Asking And Answering Important Questions

Shruti Rajagopalan asked a very important question on Twitter earlier this week:

I’m writing this post on Sunday evening, which is when Shruti asked this question (and you, of course, are reading it today) but so far, there haven’t been any encouraging responses to her query, save for this one:
That would be this report, and I don’t think it was recommending large purchase orders or calling out Prime Minister Modi’s incoherent vaccine policy. This is the entire paragraph on vaccination:

Vaccines: The Committee recommended that a vaccine should pass all phases of clinical trials before it is made public. Further, it recommended that the whole population should be vaccinated. In this regard, the Committee suggested that: (i) the cost of the vaccine should be subsidised for weaker sections of society, (ii) the cold-storage system across the country should be upgraded, and (iii) vaccines should be administered as per the World Health Organization’s strategic allocation approach or a multi-tiered risk-based approach.

https://www.prsindia.org/sites/default/files/parliament_or_policy_pdfs/Report%20summary%20COVID.pdf

Long story short, the answer to Shruti’s question is: nobody. None of us were prescient enough in 2020, and that is a failure on our part.


What Shruti is really asking for is this: who is India’s Alex Tabbarok?

Why do I say this? Because Professor Tabarrok was recommending/demanding large purchase orders…

We don’t want to find ourselves with a working vaccine but too little manufacturing capacity. From an economic point of view, it would make sense to install enough capacity so that everyone in the U.S. who wanted could be vaccinated within a month. Normally, new vaccines cannot be produced so quickly and in sufficient supply. Each step of the manufacturing process must be verified and tested, and inputs to the process may face their own supply chain bottlenecks. Just as shortages of swabs and reagents delayed the rollout of testing, shortages of glass vials, bioreactors or adjuvants (a substance that increases immune stimulation) may delay vaccines. For want of a vial, the vaccine could be lost. To stand a reasonable chance of having a substantial supply of vaccines in 2021, we need to plan for capacity and reinforce supply chains now.

https://www.nytimes.com/2020/05/04/opinion/coronavirus-vaccine.html

…on the 4th of May. That is the 4th of May 2020.

He had a post praising the idea of advance market commitments (AMC’s) out in February. Again, 2020.


And while the first excerpt up above was a plan for the USA alone, he and his collaborators expanded upon this plan, outlining what a globally coordinated plan may have looked like:

I’ve been working with Michael Kremer, Susan Athey, Chris Snyder and others to design incentives to speed vaccines and other health technologies. AcceleratingHT is our website and now features a detailed set of slides which explain the calculations behind our global plan. The global plan is similar in style to the US plan although on a larger scale. The key idea is that the global economy is losing $350 billion a month so speed pays. One way to speed a vaccine is to invest in capacity for 15-20 vaccine candidates before any candidates are approved, so that the moment a candidate is approved we can begin production (one can store doses in advance of approval). Most of the capacity will be wasted but that is a price worth paying. As Larry Summer says if you will die of starvation if you don’t get a pizza in two hours, order 5 pizzas. Human challenge trials are another way to speed the process.
A global plan is ideal since there are significant benefits to coordination. If each country invests in vaccines independently they will each choose the vaccine candidates most likely to succeed but that means all our eggs are a few baskets. There are over 100 vaccine candidates and they have different scientific and production risks so you want to choose the 15-20 which maximize the probability of success for the portfolio as a whole. To do that efficiently you need countries to agree that ‘I will invest in lots of capacity (more than I need) in candidate X if you invest in lots of capacity (more than you need) for candidate Y’, even knowing that the probability that X succeeds may be less than that of Y.

https://marginalrevolution.com/marginalrevolution/2020/05/acceleratinght.html

The website AcceleratingHT provides many more instances that reinforce my point, and as a student, reading the material there is genuinely useful.


A while ago, I wrote a post for students who want to work in the field of public policy. Alex Tabbarok’s work this past year is a great example of what that advice might look like in practice.

I do not know who India’s Alex Tabbarok is in 2021 – there may not even be one. But as a student, the correct question to ask is this:

What do I need to do to acquire the ability to be ahead of the curve when the next crisis comes around?

