Category: economics

How Little We Know: Big Gaps in Psychology and Economics

Seth Roberts7 Comments

Seth’s final paper “How Little We Know: Big Gaps in Psychology and Economics” is published in a special issue of the International Journal of Comparative Psychology (Vol 27, Issue 2, 2014). This issue is about behavioral variability and is dedicated to Seth. Abstract of the paper follows:

A rule about variability is reducing expectation of reward increases variation of the form of rewarded actions. This rule helps animals learn what to do at a food source, something that is rarely studied. Almost all instrumental learning experiments start later in the learning-how-to-forage process. They start after the animal has learned where to find food and how to find it. Because of the exclusions (no study of learning where, no study of learning how), we know almost nothing about these two sorts of learning. The study of himan learning by psychologists has a similar gap. Motivation to contact new material (curiousity) is not studied. Walking may increase curiosity, some evidence suggests. In economics, likewise, research is almost all about how people use economically valuable knowledge. The creation and spread of knowledge are rarely studied.

The family is grateful to Aaron Blaisdell Ph.D. who completed final edits to Seth’s final manuscript for publication.

“A Debt-Ceiling Breach Would be Very, Very, Very Bad”

Seth Roberts5 Comments

At the end of an article by Kevin Roose in New York about the effects of a debt-ceiling breach:

The bottom line: A debt-ceiling breach would be very, very, very bad.

Keep in mind that these are all hypothetical scenarios. Reality could be better, or much worse. The truth is that while we sort of know what a government shutdown would look like (since it’s happened in the past), we have no idea what chaos a debt-ceiling breach could bring. If, in a month, we reach the X Date, run out of money, and are stuck in political stalemate, we’ll be entering truly uncharted waters. And we’ll be dealing our already-fragile economy what could amount to a knockout blow.

This is an example of something common: Someone who has never correctly predicted anything (in this case, Roose) telling the rest of us what will happen with certainty. If Roose is repeating what experts told him, he should have said who, and their track record. Roose is far from the only person making scary predictions without any evidence he can do better than chance. Here is another example by Derek Thompson in The Atlantic.

The same thing happens with climate change, except that it is models, not people, making predictions. Models that have never predicted climate correctly — for example, none predicted the current pause in warming — are assumed to predict climate correctly. We are supposed to be really alarmed by their predictions. This makes no sense, but there it is. Hal Pashler and I wrote about this problem in psychology.

A third example is the 2008 financial crisis. People who failed to predict the crisis were put in charge of fixing it. By failing to predict the crisis, they showed they didn’t understand what caused it. It is transparently unwise to have your car fixed by someone who doesn’t understand how cars work, but that’s what happened. Only Nassim Taleb seems to have emphasized this. We expect scary predictions based on nothing from religious leaders — that’s where the word apocalypse comes from. From journalists and the experts they rely on, not so attractive.

I don’t know what will happen if there is a debt-ceiling breach. But at least I don’t claim to (“very very very bad”). And at least I am aware of a possibility that Roose (and presumably the experts he consulted) don’t seem to have thought of. A system is badly designed if a relatively-likely event (debt-ceiling breach) can cause disaster — as Roose claims. The apocalyptic possibilities give those in control of whether that event happens (e.g., Republican leaders in Congress) too much power — the power to scare credulous people. If there is a breach, we will find out what happens. If a poorly-built system falls down, it will be much easier to build a better one. Roose and other doom-sayers fail to see there are plausible arguments on both sides.

Rent-Seeking Experts

Seth Roberts18 Comments

Two thought-provoking paragraphs from Matt Ridley:

From ancient Egypt to modern North Korea, always and everywhere, economic planning and control have caused stagnation; from ancient Phoenicia to modern Vietnam, economic liberation has caused prosperity. In the 1960s, Sir John Cowperthwaite, the financial secretary of Hong Kong, refused all instruction from his LSE-schooled masters in London to plan, regulate and manage the economy of his poor and refugee-overwhelmed island. Set merchants free to do what merchants can, was his philosophy. Today Hong Kong has higher per capita income than Britain.

