Wage Slave

I now have my first regular full-time job. It's right and proper that I should get paid, of course, but it also feels strange.

I've pinpointed the awkward feeling to three things:

1. Many of the activities of my new job are very similar to things I used to do in college for free. If I were an undergraduate, I would probably be expected / willing to do this job for free, if not even pay to have the opportunity. But once I pass the magical boundary of Commencement, I suddenly get the right to demand payment for providing these services. That's strange, isn't it?
2. When you're working in large group projects, it's hard to tell how much your labor is worth. When your contribution gets mixed in with everyone else's, how do you tell how much your contribution is worth? The wage you receive seems strangely detached from your work.
3. Participating in the labor market doesn't just mean getting money for your service. It also means refusing service if there's no money. Otherwise how would people take your fees seriously? If the work is tedious and unpleasant, refusing service is rather easy. But if you go into work that you love, and which you would probably do for free anyway (which is what they tell you to do in all those Commencement Addresses in the first place, right?), then you're trapped between your natural instinct and your need for money, which can make you feel either cheap or unappreciated, depending on whether the former or latter feeling is stronger.

Money, Money, Money! New Reading List

The Reading List  is a collection of things I find in print and online that reflect what I've been finding interesting lately.

This time the reading list has a theme: money! Each of the articles, books, or video clips in the list explains a particular aspect of how money works—where it gets its value from, what keeps the system from collapsing, and how it is regulated. Money is fascinating, in part because it's one of those inventions of the modern world that we all rely on but hardly bother to question. Once you do start questioning, though, you fund that the plumbing of the international financial system runs deep.

One aspect of money that I really enjoy is how it represents not so much a technological innovation as much as a mental one. Unlike electricity, or semiconductors, or antibiotics, the innovation of money didn't require any wizardry over Nature. The paper on which we record our money is generally cheap and worthless. Instead, the major innovation was in fundamentally shifting the way we think about value, and transactions. Money made it possible to commensurate all sorts of seemingly incommensurate values, to save, to invest, to compare investments, to plan for the future, and the like—but not because money has any of these powers intrinsically, but rather because we gave it these powers by believing in it. It's truly quite remarkable how that works.

If you like what you see, or wish to discuss the readings, please add a comment below! I'll be more than eager to participate in the discussion.

Bonus Feature: The intro song and first couple minutes of the Singaporean film, Money No Enough.

Why are stock prices related to company performance?

Like electricity or semiconductors, the stock market remains a mysterious invention of the modern world, something that few of us understand entirely even though we depend upon it everyday.

I hadn't given the stock market much thought myself until I watched Niall Ferguson's excellent documentary The Ascent of Money (available to watch free online here), which shows how some of the most pivotal moments in history (the victory of the North in the Civil War, the coups of Latin America, the defeat of Napoleon) had important financial backstories to them.

This sparked my curiosity to really get a grasp of what the stock market is about. Not just that layman's wisdom of "buy low, sell high," but to really understand why the stock market exists, the value that it contributes to society, and the fundamental forces that drive stock market prices (the first and second points have gotten rather lost lately, so much so that Robert Shiller has had to write a book defending the idea that finance is useful and good).

I found the answer to most of my questions in this really good guide by HowStuffWorks.com, which walks the reader through IPOs, stock exchanges, incorporation, brokers, and the like.

But there was one question I had that I couldn't seem to find an answer for anywhere: why does the stock price have anything to do with company performance?

Often the lay explanation of how the stock market works is trapped in a circular logic. You buy stock, the thinking goes, to sell it to someone else for a higher price. But then that person, thinking the same thing, wants to sell it to someone else for an even higher price. Neither person in this scenario is thinking of profiting from the company per se. But surely it can't be that the only value of a stock is to unload it onto someone else later. So is there any value in holding on to the stock? Does the stock have any value on its own, even when most modern companies do not return profits to its shareholders?

The answer is, of course, yes. I owe (what I think to be) my understanding of the answer to the discussion at this forum, whose contributors seem to be pretty well informed. I haven't seen any discussion of this question hardly anywhere, let alone an answer, so I'm sharing it here, in case others are also curious.

But before we begin this explanation, it's worth taking a step back and establishing the mechanics of the simplist kind of stock, dividend-paying stocks. This detour will be useful to those with less background in the stock market, and will help me cement my new-found knowledge. If you already know this stuff, you can skip down to the next section.

Beginner's Detour

Although the modern stock market is incredibly complex, the earliest system of stocks was rather straightforward. The stock market was invented for two reasons: to raise money for the company, and to spread risk. The Dutch East India Company, widely regarded as the first company to issue public stock, was in great need of both of these benefits. Its voyages to the Orient were not only very expensive, but also very risky and dangerous. Without the stock market, the company would have to borrow at interest, which would have been a bad move given that the outcome of its expeditions was so uncertain. Stocks offered an ingenious way around this problem by spreading risk (and reward) amongs many, many private owners. And people gladly offered up their money, anticipating the massive profits that the company would soon earn.

In the Dutch East India Company, shares entitled their holder to two rights—a portion of the annual profits, and the right to cast a vote in company decisions. Modern stocks are much more complex (by, among other things, dividing stocks into different "classes," which entitle their owners to varying degrees of benefits). But even still, these two rights are the principal benefits that shareholders can expect. 

When shareholders receieve a portion of the profits (called dividends), as in the case of the Dutch East India Company, it is clear why trading is based on company performance. The more profits the company reaps, the larger the dividends will be, and the return will be.

Some people who did not get a chance to buy a stock in the company when they were first being sold wanted to get into the action later; and others who bought the stock wanted to get rid of it. Thus a stock market was born. Note that none of the money trading hands in the stock market went to the Company. It was strictly private agreements who were trading commodities, like people buying baseball cards from each other.

Valuing the stock is a subjective calculation. The stock yields a stream of annual dividends, of an uncertain amount, for the lifetime of the company. As long as the present value of the stream of money is more than purchase price, then it's a good investment.

The idea of present value is of central importance to valuing stocks; stocks, like all investments, return money in the future, money in the future is worth less than money in the present.