Here is my list in response to that question:

  1. Read, and write. Everyday, read and write. If you are a student of the humanities (and if you think about it, who isn’t?), you should be reading and writing everyday. It compounds, trust me.Don’t be afraid
  2. Learn the art of working backwards from the solution you want to get to. In this specific case, if you want the world to be vaccinated by the end of 2021 (let’s say), then begin by asking yourself what needs to be done to get there, but in reverse.
    7 billion vaccines will be needed – which are the manufacturers that are most likely to supply them – what do they need to get the job done – how can we get them what we need – what are the regulatory, financial, supply-chain-related hurdles they will face – how can these be removed – and so on…
    My point here is not the specifics of the exercise, whether in the case of vaccines today or something else tomorrow. My point is to learn and apply the art of working backwards from where you want to eventually be. I don’t know what you’re supposed to call this in consultant/management speak, but for starters, read about the game 21 flags in The Art of Strategy.
  3. Learn the art of being unafraid to ask big picture questions. Whenever you get that feeling of “Surely somebody somewhere must have thought to ask this question already?” – especially if you have been serious about pt. 1 above – ask the question. Repeatedly, furiously and publicly.
  4. Consume as much content as you can about crisis management from the past. (I’m working on this for my own self, and recommendations are welcome)
  5. Do not be afraid of putting out your potential solution out there. Your worst case scenario is that it is a wrong solution. As a society, we’re still better off rejecting wrong solutions than waiting for the perfect one. For rejecting a solution as being the wrong one forces us to learn more about the problem at hand.
  6. Most difficult of all: once you have offered a solution, remember that your job is to solve the original problem. Your job is to not defend your solution at all costs. This is hard.

Education and Signaling

I’d linked to this video this past Friday too, but just in case you haven’t seen it yet:

And a bonus today, Bryan Caplan on the same topic:

It is difficult, this economic theorizing business

One of my favorite questions to ask in classes on introductory economics is this one:

“By a show of hands, how many of you have a BSNL sim-card?”

The answer is rarely more than five percent, if that, and my little stunt works every time. For obvious reasons, of course: even passionate defenders of the public sector often reveal their preference through action, if not always through their statements. Free markets work, the private provisioning of goods is demonstrably efficient and the price mechanism is a wonderful, wonderful thing.

Until, every now and then, when it is not.

April 2021 is one of those times.

And to make sure we could then produce those vaccines at scale, “X” brought up an idea that came from the Biomedical Advanced Research and Development Authority when Rick Bright was its director. The authority proposed subsidizing the construction of private manufacturing facilities as long as the government has the authority to take them over in times of pandemic.
If all of this sounds as if it’ll require a lot of government action, well, it will.

https://www.nytimes.com/2021/04/01/opinion/covid-vaccine.html

Pop quiz, particularly for those of you who follow economists online. Identify “X”.

“X” is, of course, that well known pro-government socialist, Alex Tabbarok.

Sarcasm alert: Prof. Tabbarok is as much of a pro-government socialist as Rahul Dravid is a goonda. But as with Rahul Dravid and goondagiri, so also with Alex Tabbarok:

“Ninety-nine years out of 100, I’m a libertarian,” Tabarrok said with a laugh. “But then there’s that one year out of 100.”

https://www.nytimes.com/2021/04/01/opinion/covid-vaccine.html

And it is that kind of a year, 2021 – for both Alex Tabbarok and Rahul Dravid. It is a year in which the role of the government is more important than perhaps ever before, given what is at stake: public health. Public health is, by definition, a public good:

And the role of the government in this case is to do all it can to ensure the provisioning of that public good – in this case, the vaccine.

Hold on to this thought, and we’ll come back to it.


Here’s a hypothetical scenario: a joint family is considering ordering in dinner this coming Saturday, and mutton biryani is the unanimous choice1.

The restaurant this family is considering ordering from will deliver a jumbo family pack (serves 8) for two thousand bucks. Single serves of the same dish are also available, at three hundred each. There are eight family members.

Should the family order a family pack, or single serves?