In July 1948 Ludwig Erhard, director of West Germany’s economic council, abolished food rationing and ended all price controls on his own initiative. General Lucius Clay, military governor of the US zone, called him and said: “My advisers tell me what you have done is a terrible mistake. What do you say to that?” Erhard replied: “Herr General, pay no attention to them! My advisers tell me the same thing.” The German economic miracle was born that day; Britain kept rationing for six more years.

This is standard libertarianism. I like the stories but I don’t agree with the interpretation. I don’t think it is “economic planning and control” that causes stagnation in these examples. I believe it is expertise — more precisely, rent-seeking experts who know too little and extract too much rent. There are libertarian experts, too. They too are capable of doing immense damage (e.g., Alan Greenspan), contradicting Ridley’s view that “economic liberation” always causes prosperity. In both of Ridley’s examples, the experts give advice that empowers the experts. In the first example, Cowperthwaite is told by “LSE-schooled” economists to “plan, regulate and manage the economy.” All that planning, regulation and management require expertise, in particular expertise similar to that of the experts who advised it. Which you cannot buy — you have to rent it. You must pay the experts year after year after year to plan, regulate, and manage. Because the advice must empower the experts, there is a strong bias away from truth. That is the fundamental problem.

Freud is the classic rent-seeking expert. You are sick because of X, Y, and Z — and if you pay me for my time week after week, I will cure you, said Freud. Curiously no treatment that did not involve paying people like Freud would work. Curiously psychoanalytic patients never got better. Therapy lasted forever. You might think this is transparently ridiculous, but professors at esteemed universities such as Berkeley still take Freud seriously. Millions of people pay for psychotherapy. The latest psychotherapeutic fad is cognitive-behavioral therapy — which again requires paying experts to get better, week after week. Berkeley professors take that seriously, too.

Evidence-based medicine advocates are among the newest rent-seeking experts. Like Freud, they focus on process (you must follow a certain process) rather than results. (What they call process in other contexts is called ritual. Rituals always empower experts.) Rather than trying to learn from all the evidence — which might seem like a good idea, and a simple one — evidence-based medicine advocates preach that only a tiny fraction of the evidence (which you need a Cochrane expert to select and analyze) can actually tell us anything. Again, this might seem transparently ridiculous, but many people take it seriously. Evidence-based medicine has an amusing twist which is that its advocates tell the rest of us how stupid we are (for example, “correlation does not equal causation”).

The workhorses of the rent-seeking expert ecology — the ones that extract the most rent — are doctors. They are incapable of giving inexpensive advice. However they propose to help you, it always involves expensive treatment. This might seem like a recipe for crummy solutions, but again many people take a doctor’s advice seriously (by failing to do their own research). My introduction to the world of rent-seeking solutions was the dermatologist who told me I should take antibiotics for my acne. I was to take the antibiotics week after week — and because I was taking a dangerous drug, I should also see my doctor regularly. During these regular visits, the doctor never figured out that the antibiotic did nothing to cure my acne. I learned that by self-experimentation.

Like anthropologists who fail to notice their own weird beliefs (a recently-deceased Berkeley professor of anthropology took Freud seriously, for example), the profession that came up with the rent-seeking concept has failed to notice that many of them do exactly that.

One clue that you are dealing with a rent-seeking expert is that they literally ask for something like rent. Religious experts tell you to attend church week after week. Psychotherapists want you to attend therapy week after week. Psychiatrists tell you to take an anti-depressant daily for the rest of your life. My dermatologist told me to take an antibiotic daily (and to renew the prescription I needed to see him). And so on. As these examples suggest, rent-seeking experts thrive in areas of knowledge where our understanding is poor. Which includes economics.

“Rent-seeking experts” in education.

More What I call “standard libertarianism” Tyler Cowen calls “crude libertarianism”. Maybe I should have called it “off-the-shelf libertarianism”. In addition to what Tyler says, which I agree with, I would say that governments and their “central planners” have sponsored innovation (e.g., the Internet, the greenback, basic scientific discoveries) much better than Ridley seems to give them credit for. Innovation is a huge part of economic development.