This is because of interest rates. Suppose someone offers you $100 today or $100 next year. Suppose also that the generally prevailing interest rate is 5% (say in a savings account, or buying government bonds). Then if you take the $100 today and put it in the savings account you'll have $105 next year. So because you lose that year of not collecting interest, $100 in the future is worth less than $100 today. The present value of a future sum of money is the amount you would need to invest today to collect that sum of money at the future time. To collect $100 next year, one would need to invest $100 / 1.05 = $95.24 today. This is the present value of that money.

Here's a numerical example to show how this works with the Dutch East India Company. Suppose you buy the stock for $30. Suppose the interest rate is 2% and suppose that these are your annual returns for the stock.

Year 1: $20                            Present Value: $19.60
Year 2: $15                            Present Value: $14.42
Year 3: $25                            Present Value: $18.85

Total Present Value over 3 years: $52.87

So the stock pays for itself, even though each year the return is less than the purchase price of the stock.

However, just knowing that you get a return on the stock is not enough. The question you should ask on an investment is not whether you'll get a return at all, but whether you'll get more return here than you would collecting interest on safe investments (i.e. U.S. government bonds, the standard that modern markets use). It only makes sense to take on the additional risk of buying stock if there is potential for making more money. This is why interest rates are so important.

This Dutch East India type stock—the kind that returns dividends—is the simplest kind of stock. But even if we have just a couple dozen companies with this kind of stock, we already have a pretty robust stock market. Some stocks may give small but steady returns; others may be more volatile; a start-up may just be taking off that in the future will return vast sums of money; and the uncertainty around predicting how companies will do at the end of the year will lead to tons of buying and selling. When there are more buyers than sellers of a particular stock, that stock price goes up. When there are more sellers than buyers, the stock price goes down.

Non-dividend paying bonds

Most public companies, as I noted earlier, don't pay dividends to their shareholders. So why do shareholders care about company performance?

The crucial point is that all companies will eventually pay dividends. Paying dividends is the default option. The reason that companies don't pay dividends is because they believe they can generate a larger return for their shareholders by expanding the company than the shareholders could if they took their dividend and invested it themselves. But no company can grow forever (at the very least, scale problems will get in the way). As the company starts to reach its growth limit, it will run out of profitable uses of the money. At this point, the profits will come back to the shareholders, and when this moment comes the profits will be enormous (relative to the company's starting point).

This kind of stock, you'll notice, is different. When you buy this stock, you don't get anything in the short run. But eventually, say after 10 years, when this company does start issuing dividends, it's dividends will be gigantic. So even though you don't get anything for a while, it's worth buying. In the meantime, people buy and sell depending on how much they think the company will eventually be worth.

It's not an automatic process by which the company starts to issue dividends. The company may resist returning profits to its shareholders (e.g. see Apple). But once the shareholders feel that the company doesn't need the money for investment, or can't invest it better than the going interest rates, then they'll start calling for dividends, and vote for such measures at shareholder meetings.

Even if stocks never paid dividends, they would still have some value, because of a stock's ownership power. If someone amasses a controlling stake in a company (usually 51% of stocks), then they can decide how the company will be run. This power, in turn, allows someone to make a lot of money. Take an extreme example: suppose you have a company with $1 billion worth of assets, and 3 stocks, each trading at $1 each. I buy two of the stocks for $2. Then I can go and sell off the company's assets—their buildings and machines and land and other property—and pocket all the cash. This way of making money is called "corporate raiding," and is generally frowned upon. But it's another way the performance of the firm is reflected in its share price.

What I have described is the underlying fundamental forces that move the stock market. Everything else is just people trying to game the system. The layman's understanding of the stock market is based on this gaming of the system—taking advantage of people's expectations, betting on what other people think will happen, or even betting on what other people think other people will think will happen.

But this isn't what the stock market is about. The stock market is about financing companies that will be profitable, and wanting to partake in company profits and ownership. Everything else is, I think, secondary.

Back Again

I haven't given up on blogging—it's just been an unusually hectic semester. For the past two months I've been dedicating all my time to my undergraduate thesis (the main ideas of which I'll share at a later date). So I dropped off the blogosphere. But now that I have a month and a half of vacation, I have plenty of time to write down the various ideas that popped into my head over the course of this hiatus. I'm looking forward to getting back to writing again.

Some Confirmation That I'm Not Crazy

In the seventh grade, after learning that I wasn't the first one to figure out that (a + b)² = a² + b² + 2ab, I was convinced that I would never have a novel idea in my life. At the time, this was a sad thought, because I wanted to be original, and make discoveries. But since I began writing this blog, I've enjoyed finding some of my thoughts in other places. Here's a metaphor to explain why:

When I sit down to write my blog, sometimes I feel like the commander of a small space vessel, zooming through vast galaxies of ideas.

Most of my journey passes in solitude—just me (and what appear to be) parsecs and parsecs of uncharted territory. The world of ideas seems so vast. At first, because of the thrill of discovery, I preferred the emptiness. But after a while I started to wonder whether I was just lost. So when I happen to chance upon another traveler, out in the reaches of a distant nebula (where I imagine some of my ideas tend to lie), I find welcome confirmation that really I'm not as lost as I thought.

Regular readers of the blog will know that a little under a year ago I wrote a blog post entitled "Why Profit Doesn't Work in the Media Business," which tried to link the blatant biases in today's journalism with the fundamental economic structure of the business. The idea was that profit, which is supposed to encourage firms to do the socially optimal thing, actually skews their incentives away from it (where in this case the social optimum was a perfectly informed and unbiased electorate).

When I wrote this blog post, I felt I was the only economist arguing that markets may make the news industry more biased. After all, Ronald Coase (1974), Timothy Besley and Robin Burgess (2002), Besley and Prat (2002), Djankov et al. (2003), David Stromberg (2001), and Alexander Dyck and Luigi Zingales (2002) have all advance arguments for why increased competition in the media should result in greater accuracy.

But it turns out I actually wasn't alone. In a working paper called "The Market for News," Harvard economists Sendhil Mullainathan and Andrei Shleifer (M & S) agree that market competition doesn't give us a fair and balanced news media, though their argument is much more detailed.

In my blog post, I developed had two separate explanations for why competition didn't lead to unbiased news, depending on whether consumers of news were either witlessly or willfully misinformed. In the first case, I argued that consumers get biased news because they don't know it's biased. This was more of a power-elite type explanation, which assumed that the owners of the media had certain political reasons for advancing bias, which consumers weren't savvy enough to figure out. Consumers in the media industry today, I said, may be like consumers going to grocery stores before the advent of health standards, not knowing whether the meat was tainted or not.