Here’s another (not so) hypothetical scenario: Until a couple of years ago, Holi celebrations in our housing society would always mean having the neighbourhood chaatwala set up shop in the lobby. Anybody and everybody who was here playing Holi was welcome to have as many plates of chaat as their hearts desired. No payment was involved, of course, because the payment was made in advance, in bulk.

Does this make sense, or would we be better off paying for each dish as we had ’em?

Hold on to this thought too, and we’ll come back to it.


Final thought experiment (I promise!): let’s say this chaatwala is the stuff of legend. Mindblowing panipuris, outstanding bhelpuri and tokri chaats that have the potential to rule the world. We would like to have this demi-god of chaat set up shop in our society, but so would ten other housing societies in our neighbourhood.

If you were this maestro of a chaatwala, which society would you choose to shower with your culinary blessings? The housing society with the cutest kids, or the kindest grandparents, or the prettiest flower-beds? Or the one with the most number of lived-in apartments – that is, the one that was likely to give you the most business?

And conversely, if you were part of the largest housing society in the area, and you and everybody else including the chaatwala knew this to be a fact, could you maybe get a bit of a discount on the deal? Would you, at the very least, want to try?


Can I cheat a little bit and include one final thought experiment? What if eating that chaat wasn’t just good for your palate? What if it also, somehow, conferred upon you the mystical, magical ability to not infect your neighbours with some disease – say, a virus?


Now let’s combine all of the above, and resort to econo-speak where the vaccines are concerned:

When faced with a largely inelastic supply curve for a good, fragmenting demand into separate constituents means you lose out on bargaining power. When the good in question is one with large positive externalities, procuring as much as possible as quickly as possible becomes a moral imperative. The best way to do that is to have the central government procure centrally, and that right away.

In fact, if it is a question of conferring those mystical, magical abilities upon as many citizens as quickly as possible, maybe the largest housing society the government should get that chaatwala to share the recipe with other chaatwalas in the market.

All housing societies should get as many plates of chaat as quickly as possible, but the negotiating should be left to just one extremely large entity. That negotiating should include potentially sharing the recipe for that delicious, life-saving chaat.

Or, to close the loop on the metaphors:

Every state should get as many vaccines as quickly as possible, but the negotiating should be left to the central government. That negotiation should include the possibility of sharing the patent for the vaccine (and more besides). And oh, remember that the truth lies somewhere in the middle. There is indeed a role for the private sector here: distribution and last mile delivery can and needs to be an all-hands-on-deck affair. Procurement? Not so much.

Is this a free-market solution? No.

Does a non-free-market solution stand a chance of being an optimum solution?

As Prof. Tabarrok points out, every hundred years or so, the answer is yes indeed.

Very much so.

  1. It’s a hypothetical scenario, so we’ll assume away Arrow’s Impossibility Theorem[]

In Memoriam: Oliver Williamson

Why does Gokhale Institute exist? Why did all of the students at Gokhale Institute not choose to try and fashion their own degree, by independently getting in touch with faculty members of various universities the world over, and negotiating rates for teaching each subject?

Similarly, why did I join Gokhale Institute as a faculty member? Why do I not try and advertise myself as a guy who can teach different subjects in econ, finance and stats to students the world over, every semester?

Why, as I said at the start of this post, does the firm I work in exist at all?

For that matter, why do firms exist in general? The “miracle” that is Walrasian economics guarantees that in a perfectly competitive economy with no frictions and perfect foresight, everything will be in a state of eternal bliss.

Except, economies are not perfectly competitive. Who teaches you which subject is important to you as students – which is another way of saying that labor is not homogeneous. There are frictions, such as teachers falling ill, or monsoons disrupting schedules, or uh, pandemics occurring every 100 years or so. And there isn’t perfect foresight (see pandemics, previous sentence).

And because we live in an imperfect world, we outsource, as students, the difficult job of finding appropriate professors, managing the physical infrastructure, and awarding degrees to an entity we call “the firm”. The firm exists in order to make it worth our while to get an education without having to spend time figuring everything else out.

