Cowen Writes A(I) Book

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Tyler writing a book has happened quite often, and will happen again. But this is a book written for and in AI. But not, it should be noted, with AI.

Do you yearn for something more than a book? And yet still love books? How about a book you can query, and it will answer away to your heart’s content? How about a book that will create its own content, on demand, or allow you to rewrite it? A book that will tell you why it is (sometimes) wrong?
That is what I have tried to build with my latest work. It’s called GOAT: Who is the Greatest Economist of all Time and Why Does it Matter?

https://goatgreatesteconomistofalltime.ai/en

I have not finished reading the book, but plan to do so in the next couple of days. I’ve finished reading the chapters on Friedman, Keynes and Hayek, along with the introductory chapter – but in a manner of speaking, I haven’t even started.

Not because I’m less than halfway through the book (though there’s that too) – but because I haven’t yet read the book in ChatGPT. And that, I suspect, is where the book will really and truly come alive. But even without that mouth-watering prospect being taken into consideration, the book is already well worth my time (and I know one is supposed to say your mileage will vary, but it will be worth yours as well).

Because how many books about the history of economic thought will talk about basketball, peering in through Gottfried Haberler’s window and Edgeworth looking like a Schnauzer Terrier? And all that in just the first chapter!

The first chapter explains, in typically Tylerian fashion what is being supplied by Tyler, and there are four broad things that are being supplied:

  1. The teaching of economics (duh)
  2. Economics as a vehicle for carrying ideas about the world (about which there is a paragraph below)
  3. Economists and how to think about their talents
  4. Tyler’s adjudication for who is the GOAT in economics

I find it interesting that the title of the book is actually his fourth reason for writing the book. Come for the shortlisting and the prize giving ceremony, Tyler seems to be saying, but stay to learn economics (1), learn more about economists (3), and (maybe, and best of all), learn how to carry ideas about the world in your creations (2).

And again, in typically Tylerian fashion, we learn that the inspiration for writing this books comes not from what you and I would have considered the usual suspects – but from some book about basketball. When I say “some book about basketball”, I do not mean to be disparaging about the sport. I mean to convey how little I know about the sport, and about books written about the sport. But the point is well taken – this is a book written by a fan of the subject. I take that to mean that this book is to be taken the way Tyler’s podcast is to be taken – this is Tyler’s conversation with himself about his favorite subject, not the conversation you wish to have with Tyler about his favorite subject.

By the way, in an interesting coincidence, just yesterday I was talking to a friend about a post I’d written on the blog a while ago, about who, in my opinion, was the worst economist of the 20th century. Two people (who will both remain anonymous) told me in conversations that Milton Friedman is their pick for the worst economist of the 20th century. One of them meant it as a joke, and one of them was quite serious. I disagree, of course. Milton Friedman was undoubtedly one of the best economists of the 20th century, and certainly among the top 10 all time, in my book.

But who would be my pick for the GOAT?

So far, Adam Smith.

But I hope to be able to update you by the end of the week, if not sooner, if my answer changes.

Bloomberg on Pakistan’s Endless Economic Crisis

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