My argument in the second case was much more straightforward. Basically (if I'm to tease the empirical argument out of the highly normative argument I was making), I said that biased news was a particular kind of product that news media could sell, and that if demand was sufficiently high companies would provide it. This seemed intuitive enough, but I didn't have any model of how that worked.

That's where M & S's paper comes in. M & S propose a simple model of how firms bias their news by essentially constructing a variant of a Hotelling model. In a Hotelling model, customers are distributed over some space, and firms position themselves in the space so as to "catch" as many of them as possible. In this case, the relevant space is ideology. Firms compete by announcing their "slanting strategy" and the price for their product, and customers choose the news source that most aligns with their bias, for the lowest price.

In M & S's framework the way competition leads to bias is that it causes firms to segment the market. To avoid competing for the same customers, firms find it optimal to maximally distance themselves from their competitors. Practically, this means separating themselves ideologically as much as possible—even if that means taking more extreme positions than even their most biased readers. The average reader will find, then, more and more extreme positions (a.k.a. bias) in the news after competition.

This model helps explain the perception that the media has become increasingly biased in recent years. Since the entrance of competitors in the market increases bias, one important contributing factor could be that

changes in media technology have lead to significant entry, especially in television. If these media sources divide the market along ideological lines, we expect them to become more biased than they were in the regime of moderate competition.

Unfortunately, the model also suggests that news bias is very difficult to remove. No firm would find it advantageous to become less biased; but even if one firm credibly committed to ending bias, the other firm would still gain more profits by choosing to bias. This is more or less the conclusion I reached, and why I argued that the only way to reduce bias was for firms to commit do so based on moral or ethical reasons.

Why does no one like free trade?

Most states engage in protectionism, and lots of it. Brazil, for example, just put up a significant tariff against Chinese imports, amidst fears of de-industrialization. And Obama, in his State of the Union, signaled that the U.S. isn't about to let its manufacturing jobs go either. 

The properly schooled free-trading economist is supposed to dismiss all these efforts as "politics" (or so I've been told); and sigh that their advice is once again ignored. But I think it's telling that time and time again, when push comes to shove, most governments are not willing to embrace free trade, even though almost all economic theory shows that the benefits of free trade clearly outweigh the costs in the aggregate and in the long run. Such a consistent pattern begs an explanation.

Whether a country pursues free trade policies or not depends on how it balances the resulting costs and benefits. Clearly, the people who bear the costs and benefits are often different—and this is dilemma that the political economy literature has seized upon to explain opposition to free trade. The way the explanation goes is that because the winners and the losers are different people, and particularly because the benefits are small and dispersed across the population, while the costs are concentrated for small sectors of the economy, politicians find it more expedient to cater to the losers (who put up an effective lobby, since they have much at stake) rather than to the winners (who only stand to gain a little at the margin, and so won't notice if they lose their gain from trade). So free trade is blocked.

This is a powerful explanation, and goes a long way towards explaining a lot of the resistance to free trade. But it makes it seem as if opposition to free trade is inevitable.

Here's an alternative explanation that gives some clear conditions for when individuals will choose to support free trade. It relies on turning the focus away from the distribution of costs and benefits across different individuals, and instead to the costs and benefits over time.

The costs of free trade are most often immediate: lost jobs, industries, careers, and livelihoods. The benefits—economic growth, cheaper and higher quality stuff—come much later. Economists know well that people discount future benefits—that is, people value future costs and benefits less than those in the present. So if the discount factor is large enough, the benefits may come too far in the future to offset present losses.

To illustrate the effect that discounting can have, consider the following numerical example. Suppose a voter is deciding whether to support free trade or not. If she supports it, she'll face a stream of costs and benefits. Denote them by  and . If she doesn't support it, then (in her mind) nothing changes and the net cost/benefit is zero. So it follows that if her valuation of the benefits is greater than her valuation of the costs, then she will support free trade.

Note that this is different than asking whether the benefits are greater than the costs for that individual. This question is given by:

  

whereas the inequality that the voter checks is instead the following:

where    is the discount rate. These sums can produce substantially different values. For example, the following seems to me to be a reasonable graph of the costs and benefits of trade over time.

The costs start very high, but fade quickly. The benefits increase significantly over time. I have set the cost and benefit values so that the sum of the benefits is approximately 3 times the sum of the costs (43 to 16). That, in itself, seems to be a strong argument in favor of free trade. But given a reasonable discount rate of 0.9, the present value of the benefit stream is only 9.5, compared to 15 for the costs! Rationality demands that the voter vote against free trade.

Within this framework, how would we get the individual to support free trade? There are three clear options:

1. Mitigate costs in the present.
   Since the initial impact has such a strong effect, even small reductions in the initial cost can significantly alter the cost-benefit calculus.


2. Accelerate the arrival of the benefits.
   The sooner they arrive, the more they are worth.


3. Allow people the wherewithal be more patient.
   The easier it is for people to wait for future benefits, the more willing they will be to do so

These general principles, in turn, recommend specific policy prescriptions. Mitigating costs in the present often takes the form of a social safety net: unemployment insurance, compensation funds to those who lose their jobs, and the like. Accelerating the arrival of the benefits can mean something like including provisions in free trade agreements to require foreign investment to begin immediately. And a policy that would allow people to be more patient could include setting up a robust and ready job retraining program so that people know they have future benefits to look forward to. [Incidentally, ideology, control, and repression are also ways to make people more patient and more willing to support free trade, and unfortunately this is the way many countries (particularly in Latin America) have gone about it.]

Often I hear economists say that people oppose free trade because they are misguided, or stubborn, or selfish. But my point here is that people may oppose free trade, even if they know full well its implications, simply because the timing of the costs and benefits are unfavorable. The timing of some of those costs and benefits can't be changed—but a lot of them can, and that means there is a lot of scope for policy to shift the politics of free trade. Focusing on concrete policy steps to alter the cost / benefit calculus are likely to go much farther towards increasing trade than the 300 years of sermonizing that economists have been doing.

Absence

Sorry for the long absence, everyone. It's application season, and I've been busy with that. But I plan to get back to the blog now that I have more time. Plan to see a couple new posts in the coming weeks....I've had ideas brewing.