Professors outsource the grunt work too the college too. It would be too painful for me to try and figure out which students across the world will want to learn Principles of Economics next year. I outsource the job of filtering the students out so that I get sixty students to teach to the Gokhale Institute. Plus, Gokhale Institute fixes the fees, arranges for the whiteboard, the benches. I just have to strut over into the classroom and teach.

We – you and I – minimize transaction costs by using the Institute as an intermediary. That’s Ronald Coase’s answer to why the firm exists. Read both of his papers (The Nature of the Firm, and The Theory of Social Cost). Here are past mentions of Prof. Coase on EFE.

Now, Prof. Coase had a student. His name was Oliver Williamson.

He extended Coase’s ideas about the firm, and that is why he really and truly matters when it comes to economics. There are many things to learn by reading Williamson, but three concepts stand out, in my opinion:

  1. Contract incompleteness: Imagine that the director of Gokhale Institute tells me that my performance as the course coordinator for the BSc programme hasn’t been good enough, and that he’ll be letting me go by the end of the year (I’m hoping this is only an example.) Will I muster up the same enthusiasm for coming up with new stuff this year, now that I know I am going to be out of a job? Or, on the other hand, imagine that the director says that my performance has been so good that I’m guaranteed this job for the next decade. Will there be a drop in my performance, now that I’m guaranteed the post no matter what? So how to write a contract that overcomes these hurdles? That’s one of the problems he tackled.
  2. Asset specificity: There are many definitions on the internet, but I liked the one supplied by Alex Tabarrok on Marginal Revolution the best. I’ll get to it in a while, but here’s the textbook-ish statement first: “Asset specificity is a term related to the inter-party relationships of a transaction. It is usually defined as the extent to which the investments made to support a particular transaction have a higher value to that transaction than they would have if they were redeployed for any other purpose.”
    And here’s Alex Tabarrok’s explanation:
    “Marriage, for example, takes away some possibilities but it adds others. With marriage, for example, comes a greater willingness to invest in children (n.b. asset specificity, the child is of extra value but only to the specific parties involved in the marriage)”. Asset specificity can help lock in a relationship – whether it be marriage or an employment contract.
  3. Appropriable quasi-rents: Let’s say I create software to enter marks and grades while at Gokhale Institute. I wouldn’t have created this software without being employed at Gokhale Institute, and it is valuable enough to sell to other firms (let’s assume). These AQR’s exist precisely because of the fact that I (with my skill-sets) was hired by Gokhale Institute. Discernible value has been created precisely because the employee was hired by the employer – this specific employee, by this specific employer (non-homogeneity of labor)

There is a whole can of worms that opens up as a consequence of thinking through the implications of what is written above. That can of worms is called industrial organization. Long story short, if you want to study the field of IO – and as a student of economics, you do! – you really need to start with Profs. Coase, and Williamson.

An assortment of links, with the one common theme

Arnold Kling runs some numbers, and comes away less than optimistic:

Now for some grim math. Let C be the number of known cases, H be the ratio of hospitalizations to known cases, and D be the ratio of deaths to hospitalizations. Then we have:

(1) total deaths = DxHxC

For example, if there are 1000 known cases (C=1000), 5 percent of these are hospitalized, and 20 percent of those who are hospitalized die, then deaths = 1000x.05x.20 = 10. Note that in this particular example, I assumed that no one dies who is not hospitalized. In reality some people will die without being hospitalized, and they will count in D.

FT Alphaville with a three point agenda for economic policy, and in the order mentioned:

deal with the health crisis | make sure incomes don’t spiral downwards | investment led programs to boos incomes

Read the post for the details.

Also from FT Alphaville, a plea to let markets be:

We don’t disagree that calming markets is important; the current volatility is bad for thousands of viable businesses looking to raise capital, and for those who are hoping to retire soon. But a ban on short-selling helps absolutely no one, bar perhaps the egos of the regulatory community. Time for a change of tack.

And Alex Tabarrok over at MR is fuming about Theranos and patents. Here are old EFE posts on patents.

And finally, EconLife on externalities, the corona virus and demographics:

An externality refers to the impact of an activity or a contract or a decision on an uninvolved third party. Good and bad, externalities can be positive and negative. A vaccine creates a positive externality while water pollution results in the negative ripple. For the coronavirus, we have a cascade of results that can become positive and negative externalities. They include a depressed or accelerated birth rate and divorce rate.