Who is the Richest Person in China?

Seth Roberts6 Comments

If you open the American edition of Forbes, you will find articles about the richest people in America. If you open the Russian edition, you will find articles about the richest people in Russia. If you open the Chinese edition, you will find articles about the richest people in America.

A Russian friend of mine noticed this. He happened to know an sophomore economics major at Tsinghua. It is incredibly difficult to get into Tsinghua and the economics major is the most desirable major of all. To be an economics major at Tsinghua you need a test score that is in something like the top 1 out of 100,000. Staggeringly high. My Russian friend asked the Tsinghua economics major, “Who is the richest person in China?”

The economics major didn’t know. He seemed a little angry. “Why should I know? We’ve never been taught that,” he said.

 

Two Dimensions of Economic Growth: GDP and Useful Knowledge

Seth Roberts9 Comments

Ecologists understand the exploit/explore distinction. When an animal looks for food, it can either exploit (use previous knowledge of where food is) or explore (try to learn more about where food is). With ants, the difference is visible. Trail of ants to a food source: exploit. Solitary wandering ant: explore. With other animals, the difference is more subtle. You might think that when a rat presses a bar for food, that is pure exploitation. However, my colleagues and I found that when expectation of food was lower, there was more variation — more exploration — in how the rat pressed the bar. In a wide range of domains (genetics, business), less expectation of reward leads to more exploration. In business, this is a common observation. For example, yesterday I read an article about the Washington Post that said its leaders failed to explore enough because they had a false sense of security provide by their Kaplan branch. “Thanks to Kaplan, the Post Company felt less pressure to make hard strategic choices—and less pressure to venture in new directions,” wrote Sarah Ellison.

Striking the right balance between exploitation and exploration is crucial. If an animal exploits too much, it will starve when its supply of food runs out. If it explores too much, it will starve right away. Every instance of collapse in Jared Diamond’s Collapse: How Socieities Choose to Fail or Succeed was plausibly due to too much exploitation, too little exploration (which Diamond, even though he is a biologist, fails to say). I’ve posted several times about my discovery that treadmill walking made studying Chinese more pleasant. I believe walking creates a thirst for dry knowledge. My evolutionary explanation is that this pushed prehistoric humans to explore more.

I have never heard an economist make this point: the need for proper balance between exploit and explore. It is relevant in a large fraction of discussions about how to spend money. For example, yesterday I listened to the latest EconTalk podcast, a debate between Bob Frank and Russ Roberts about whether it would be a good idea for the American government to spend $2 trillion on infrastructure projects (fix bridges, etc.). Frank said it would create jobs, and so on — the usual argument. Roberts said if fixing bridges was such a good idea, why hadn’t this choice already been made? Roberts could have said, but didn’t, that massive government shovel-ready expenditures, such as $2 trillion spent on infrastructure repair, inevitably push the exploit/explore balance toward exploit, which is dangerous. This is an argument against all Keynesian stimulus-type spending. I have heard countless arguments about such spending. I have never heard it made. If you want examples of how the American economy suffers from a profound lack of useful new ideas, look at health care. As far as I know, there are no recorded instances of a society dying because of too much exploration. The problem is always too much exploitation. People at the top — with a tiny number of exceptions, such as the Basques — overestimate the stability of their position. At the end of The Economy of Cities, Jane Jacobs says that if a spaceship landed on Earth, she would want to know how their civilization avoided overexploitation. When societies exploit too much and explore too little, said Jacobs, problems (in our society, problems such as obesity, autism, autoimmune disease, etc.) stack up unsolved. Today is China’s birthday. Due to overexploitation, I believe China is in even worse economic shape than America. Ron Unz, whom I respect, misses this.