Competition Inflation

In some places in the U.S., especially on the coasts, the competition in schools is absolutely insane. In Manhattan, for example, moms are enrolling their toddlers in gifted kindergarten test prep classes, in hopes that their child will make it into the "best" kindergartens in the city. In Southern California, it's common that kids will make hour-long commutes every day to attend the gifted magnet school, or will start studying for the SAT their freshman year, or hire private counselors to help them craft the perfect college application. All of this is a far cry from life in Arizona, where, for the most part, pretty much no one bothers with any of that.

All this extra competition, though highly stressful, might be worth it if it produced brighter, more able, students. But in my experience that doesn't happen. Students from the coasts aren't, on average, any smarter than those from other parts of the country. Even the brightest students from the coast are no brighter than the brightest from Arizona, or any other laid-back state. They've just done a lot more work. So ultimately all this extra work seems to amount to a tax on students with ambition in highly competitive environments. Society doesn't gain, and these kids are certainly made worse off.

Why, then, does it continue? And what accounts for the discrepancy in competition between places like Arizona and places like New York, or California?

Asking these questions has led me to a fascinating synthesis between monetary and labor economics. The idea is this: labor markets, like the macro-economy in general, can also suffer from inflation. And some of the insights about inflation that we've learned from monetary economics apply to this labor version of inflation, or what I'll call "competition inflation."

In this analogy, we can think of the jobs, positions, fellowships, etc. (i.e. the total available number of positions to which we can allocate people), multiplied by its prestige factor, as representing the "real output" of the labor market. To illustrate, suppose the labor market wealth is 100. This sum could be achieved either through 100 jobs with a prestige factor of 1, or 5 jobs with a prestige factor of 20. But by this metric, in both cases the labor market has the same level of output.

One's resume is the price one pays for a position. The more prestigious the position, the more it costs, i.e. the better the resume has to be. Like money, resumes have relative, and not absolute, purchasing power; to get a good position, not only does your resume have to be good, but it has to be better than everyone else who applies for the position. This makes resumes like a nominal asset, a kind of currency in the labor economy.

Regular inflation, you'll recall, occurs when the money supply increases faster than the total value of goods and services in the economy. Similarly, competition inflation—or the phenomenon of an escalating resume-price to achieve any given position—occurs when more people have good resumes than there are positions in the labor market to support them (i.e. to draw a more complete analogy, when people's resume holdings outstrip real labor market wealth).

One direct implication of this formulation is that competition inflation isn't inevitable: as long as labor market output increases with the rate of resume improvement, then inflation should stay close to zero. Labor market output is a function of prestige, and job availability. Clearly, if there were an expanding number of prestigious positions to go around, then inflation would be low. But inflation could also be kept low if the number of not-so-prestigious positions expanded at a fast enough rate as well. The reason is that the more plentiful and easily available not-so-prestigious positions become, the less and less motivated people will be to put in the effort for the prestigious positions. That will, in turn, slow the rise of ridiculously lavished resumes.

(We can think of each person as having a tipping point at which they abandon striving for a prestigious position and settle for less, depending on the relative availability of jobs. That tipping point will be radically different for different people. Some people will only work for the prestigious job if there are no other jobs available, and some people will never work in a less-than-prestigious job; most people will fall somewhere in between. Incidentally, this tipping point may be a way of assessing people's subjective prestige valuations.)

Like regular inflation, competition inflation is something that occurs naturally from generation to generation. Baby boom Ivy Leaguers "love to talk about how they would have been turned down by the schools they attended if they were applying today," perhaps in the same way they talk about 25 cent comic books [source]. Since their time, there has in fact been several "devaluations" of the resume. Test scores used to be enough to get into a good college. But when there were too many kids with perfect test scores, admissions officers started looking to extracurriculars, and touting the benefits of the "well-rounded" students. Now they're seeing so many "well-rounded" students that the new fad is "pointy-ness"—being well-rounded plus having some achievement spike in a particular area. No doubt, within ten years the standards will shift again. Each time this shift happens, someone who builds his resume according to the old model will find that their achievements no longer mean as much.

In general, a modest amount of inflation is a good thing, and the same holds true here: as the economy becomes more complex, and as modern jobs require more and more skills, it's a good thing that our institutions push people to become more skilled. The problems come with hyperinflation, as is the case on the coasts. When resume-building ceases to represent any greater skill or talent acquisition, people start to lose faith in the currency. Employers become more skeptical, and students begin to think of the competitive process as arbitrary, or unfair, or meaningless. Having a good resume loses its respect. (Note, for example, the tone of this NYT piece).

In the face of high inflation, people switch to more durable assets. In the labor market, those durable assets are relationships, and networks. When everybody speaks three languages, and has volunteered in orphanages in Peru, employers need some way to make a decision, so professional networks do the work that resumes used to do. In highly competitive environments, then, networking becomes essential, and those people who are highly capable but without contacts lose out the most.

With inflation, there are always winners and losers. The losers are everyone in training, the young and the inexperienced. The winners are the people who already have jobs, i.e. the people who have cashed out their resumes. Someone who starts working may find that twenty years later the average resume required to achieve the same position has increased substantially. In that case, the person has experienced a capital gain; when they leave their job, they will have a job experience more valuable than what they paid for.

With this framework, we can explain some generally puzzling phenomena. For example, we see that competition inflation is most intense at the high school level, but peters out post-college, and is virtually zero for the most demanding positions. (The President's resume has remained about equally impressive on average throughout our country's 200+ years.) The reason for this is that early in our career, the relevant labor market that we face is more closed and restricted. High school students compete only within their city for the prestige positions, which they need in order to get recognized by colleges. But if the city happens to be a hotspot of ambition (because, say, all the kids' parents are investment bankers, or highly successful government officials), then the same ambitious kids will be competing against themselves—and so the resume price will be bid up. After college, however, students compete nationally, and internationally, for jobs. That spreads the ambition around and helps keep competition inflation more stable. Imagine, for example, if Harvard kids were only allowed to get jobs in Boston: competition inflation would be through the roof!