 

Econ101: Policy Responses to a Pandemic

If you haven’t played it already, go ahead and give this game a try: The Fed Chairman Game. I have a lot of fun playing this game in class, especially with students who have been taught monetary policy. It usually turns out to be the case that they haven’t understood it quite as well as they think the have! (To be clear, that’s the fault of our educational system, not the students.)

But the reason I started with that is because the game always throws up a scenario that mimics a crisis, and asks you what you would do if you were the Chair of the Fed.

In this case, policymakers the world over are now staring at a very real crisis, and they need to be asking themselves: what should we do?


 

There are two broad answers, of course: monetary policy, and fiscal policy.

The Federal Reserve has cut interest rates to zero, and while it has other tools to stimulate the economy, a crisis like this requires fiscal as well as monetary responses. The legislation passed thus far has been important, but another round of fiscal policy will be required immediately to fully address this crisis.

A robust fiscal response can provide income support to households, ensure broad and continuous access to safety net programs, provide incentives for employers to avoid layoffs, provide loans to small businesses, give liquidity cushions to households and firms, and otherwise stimulate the economy.

That’s a write-up from Brookings. The specifics follow in that article, but the article makes the point that more of the lifting will need to  be done by fiscal, rather than monetary policy. And that is true for a variety of reasons,  which the article does not get into, but long story short – fiscal, more than monetary.

But, ok, fiscal policy of what kind? Should we give money to firms or to workers? Here’s Paul Krugman with his take…

And here’s Alex Tabarrok with his response:

So what’s the correct answer? Well, as we’ve learnt before, and will learn again, macro is hard! In an ideal world, all of the above, but as is manifestly clear, we are not in an ideal world. If we must choose between giving money to firms or to people, to whom should we give it? My opinion? People first, businesses second. This is, of course, a US centric discussion, what’s up with India?


 

Here’s, to begin with, a round-up from around the world – you can search within it for India’s response thus far.

Calls are getting louder for governments to support people and businesses until the new coronavirus is contained. The only questions are how much money to shovel into the economy, how to go about doing it, and whether it will be enough.

Already, officials from Paris to Washington DC are pulling out the playbook used in Asia for slowing the spread of Covid-19: they’re restricting travel and cracking down on public gatherings. While those measures have the potential to reduce deaths and infections, they will also damage business prospects for many companies and cause a synchronized worldwide disruption.

Here’s the FT from two weeks ago about the impending slow down:

Venu Srinivasan, whose company TVS is one of India’s largest makers of motorcycles and scooters, said the business had lost about 10 per cent of production in February owing to a lack of Chinese-made parts for the vehicles’ fuel injection system. He added that TVS has now managed to find a new supplier.

But Mr Srinivasan said he was bracing for India’s recovery to take longer than anticipated. “One would have expected a V-shaped recovery, but instead you have an L shaped recovery,” he said. “It’s been the long haul.”

R Jagannathan in the LiveMint suggests this:

This is how it could be designed. Any unemployed urban youth in the 20-30 age group could be promised 100 days of employment and/or skilling options paid for by the government at a fixed daily rate of ₹300 (or thereabouts, depending on city). At an outlay of ₹30,000 per person annually, the unemployed can be put to work in municipal conservancy services, healthcare support, traffic management, and other duties, with the money also being made available for any skill-acquiring activity chosen by the beneficiary (driver training for Ola-Uber, logistics operations, etc). All companies could be given an opportunity to use the provisions of the Apprentices Act to take on more trainees, with the apprenticeship period subsidized to the limit of ₹30,000 per person in 2020-21. If the pilot works, it could be rolled out as a regular annual scheme for jobs and skills. Skilling works best in an actual jobs environment.