My broad point is that a lot of economic thinking, especially about growth and development, is one-dimensional (measuring primarily growth of previously existing goods and services — exploitation) when it should be two-dimensional (measuring both (a) growth of existing stuff and (b) creation of new goods and services). Exploration (successful exploration) is inevitably tiny compared to exploitation, but it is crucial there be enough of it. If there is a textbook that makes this point, I haven’t seen it. An example of getting it right is Hugh Sinclair’s excellent new book Confessions of a Microfinance Heretic (copy sent me by publisher) that debunks microcredit. Leaving aside the very high interest rates, the use of microcredit loans to buy TVs, and so on, microcredit is still a bad idea because the money is, at best, used for a business that copies an existing business. (The higher the interest rate, the less risk a loan recipient dares take.) When a new business copies an already-existing business, you are taking an existing pie (e.g., demand for milk, if the loan has been used to buy a cow and sell its milk) and dividing it into one more piece. The pie does not get bigger. As Sinclair says, the notion that dividing existing pies into more pieces will “create a poverty-free world” is, uh, not worthy of a Nobel Prize.

Sure, it’s hard to measure growth of useful knowledge. (It is perfectly possible for a company to waste its entire R&D budget.) However, I am quite sure that realism does better than make-believe — and the notion that growth of GDP is a satisfactory metric of economic growth is make-believe. If you’ve ever been sick, or gone to college, and have a sense of history, you will have noticed the profound stagnation in two unavoidable sectors (health care and education) of our economy. That are growing really fast.

The Next Time a Top Economist Predicts Disaster…

Seth Roberts2 Comments

Shortly before Obama took office, many American banks, including the largest ones, were given a huge amount of money by the Federal government (“bailed out”). Why? Because Secretary of the Treasury Henry Paulson, Chairman of the Federal Reserve Ben Bernanke and other economists (not necessarily independent of Paulson and Bernanke) predicted a second Great Depression if they weren’t. I didn’t believe Paulson et al. — their track records of prediction were terrible. They hadn’t foreseen the crisis. Why should I think they knew how to fix it? I believed their predictions of disaster were too confident.

At the time I didn’t know this bit of history:

The blood-curdling threats [now] being issued by Eurocrats should sound familiar to British readers. We went through precisely the same experience 20 years ago, when we were stuck with an over-valued exchange rate in the Exchange Rate Mechanism.

As in Greece, our leaders – all the main parties, the CBI, the TUC, the Bank of England – assured us that leaving the ERM would be disastrous. On September 11, 1992, John Major solemnly told us that withdrawal was ‘the soft option, the inflationary option, the devaluer’s option, a betrayal of our country’s future’.

Four days later, we left the system, and our recovery began immediately. Inflation, interest rates and unemployment started falling, and we enjoyed 15 years of unbroken growth

Those who don’t know the past are doomed to over-trust experts.

Gelman and Fung versus Levitt and Dubner: How “Wrong” is Freakonomics?

Seth Roberts4 Comments

In the latest issue of American Scientist, Andrew Gelman (an old friend) and Kaiser Fung criticize Freakonomics and Superfreakonomics by Steve Levitt and Stephen Dubner (who wrote about my work). Although the article is titled “Freakonomics: What Went Wrong?” none of the supposed errors are in Freakonomics. You can get an idea of the conclusions from the title and this sentence: “How could an experienced journalist and a widely respected researcher slip up in so many ways?”

Gelman and Fung examine a series (“so many ways”) of what they consider mistakes. I will comment on each of them.

1. The case of the missing girls. I agree with Gelman and Fung: Levitt and Dubner accepted Emily Oster’s research too uncritically.

2. The risk of driving a car. I think Gelman and Fung miss the point. Yes, the claim (driving drunk is safer than walking drunk) was not well-supported by the evidence provided because the comparison was so confounded. However, I read the whole example differently. I didn’t think that Levitt and Dubner thought drunk people should drive. I thought their point was more subtle — that comparisons are difficult (“look how we can reach a crazy conclusion”).