Of course, the major, elephant-in-the-room difference between monetary and competition inflation is that the latter has no central authority that issues currency from the outside: there is no Federal Reserve of Resumes. Instead, resume creation is a highly decentralized process that depends mostly on people's ambitions. However, there are several smaller authorities that set resume standards. For example, ETS, the company that administers the SAT, could increase the value of a perfect score by making the test harder. At an extreme, passing high school (or university) could be made a very difficult, demanding task. These measures would be equivalent to cutting the supply of currency in the labor market, and would curb inflationary pressures. But this solution would be very temporary. Soon enough, there will be enough people mastering the new standard that it will have to be set higher still. (There's also a question of what would happen to the kids who DGAF, and will just stop trying when the standards are raised. It's a question I'll have to explore some other time.)

Is there any resolution to the problem? Ultimately, it seems that controlling resume creation will have no long term effects, since there are enough ambitious kids willing to do whatever it takes. That means the only option is to expand the number of positions available—we need more places for these ambitious high school kids to go. But that won't happen unless there is some miraculous boom in job-creation in this country, or a number of good universities suddenly open up, or ambitious students suddenly gain another route to prestigious position besides college. None of these seems particularly likely.

Update (October 7, 2011):  One important implication of this framework, which I didn't mention earlier, is the presence of an inflation tax. In the normal economy, inflation works like a tax. Suppose the government needs to spend an extra $100 million dollars. Then it can raise that money either by collecting it in taxes, or by just printing it. The latter spares the government the hassle of dealing with angry taxpayers, and makes everyone feel richer, but it still costs them in the end: by printing enough money, the government makes each dollar have less purchasing power, which in effect takes a cut of real wealth away from people proportional to the amount of money they hold.

The labor-resume economy has the same phenomenon. Suppose that the government wants to boost the employment opportunities that people enjoy. It can do so by making it easier to graduate high school and college. In the short run, people will find better jobs. But in the long run, if graduation becomes too easy, the value of the degree will just become worth less, and you end up with situations like this:

“I was in a taxicab a couple days ago, and this is a story that really exemplifies how the economy is changing.  Over the two-way radio, the dispatcher’s voice comes, and he says, ‘Gentlemen, I’m looking for someone to pick up one extra shift on the night shift, a new taxicab driver.  If you know someone, they need to have experience.  And I also need a college education.’  And I thought to myself, ‘If you need a college education to drive a cab in this country, what job don’t you need to have a college education for?’" [from this Freakonomics podcast]

Update (October 13, 2011): Caveat: Thinking of a resume as currency only makes sense when we think of it as a homogeneous product. In actuality, though, what happens is that experience that some employers value applicants experience differently, depending on how it matches with the skills necessary for the job for which they are applying (e.g. as an extreme example, having 10 years of solid experience in engineering will not help you get a Broadway gig).

There are some ways to work around this. For one, we could focus on just (near) universally valued qualifications, like college graduation. Alternatively, we could focus on what happens within specific industries, where all applicants are competing on the same resume, and where it is easier to make apples-to-apples comparisons on qualifications. Either of these would do the trick to preserve the integrity of the analysis.

As one of my professors pointed out, models aren't meant to explain everything at once. So naturally this one can't either.

Update #3 (October 15, 2011): More evidence for my thesis, from this NYT article:

Moulshri Mohan was an excellent student at one of the top private high schools in New Delhi. When she applied to colleges, she received scholarship offers of $20,000 from Dartmouth and $15,000 from Smith. Her pile of acceptance letters would have made any ambitious teenager smile: Cornell, Bryn Mawr, Duke, Wesleyan, Barnard and the University of Virginia.

But because of her 93.5 percent cumulative score on her final high school examinations, which are the sole criteria for admission to most colleges here, Ms. Mohan was rejected by the top colleges at Delhi University, better known as D.U., her family’s first choice and one of India’s top schools.

Ms. Mohan, 18, is now one of a surging number of Indian students attending American colleges and universities, as competition in India has grown formidable, even for the best students. With about half of India’s 1.2 billion people under the age of 25, and with the ranks of the middle class swelling, the country’s handful of highly selective universities are overwhelmed.

This summer, Delhi University issued cutoff scores at its top colleges that reached a near-impossible 100 percent in some cases. The Indian Institutes of Technology, which are spread across the country, have an acceptance rate of less than 2 percent — and that is only from a pool of roughly 500,000 who qualify to take the entrance exam, a feat that requires two years of specialized coaching after school.

The problem is clear,” said Kapil Sibal, the government minister overseeing education in India, who studied law at Harvard. “There is a demand and supply issue. You don’t have enough quality institutions, and there are enough quality young people who want to go to only quality institutions.”

A recipe for those that don't like Brussels Sprouts

Brussels sprouts have a very bad reputation, but that need not be the case. If you dislike Brussels Sprouts, here's a recipe designed to change your mind. (The trick? Boil them until they lose their original flavor, and then douse them with spices.)

Brussels Sprout Subji

Ingredients
1 pound of Brussels Sprouts
3 tomatoes
1 medium-sized onion
1 small piece of green chili
1 chunk of ginger
3 teaspoons coriander seed powder
1/3 teaspoon tumeric powder
1 teaspoon red chili powder [depending on how much you can handle]

Steps
1. Boil the Brussels Sprouts. You'll know they're done when you're able to smash them easily.
2. Meanwhile, chop the onion, chili and ginger and fry it in vegetable oil. When the onions are slightly golden, add the chopped tomatoes.
3. Let the tomato mixture cook until the tomatoes become a pulp. Then add the spices. Mix well. Make sure that the mixture doesn't dry out—if you find that it's getting dry, cover the pan with a lid.
4. When the Brussels sprouts are done, scoop them out of the pot and place them in the tomato mixture. Then mash some of them, so that they soak up the flavor. Add salt, and then let the mixture simmer for about 5 minutes.
5. Eat with roti, naan, or rice.

New Reading List — Economics, Ethics, and Development

Check out the new Reading List, which includes some of the most interesting articles that I've found over the past couple months.

You'll notice that almost all of the readings focus on economic theory and development (with the exception of a beautiful personal statement, which I encourage you all to read), which pretty much sums up where my mind has been for the past few months. But even if you don't study social science, I encourage you to read some of the articles. They are all highly relevant to our understanding of public policy, the role of government, and the meaning of economic progress in society—themes that I've found people can't help but care about.

If you like any of the readings, or you have anything to say about them at all, please leave a comment! I'd like to hear your reactions and opinions.

Look forward to some blog posts in the next couple of days.