 

He also mentions making the GST simpler, which the Business Standard agrees with:

Certainly, the rationalisation of GST will also affect government revenues. However, a simpler and more transparent system would allow greater collection and reduce evasion. The government will receive a windfall this year from lower crude oil prices. The moment to move on the structural reform agenda is now. The GST Council has done well to address the inverted duty structure in mobile phones. Further rationalisation will give confidence to the market that the government is serious about reforms. It was promised that GST would remain a work in progress, and that the GST Council would act often to improve it. So far, however, the changes have been marginal and haphazard. A more structured and rational approach, which outlines a quick path to a single rate, would pay dividends for the economy in the longer run. It would also be an effective way to manage the immediate effects of a supply shock such as is being caused by the pandemic.

Also from the Business Standard, a report on the government now considering (not happened yet) relaxing bad loan classification rules for sectors hit by the corona virus. That’s pretty soon going to be every sector!


 

Assorted Links about the topic – there’s more to read than usual, please note.

Here is Tyler Cowen on mitigating the economic impacts from the coronavirus crisis.

Here’s Bill Dupor, via MR, about the topic:

First, incentivize behavior to align with recognized public health objectives during the outbreak.

Second, avoid concentrating the individual financial burden of the outbreak or the policy response to the outbreak.

Third, implement these fiscal policies as quickly as possible, subject to some efficiency considerations.

Again, via MR, New Zealand’s macro response.

Arnold Kling is running a series on the macro response to the crisis.

Claudia Sahm proposes direct payment to individuals:

This chapter proposes a direct payment to individuals that would
automatically be paid out early in a recession and then continue annually
when the recession is severe. Research shows that stimulus payments that
were broadly disbursed on an ad hoc (or discretionary) basis in the 2001 and
2008–9 recessions raised consumer spending and helped counteract weak
demand. Making the payments automatic by tying their disbursement to
recent changes in the unemployment rate would ensure that the stimulus
reaches the economy as quickly as possible. A rapid, vigorous response to
the next recession in the form of direct payments to individuals would help
limit employment losses and the economic damage from the recession.

Here are the concrete proposals, the entire paper is worth a read:

Automatic lump-sum stimulus payments would be made to individuals
when the three-month average national unemployment rate rises by
at least 0.50 percentage points relative to its low in the previous 12
months.
• The total amount of stimulus payments in the first year is set to
0.7 percent of GDP.
• After the first year, any second (or subsequent) year payments would
depend on the path of the unemployment rate.

 

Macroeconomics IS HARD!

Economics in the times of COVID-19, there is already a book. I learnt about it from Tim Taylor’s blogpost. I have not read the book, but will soon.

The NYT, two weeks ago, on the scale of the problem facing policymakers.

 

Five articles about – what else – the corona virus

Please read this one, even if you choose to not read the others. This is important. Alex Tabbarok in MR about the mathematics of large gatherings in the times of corona.

Now here is the most important point. It’s the size of the group, not the number of carriers that most drives the result. For example, suppose our estimate of the number of carriers if off by a factor of 10–that is instead of 20,000 there are just 2000 carriers in the United States. In this case, the probability of at least one carrier at a big event of 100,000 drops not by a factor of ten but just to 45%. In other words, large events are a bad idea even in scenarios with just a small number of carriers.

And via MR, this read:

The veteran of numerous global health crises, from SARS to bird flu to Ebola, Ryan points out that incredibly aggressive measures by China, South Korea and Japan appear to be bringing outbreaks in those countries under control.

“There’s clearly an indication that a systematic government-led approach using all tactics and all elements available seems to be able to turn this disease around,” he says.

He has been pleading with governments around the world to prepare for the new coronavirus before it shows up at their door — or to spring into action when it does arrive.

That’s what Hong Kong and Singapore did.

Both quickly set up systems to try to identify and treat every case in their territory. Hong Kong developed diagnostic tests and rapidly deployed them to labs at every major hospital in the city. At one point in February, Hong Kong had 12,000 people in quarantine. Singapore’s prime minister called for calm and assured residents that all health care related to the disease would be free.

Both Hong Kong and Singapore continue to find a few new cases each week, but they’ve avoided the explosive outbreaks that have occurred elsewhere.