3. Stars are made not born. I think Gelman and Fung fail to see the big picture. The birth-month effect in professional sports, which Gelman and Fung dismiss as “very small,” is of great interest to many people, if not to Gelman and Fung. It suggests what Levitt and Dubner and Gladwell and others say: Early success matters. That’s not obvious at all. There are lots of similar associations in epidemiology. They have been the first evidence for many important conclusions, such as smoking causes lung cancer. Are professional sports important? Maybe. But epidemiology and epidemiological methods are surely important. By learning about this effect, we learn about them. Lots of smart people fail to take epidemiology seriously enough (e.g., “correlation does not equal causation”).

4. Making the majors and hitting a curve ball. Gelman and Fung point out that one sentence is misleading. One sentence. This is called praising with faint damn.

5. Predicting terrorists. Gelman and Fung say that the terrorist prediction algorithm of a man named Ian Horsley, which Levitt and Dubner seem to take seriously, is not practical. But their review fails to convince me it was presented as practical. Since there are no data about how well the algorithm works, and Levitt and Dubner are all about data….

6. The climate change dust-up. I agree with Gelman and Fung that Nathan Myrvold’s geoengineering ideas are unimportant. (My view of Myrvold’s patent trolling.) But in this case, I’d say both sides — Gelman and Fung and Levitt and Dubner — miss what’s really important, namely that the usual claims that humans are dangerously warming the planet are held far too strongly. The advocates of this view are far too sure of themselves. I have blogged about this many times. In a nutshell, the climate models that we are supposed to trust have never been shown to persuasively predict the climate ten or twenty years from now (or even one year from now). There is no good reason to believe them. That Levitt and Dubner seem to take that stuff seriously is the only big criticism I have of their work . At least in that geoengineering stuff Levitt and Dubner were dissenting from conventional wisdom. Gelman and Fung do not. They fail to realize that something we’ve been told thousands of times is nonsense (in the sense of being wildly overstated). It was Levitt and Dubner’s comments about this that led me to look closely at all that climate-change scare stuff. I was surprised how poor the evidence was.

The biggest problem with Gelman and Fung’s critique is that they say nothing about the great contribution of Steve Levitt to economics. They fail to grasp that he has made economics considerably more of a science, if by science you mean a data-driven enterprise as opposed to an ideologically-driven or prestige-driven one (mathematics is prestigious, the more difficult, the more prestigious). He did so by pioneering a new way to use data to learn interesting things. His method is essentially epidemiological, except his methods are considerably better (better matching, less formulaic) and his topics much more diverse (e.g., sumo wrestling) than mainstream epidemiology. A large fraction of prestige economics is math, divorced from empirical tests. This stuff wins Nobel Prizes, but, in my and many other people’s opinion, contributes very little to understanding. (Psychology has had the same too much math, too little data problem — minus the Nobel Prizes, of course.) To persuade a big chunk of an entire discipline to pay more attention to data is a huge accomplishment.

Levitt’s methodological innovation makes Freakonomics far from what Gelman and Fung call “pop statistics”. It is actually an amusing and well-written record of something close to a revolution. In the 1980s, a friend of mine at UC Berkeley took an introductory economics class. She told me a little of what the teacher said in class. All theory. What about data? I said. It’s a strange science that doesn’t care about data. My friend went to office hours. She asked the instructor (a Berkeley economics professor): What about data? Don’t worry about data, he replied. Gelman and Fung fail to appreciate what economics used to be like. The ratio of strongly-asserted ideas to persuasive data used to be very large. Now it is less.

Thanks to Ashish Mukharji.

Assorted Links

Seth Roberts10 Comments
  • A brash high-school student discovers — maybe by accident — how much famous writers, such as Ralph Ellison, Norman Mailer, and John Updike, don’t want to write. Any excuse to avoid writing will do.
  • A pretty good talk by John Cochrane, a University of Chicago professor of economics, called “Restoring Robust Economic Growth in America”. What’s most interesting is what’s missing. At one point he asks: “Why are we stagnating? I don’t know. I don’t think anyone knows, really. That’s why we’re here at this fascinating conference.” In spite of this topic, his talk contains nothing about what controls the rate of innovation. Not only does he not know anything about this (judging by this talk), he doesn’t even realize the gap in his knowledge (judging by this talk). Shades of Thomas Sargent. It’s as if a Harvard Medical School professor spoke about how to fight disease without mentioning the immune system, without even appearing to know that the immune system exists. (Which happens.)
  • Garum, a fermented fish sauce. It was the “supreme condiment” of ancient Rome.