Economics as Medicine

Over the past couple decades, the field of economics has grown enormously. It has invaded its neighboring fields (like political science, and psychology), taken over their journals, and converted their students. However, it's a pity that the transfer of knowledge has been mostly one way. Economics could stand to gain some insights from other disciplines.

I'm particularly struck by the similarity between economics and medicine. At first it seems like an odd connection, but after a minute it seems completely natural. After all, the economy, like individuals, has health. Turn on the TV at any point of the 24 hour news cycle these days and you'll see at least eight different people discussing it. Especially now that the economy is doing poorly, these commentators are like doctors huddled around a patient with a stubborn disease, debating the cause and various prescriptions. In the case of the economy, the names of the diseases are inflation, or high unemployment, and the prescriptions are called tax cuts, stimulus packages, or deficit reduction.

I got the idea to think of economics as medicine from Jeffrey Sachs. As Professor Sachs was making a career out of advising crisis-ridden developing countries, he noticed how many of the skills he needed in his work aligned with those that his wife Sonia needed in her medical practice. Based on these experiences, which he details in his book The End of Poverty, he calls for a new kind of economics, which he calls "clinical economics," that "underscores the similarities between good development economics and good clinical medicine." There are a number of ways, he says, that [development] economics can learn from medicine. Here's his list:

1. The economy is a complex system, and complex systems require differential diagnosis. Doctors don't treat all symptoms the same way; they try to find the underlying cause. Economists, says Sachs, should do the same.
2. All medicine is family medicine. A country's economic situation depends on its history, and its international context. As Sachs puts it, "it's not enough to tell Ghana to get its act together if Ghana faces trade barriers in international markets....if Ghana is burdened by an unpayable mountain of debt....if Ghana requires urgent investments in basic infrastructure as a precondition for attracting new investors...and if Ghana is burdened by refugee movements and disorders emanating from neighboring countries."
3. Monitoring and evaluation are essential. Here takes a stab at the (now outdated) IMF and World Bank practice of judging a country's progress by policy inputs and not outputs. If it's told to cut the deficit, then it's judged by whether it follows through, and not whether this results in any solutions to their problems.
4. Medicine is a profession, and as a profession requires strong norms, ethics, and codes of conduct. Development workers need to take their work as seriously as doctors take theirs.

Excited by the prospects of this idea, I wanted to see how far I could push the analogy. In addition to the parallels that Professor Sachs pointed out, I found these ones as well:

1. Both disciplines have to find a way to make decisions in the face of vast uncertainty and bewildering complexity. In the case of medicine, the root of uncertainty is that the scale of the action is too microscopic for doctors to directly observe; but in the case of economics, it's because the scale is too big. Hence the reason why doctors and economists rely heavily on (statistical) data to figure out what's going on; the sense data (seeing, hearing, etc.) are just not available.
   
2. Both disciplines are fundamentally concerned with the well-being of people. For people to be able to live their lives, they not only need to be physically healthy, but the economy which sustains them also has to be healthy.
   
3. Both disciplines carry high stakes. In medicine, the stakes are life and death. In economics as well, the stakes can be just as severe. Poor economic policy can result in severe depressions, mass poverty, famines (even when food is plenty), and political instability.
   

Sachs' conclusion, and mine as well, is that in all the important ways, the economist's job is essentially the society-level analogue to that of the doctor, or the medical researcher. That is, even though the content of the questions economists and doctors ask are different, and even though the techniques divergely widely, and despite the myriad other differences that mark the two professions as distinct, there's a fundamental common pursuit for well-being that binds them together.

To some extent, the transfer of knowledge from medicine to economics has already begun. Esther Duflo and Abhijit Banerjee have won a lot of fame for their work at using randomized control trials to assess the impact of various development policies. In talking about how they developed these techniques, Duflo and Banerjee cite medicine as their direct source of inspiration. The world of medicine before randomized trials gave us reliable information was dangerous. We hear tales of medieval doctors performing procedures (like leeching) or prescribing drugs without really knowing whether they worked; sometimes the patient's condition would improve, and sometimes not, and recovery seemed to depend more on random chance than anything else. This world seems so long past—but that's pretty much the state where we find modern economics. Economists prescribe policies based on their best guesses, but sometimes they work and sometimes they don't. Randomized field trials finally give us a chance of knowing what works.

But Duflo & Banjerjee's randomized control trials are just the tip of the economics-medicine-interaction iceberg. Just sitting in my chair right now I was able to come up with this intriguing list of research topics:

• The first dictum of medicine is "Do no harm." Should that not be the starting point for economic policy as well? (This seems particularly applicable to the IMF and the World Bank when they advise developing countries.)
• In medicine, a very related concept to randomized control trials is the placebo effect. What if something like that exists in economic policy—which is to say, what if some policies fix recessions, or solve prisoner's dilemmas, or promote cooperation (all classic economic problems) simply because enough people believe they will work. Will Wilkinson, my favorite blogger on the web, gives a scenario of how that's possible.
• Our health, and in particular our weight, depends not just on the amount of food we eat, but also the quality of the food. Two thousand calories of junk food is very different than two thousand calories of a balanced diet. In the same way, we can't measure the performance of the economies just in terms of quantities: it matters not just how much GDP grows, or how much investment increases, or how much consumption increases, but also the kind of GDP, investment, and consumption growth that we see. Knowing that GDP increased 3% tells us very little about whether people are actually better off. (What fraction of the U.S.'s GDP growth in 2002-2008 came from housing and easy credit?). Similarly, as I discussed in an earlier post, not all kinds of consumer confidence (which is generally considered a good thing) are made equal.

Thinking about this connection between economics and medicine is really exciting. Not only do I see society, politics, the other disciplines in the social sciences all in a new light, but I'm also reminded of why I got into economics in the first place.

River Plate's Loss as a Metaphor for the History of Argentina

On June 26th, the unthinkable happened: the Argentine football club River Plate got demoted to the B league. It's an event that provoked this kind of reaction throughout the country and the football-playing world:

For those of you who don't follow Argentine football, let me explain. The two strongest teams in Argentina have always been River Plate and Boca Juniors, and they have a rivalry that's practically unmatched anywhere else in the world. Every person in Argentina is a fan of either one or the other. When the two teams play, it's the sporting event of the year.