And a silver lining:

COVID-19 is a massive global economic and health challenge, having caused >3500 global deaths as of this writing (Mar 8) and untold economic and social disruption. This disruption is only likely to increase in coming days in regions where the epidemic is just beginning. Strangely, this disruption could also have unexpected health benefits — and these benefits could be quite large in certain parts of the world. Below I calculate that the reductions in air pollution in China caused by this economic disruption likely saved twenty times more lives in China than have currently been lost due to infection with the virus in that country.

The psychology of the virus:

If you’re feeling overwhelmed as you try to assess what this all means for you and your family, know that this is a normal and perhaps even useful response. “The adjustment reaction is an emotional rehearsal, getting you psychologically ready to cope if you have to,” Peter Sandman, an expert on risk management, has written. “It is also a logistical rehearsal; it’s how you start figuring out what to do and how to do it.”

And finally, not an excerpt, but a useful catch-all guide to the corona virus from The Atlantic.

2 Videos on Property Rights

Tomorrow’s essay will be on property rights, what with it being the first Monday of the month – a continuation of the series of essay I am writing about aspects of the Indian Constitution. Research for that essay included these two videos, which I learnt a great deal from.

 

 

Ec101: Choices matter!

We’ve, in our Thursday posts this year, learnt about incentives and costs. But, and this is a really, really big “but” – they become operational only when we live in a world where we’re able to choose.

Tyler Cowen and Alex Tabbarok – two people who have probably done more for educating people in economics than anybody else over the last thirty years or so – have written two of the best textbooks on economics available anywhere – one on micro and the other on macro.

In the book on microeconomics, they summarize ten different “big ideas” in economics: incentives, the invisible hand is the best kind of magic*, trade-offs matter, thinking on the margin matters, trade matters, wealth matters, institutions matter, business cycles are unavoidable, printing more money will lead to inflation and central baking is hard.

*I’ve paraphrased practically all of the big ideas, but this in particular is my phrasing, not theirs.

Two other asides before we proceed: in retrospect, it is interesting (at least to me) that at least one of their PhD’s (Tyler Cowen’s) and quite a few of their books are based literally on nothing more complicated than an exposition of these big ideas. There’s a lesson in there somewhere.

Also, they say that the biggest idea of them all is that economics is fun. I’d paraphrase that too: learning about the world is fun, and economics is a great tool to use towards that end.

Now, that allows for a neat segue to the topic du jour. At the very start of the book, even before the table of contents, they provide their definition of economics, one that I agree with wholeheartedly: economics is the study of how to get the most out of life.

Here’s the two word version: choices matter!

Unless we live in a society that is free to choose, at an individual level or otherwise, none of the other big ideas even come into play. So, to me, economics is first and foremost about being free to choose – and then about the benefits and costs of the choices that you make.

Which, I’d argue, means that learning about choices is plenty important. Ergo, this post.