Thanks to Allan Jackson and Peter Couvares.

Duct Tape, the Eurozone, Status-Quo Bias, and Neglect of Innovation

Seth Roberts11 Comments

In 1995, I visited my Swedish relatives. We argued about the Euro. They thought it was a good idea, I thought it had a serious weakness.

ME It ties together economies that are different.

MY AUNT It reduces the chance of war in Europe.

You could say we were both right. There have been no wars between Eurozone countries (supporting my aunt) and the Eurozone is now on the verge of breaking apart for exactly the reason I and many others pointed out (supporting me).

Last week a friend said to me that Europe was in worse shape than America. I was unconvinced. I said that I opposed Geithner’s “duct-tape solution”. It would have been better to let things fall apart and then put them back together in a safer way.

MY FRIEND Duct-tape works.

ME What Geithner did helped those who benefit from the status quo and hurt those who benefit from change. Just like duct tape.

This struck me as utterly banal until I read a one-sided editorial in The Economist:

The consequences of the euro’s destruction are so catastrophic that no sensible policymaker could stand by and let it happen. . . . the threat of a disaster . . . can anything be done to avert disaster?

and similar remarks in The New Yorker (James Surowiecki):

The financial crisis in Europe . . . has now entered a potentially disastrous phase.. . . with dire consequences not just for Europe but also for the rest of us. . . . This is that rarest of problems—one that you really can solve just by throwing money at it [= duct tape]

Wait a sec. What if the Eurozone is a bad idea? Like I (and many others) said in 1995? Why perpetuate a bad idea? Why drive further in the wrong direction? Sure, the dissolution will bring temporary trouble (“disaster”, “dire consequences”), but that will be a small price to pay for getting rid of a bad idea. Of course the Euro had/has pluses and minuses. Anyone who claimed to know that the pluses outweighed the minuses (or vice-verse) was a fool or an expert. Now we know more. Given that what the nay-sayers said has come to pass, it is reasonable to think that they (or we) were right: The minuses outweigh the pluses.

You have seen the phrase Japan’s lost decade a thousand times. You have never seen the phrase Greece’s lost decade. But Greeks lost an enormous amount from being able to borrow money for stupid conventional projects at too low a rate. Had loans been less available, they would have been more original (the less debt involved, the easier it is to take risks) and started at a smaller scale. Which I believe would have been a better use of their time and led to more innovation. Both The Economist‘s editorial writer and Surowiecki have a status-quo “duct-tape” bias without realizing it.

What’s important here is not what two writers, however influential their magazines, think or fail to think. It is that they are so sure of themselves. They fail to take seriously an alternative (breakup of the Eurozone would in the long run be a good thing) that has at least as much to recommend it as what they are sure of (the breakup would be a “disaster”). I believe they are so sure of themselves because they have absorbed (and now imitate) the hemineglect of modern economics. The whole field, they haven’t noticed, has an enormous status-quo bias in its failure to study innovation. Innovation — how new goods and services are invented and prosper — should be half the field. Let me repeat: A few years ago I picked up an 800-page introductory economics textbook. It had one page (one worthless page) on innovation. In this staggering neglect, it reflected the entire field. The hemineglect of economics professors is just as bad as the hemineglect of epidemiologists (who ignore immune function, study of what makes us better or worse at fighting off microbes) and statisticians (who pay almost no attention to idea generation).

MORE Even Joe Nocera, whom I like, has trouble grasping that the Euro might be a bad idea. “The only thing that should matter is what works,” he writes. Not managing to see that the Euro isn’t working.