River (as it's known colloquially) has been one of the most successful Argentine clubs of all times. But lately they've been struggling, and losing, and losing. By June 26th it got to the point where River had to win the match in order to stay in the top ('A') league of Argentine football. It should have been a no contest; they were playing some no-name team from the interior.....and still they lost.

A dedicated River fan became so irate while watching that fateful game that this video of his tirade has made him the most well-known man in Argentina:



[As you'll soon tell, there aren't many different kinds of curses in Argentine Spanish. This man uses about three or four principal insults, with variations and combinations:

"la puta que te pario" = the whore that gave you birth
"pendejo / boludo / pelotudo" = stupid / asshole
"andate a la concha de tu madre / hermana / etc." = your mother / sister's /etc.'s pussy

At one point he cries out, in supplication, "¡No les pido que hagan 28 pases como el Barcelona, hagan dos seguidos, nada más!" ("I'm not asking you to make 28 passes like Barcelona, just two in a row, nothing more!")]

On the media circuit on which this poor man was later dragged, he sheepishly explained that he did go a little too far. But really, given the situation, who can blame him? Imagine being a fan, a devotee of River, learning from a young age to adore the River jersey, to be proud of a team with an international reputation and a long, glorious history; and to have that team that you so adore now be known as just "some other" team, with bygone glory days?! It's hard to comprehend how one copes with such a trauma.

But these kinds of falls from glory aren't new to Argentina. Rolando Hanglin, writing for the daily La Nacion, puts this story in its larger context, tapping into the essence of the Argentine psyche:

River ya no es la élite del fútbol mundial. Es sólo un equipo que fue próspero y señorial (de ahí el apodo de "Millonarios") con una escuela refinada, que se ha perdido. Además, está rodeado del entorno que corresponde a un país del Tercer Mundo. Un país que fue rico hace ciento veinte años, y que ya no lo es.

"River is no longer in the elite of world football. It's just another team that used to be successful and noble (from there came the nickname of "The Millionaires") with a refined school that has lost its way. In addition, it's surrouned by an environment that corresponds to a country in the Third World. A country that used to be rich one hundred twenty years ago, but no longer is."

What Mr. Hanglin is referring to is how Argentina (believe it or not) was contending with the United States as a world power in the New World around the end of the 19th century. Why not? Argentina had a vast resource endowment, skilled European immigrants, industry and trade. All signals pointed to success. But now all the books written on the history of Argentina have the subtitle, "What went wrong?" (how Argentine ended up "failing" is a subject that has so interested researchers that it has its own name: the so-called "Argentine Riddle").

For decades now, economists and sociologists from Latin America's dependencia school have been arguing that poorer countries have an inherent disadvantage when competing in the world economy. Something analogous seems to be true for football in the case of River: as D.S. over at The Economist notes,

The cruelest consequence of relegation, of course, is that the demotion itself makes it much harder for a club to work its way back up to the top:" River’s annual television revenues will fall from $6.8m to about $4m, and it will have to cut ticket prices. It will probably lose transfer income as well, since few European clubs search for talent in the second division.

For Argentines with pride in their people and their country, all this must be terribly frustrating. How do you prove you don't suck? If you're a batter in a slump, every hit you make seems fleeting; every strikeout just confirms and reemphasizes your worst fears. Similarly, every time the newspapers in Argentina report rising inflation, or the lack of respect their dignataries receive abroad, the more and more Argentines confirm their fears that they're stuck in the "Third World" (a category that they care a lot about, critical theory be damned) forever.

Argentines respond to this frustration in different ways. There are some (especially the rich) who stopped caring, and have simply shifted allegiances to America or Europe. They openly put down their country and go on and on about how glorious it is abroad. Then there are those who care about their country, but resigned at its fate. Many still harbor resentment against the world superpowers, especially Britain and America, for having cheated them out of a better position in the world pecking order. Throughout Latin America, Argentines are derided for their arrogance, and they have it, it's true; but when we see that arrogance through the lens of their history, it's much easier to sympathize and understand how they're feeling.

Like Argentina, which has been struggling to find its identity for the past century, River too will have to reorient itself in the world of football. Most Argentines haven't handled their country's fall from grace well, and remain bitter at the world. Let's hope River fares better.

Musharraf's Talking Points

Yesterday I attended a talk by the former President of Pakistan, General Musharraf, who spoke at the Baker Institute at Rice University. Here are the talking points that I imagine he would have outlined for himself, had he been perfectly objective about the content of his talk. You can view his full talk here.

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[Stylized] Talking Points for His Excellency General Pervez Musharraf

• Intro: The deterioration in relations between the US and Pakistan is unfortunate. In my time, I had great relations with President Bush [...mostly because he was glad I was cooperating and I was glad he wasn't invading us.]
• Thesis: Pakistan is the sufferer, the victim, and not the perpretrator, of terrorism. [Any actual violence supported by the state—say, in Kashmir—is actually freedom fighting, stemming from overwhelming public support for the cause].
• Pakistan faces four main challenges: terrorism, extremism, terrorism, and extremism
• Some FAQs:
• What accounts for the "antipathy" of Pakistanis towards America?
• America betrayed Pakistan in 1989. With the Cold War over, America left an anarchical Afghanistan that Pakistan wasn't able to handle; this in spite of Pakistan helping during the war effort against the Soviets.
• What accounts for the current extremist problem in Pakistan?
• The Betrayal of 1989
• What accounts for the strength of the Taliban and Al-Qaeda?
• The Betrayal of 1989
• US failure in Afghanistan
• Let's not get too distracted by Afghanistan, though. The real threat to regional stability is India. India is the clear enemy.
• India is setting up an anti-Pakistan Afghanistan. For instance, Afghanistan sends its forces to train in India, but not once have they come to Pakistan.
• India is not resolving the Kashmir dispute, which spurs attacks [not that we discourage that].
• It's not fair that India gets special treatment and we don't. The world is, for some reason, hostile to our nuclear weapons. But our nuclear weapons are the pride of our people, even down to the most illiterate man, a symbol of our acheievement [even if they had to 'eat dust' for it, right?].
• The stump speech: There is currently no strong candidate for election next year, so I'm "offering myself as a third alternative."
• Be selfless: "I'm not doing this for myself. I'm comfortable already, I make good money, I could live anywhere in the world. But the people of Pakistan need a leader like me."
• (Since I have to): We did not, did not, did not know about Osama bin Laden. We did not. [Delivered somewhat like this].