  1. First things first. What is choice?
    ..
    ..
    I chose (see what happened there?) this Quora post not because it is the “best”, but simply because it is so typical. Here’s what I think choice is: it is an admission of the fact that you can’t have everything. A particularly relevant example for me: what to eat from a buffet at a five star restaurant? With every passing year, “everything!” becomes an increasingly unrealistic answer. So choose those dishes that are likely to taste the best (maximizing happiness), or those dishes that are likely to cause the least harm (minimizing unhappiness) along some dimensions such as spiciness, oiliness or what have you.
    Or hey, do both at the same time! Choose the dish that is likely to taste the best and the dish that is likely to do the least harm. That’s half your micro paper right there – the rest is just math and diagrams. (I am kidding, of course, but only a little bit.)
    Choice is an admission of the fact that you can’t have everything, but that’s a good thing! It forces you to go with the best. Which paintings should you look at when you’re at the Louvre? “Every single one!” is unrealistic. Force yourself to choose, therefore, the very best of the lot. Constraints help you understand your own tastes better: aesthetics is, among other things, a matter of acknowledging the existence of constraints.
    ..
    ..
  2. So having too many choices is a bad thing? It would seem so:
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    “It all began with jam. In 2000, psychologists Sheena Iyengar and Mark Lepper published a remarkable study. On one day, shoppers at an upscale food market saw a display table with 24 varieties of gourmet jam. Those who sampled the spreads received a coupon for $1 off any jam. On another day, shoppers saw a similar table, except that only six varieties of the jam were on display. The large display attracted more interest than the small one. But when the time came to purchase, people who saw the large display were one-tenth as likely to buy as people who saw the small display.”
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  3. But hang on. Of what use is an economics theory that doesn’t have a on-the-other hand angle? Tim Harford, as is so often the case, to the rescue.
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    “But a curious thing happened almost immediately. They began by trying to replicate some classic experiments – such as the jam study, and a similar one with luxury chocolates. They couldn’t find any sign of the “choice is bad” effect. Neither the original Lepper-Iyengar experiments nor the new study appears to be at fault: the results are just different and we don’t know why.”
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  4. And on a related note, have you heard of Herbert Simon and satisficing? This excerpt is from a Wikipedia article on Barry Schwartz’s book, The Paradox of Choice, but it is actually about Herbert Simon.
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    “A maximizer is like a perfectionist, someone who needs to be assured that their every purchase or decision was the best that could be made. The way a maximizer knows for certain is to consider all the alternatives they can imagine. This creates a psychologically daunting task, which can become even more daunting as the number of options increases. The alternative to maximizing is to be a satisficer. A satisficer has criteria and standards, but a satisficer is not worried about the possibility that there might be something better. Ultimately, Schwartz agrees with Simon’s conclusion, that satisficing is, in fact, the maximizing strategy.”
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  5. And the final word goes to Tyler Cowen. Or is it Herbert Simon all over again? Choices, choices.
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    “What if you asked people the following: do you wish to choose your own means of limiting your (subsequent) choices, or do you wish to let someone else, perhaps the government, do the work? I suspect the answers would overwhelmingly favor the former option, namely voluntary choice at the meta-level. And if you reexamine the experiments mentioned above, they are all about ways in which people voluntarily limit their own choices. Maybe you don’t wish to run your own cancer treatments, but you wish to choose the doctor who will.”

 

Ec101: Links for 9th January, 2020

Five articles on sunk costs today.

  1. First up, a somewhat basic introductory article. Feel free to skip it if you’re sure you know what sunk costs are (pausing only to note that it is not so much the knowing that matters with sunk costs, but remembering to apply it)
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  2. “The United States has invested much in attempting to achieve its objectives. In addition to the many millions of dollars that have been spent, many thousands of lives have been lost, and an even greater number of lives have been irreparably damaged. If the United States withdraws from Vietnam without achieving its objectives, then all of these undeniably significant sacrifices would be wasted”
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    The quote itself is a quote (if you see what I mean) from this paper, which is a wonderful rumination on sunk costs. Read Taleb on the subject (and not just his tweets!)
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  3. This entire post by Alex Tabarrok is very short (and I have linked to it before, I think), but it is worth reading. Especially the last sentence: do think about it, if you are an economics student.
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  4. “Once your model of choice is at all complex, no one knows what a sunk cost means any more. So a theoretical scolding of those who honor “sunk costs” is not completely well-defined. That being said, there is still the empirical question of whether most people attach too much weight to previous plans and have a status quo bias. The experimental evidence suggests that we are more rigid than we need to be. The propensity to honor previous commitments may have efficiency properties, but we cannot discard this proclivity when we ought to.”
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    The bottom line from Tyler Cowen’s post on the topic. He was responding to Tabarrok’s post above.
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  5. “Suppose that you are trying to pursue a morally worthy goal, but cannot do so without incurring some moral costs. At the outset, you believed that achieving your goal was worth no more than a given moral cost. And suppose that, time having passed, you have wrought only harm and injustice, without advancing your cause. You can now reflect on whether to continue. Your goal is within reach. What’s more, you believe you can achieve it by incurring—from this point forward—no more cost than it warranted at the outset. If you now succeed, the total cost will exceed the upper bound marked at the beginning. But the additional cost from this point is below that upper bound. And the good you will achieve is undiminished. How do the moral costs you have already inflicted bear upon your decision now?”
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    I am reminded, very strongly indeed, of the Mahabharata. That is the abstract of this paper.