Note to self: Be respectful. Make sure to address audience as "ladies and gentlemen." The more, the better.

A Princess's Plea

Last Wednesday, I saw a real, live princess. Her Royal Highness Princess Haya Al Hussein of Dubai came to the Baker Institute here at Rice University to speak on "The Politics of Hunger," as part of her larger efforts, through her non-profit Tkiyet Um Ali, to end world hunger.

The talk began at 6pm. As I approached the Institute I saw a number of black sedans parked in front, and men in impeccable suits. In the lobby sat a pretty, smiling receptionist, checking the roster for names (the day before I had to fill out a detailed online RSVP form and register as a Rice student to get in). A police officer was watching from the corner as she checked me in.

I walked inside, with my jeans and T-shirt (covered in chalk from class), and immediately felt out of place. Most of the attendees were clearly important people; donors, public officials, distinguished members of the community. They were dressed up, had white hair, and clearly knew each other. It was a group as close to aristocracy as we get in America.

We were kept waiting a little bit. In the meantime I flipped through the program, and people-watched the aristocrats, who were greeting each other with the familiarity and affection of fellow parishioners. Every now and then I would hear the loud tak-tak of high heels as someone from the Institute went in the back to check on something. After a while, people started trickling from the back; at first a couple men in suits, then some women, who would later walk back to check on something; they would return; some more important-looking people; and then finally, the princess herself, surrounded by a whole delegation of people, including the former Secretary of State James Baker, with whom she was finishing up a conversation. As I watched this scene, it struck me how the extended wait and the scurrying back and forth of the Baker Institute staff represented an integral part of the very spectacle of power and status that we were there to see. By the time the princess did come out, I already felt distant from her, blocked by layers upon layers of guards, staffers, and officials who guarded her access; a common man, glimpsing a world to which I wasn't privy. An aura befitting a princess, I guess.

Her Royal Highness shook hands with some people sitting in the front row, and then took her seat.

Mr. Baker introduced the princess. He spoke fondly of the work he did with her father, the King of Jordan, and the honor of having her to visit. He gave the air of a man proud to see his friend's daughter all grown up.

Then Princess Haya took the podium. She was just as I imagined a princess should be. She had a British accent (being educated at Oxford), and spoke only as loud as she needed to be heard, lending her voice an ethereal and other-wordly quality. If it weren't for the Bose speakers, I would have to strain my ears to hear her:



The main theme of her talk was that America needed to take moral leadership in the fight against world hunger. Global hunger "has to become a priority," she said. Without food security, "there can be no political security, and no peace."

What most struck me about her talk was the latent frustration that bubbled behind her serene front. She admitted to feeling powerless at times, despite her high station; and she explained her annoyance for endless rounds of policy debates, which she saw as an excuse for not meeting our responsibilities. Most of all, she couldn't understand why policymakers weren't sincere about fighting global hunger. Why do countries spend so much on weapons and so little on aid? Why do we permit hunger to continue? Where is the outrage?

This plea was so earnest and sincere that I felt guilty for also thinking it was futile. There is, I think, a natural progression of thought when one works for moral causes like this: first comes outrage, and zeal, and disbelief; but eventually, sometimes soon but often much later, there settles in a kind of serenity that comes with wisdom and understanding. Yes, fight on for the causes that are important, but there are reasons for why things happen. (In this particular case, I would say, Princess, that it is possible for all the people in the world to have good intentions and still find ourselves in miserable situations.)

But I know well enough not to become cynical. Exhorting important people to spend more money on food aid may not be the most effective way of ending world hunger, but God knows the world could always use more of the princess's sincerity.

Welfare as Poverty Insurance

Most of the arguments I've heard in favor of "the welfare state" (i.e. a government guarantee of a basic standard of living, a.k.a the social safety net) appeal to compassion, or justice. This works for people who are already sympathetic to such appeals (such as myself), but it really does no good for those who don't put much stock in loose and subjective ideas like justice and compassion to begin with. Fortunately, this paragraph from University of Arizona Professor Lane Kenworthy's blog suggests an alternate—and, I think, fruitful—approach:

As people get richer, they tend to be willing to buy more insurance and more services. We observe this both among individuals and among countries. Some insurance and services are provided at good quality and price by private markets. Others less so. That’s the underlying reason why nations have tended to expand social policy as they grow wealthier.

Once we start thinking of welfare as insurance rather than charity, it opens a whole new series of possibilities. Most importantly, it gives us a way of addressing opponents of welfare programs (mostly conservative economists and their students), on their own terms, by providing an account of welfare programs that appeals not to any sense of morality or altruism, but rather rational choice, fully consistent with the idea of individuals maximizing their well-being.

Even though I myself don't fully believe in the conception of rational choice as self-interested utility maximization (for the same reasons that Amartya Sen doesn't either), I'll make an attempt here to defend the welfare state on this premise. This short post, of course, cannot hope to cover all the relevant issues. But I'll try to make a good sketch of what such an argument might look like.The exposition of the argument (below) makes four claims that collectively show how government-provisioning of poverty insurance is both consistent with rational choice and certain principles of liberty.

Claim #1: It is sensible to think of welfare policies as poverty insurance.

Birth is a kind of lottery. By random luck, and through no fault of our own, we end up either in a poor household, or a well-off household. Every one of us, when we are born, stands an equal chance of landing in a poor household. Therefore, we all stand to gain from a welfare program that would make the poverty that we would potentially face less dire.

Even after we are born, we face a non-trivial chance of becoming poor in the future. Upward income mobility is a blessing for poor people, but downward income mobility is a significant risk for the non-poor:

Most policy-makers view poverty as akin to a stagnant pool which may be slowly drained as each individual or family trapped there is helped to climb out. What this imagery and the policies it suggests disregard, however, is the fact that of those who are poor in any particular year, most were not poor in the preceding year. In other words, at any given time, many of the poor are newly poor. According to the University of Michigan‘s Survey Research Center study, Five Thousand American Families, the “persistently poor” (defined as those who were poor during all five years studied) amount to only 9 percent of the total poverty population. [link]

If it's not us that falls into poverty, then it is perhaps our children who will. Most often sons do not end up in the same income bracket that their fathers belonged to:

This table (source) shows intergenerational mobility between income quintiles in the U.S. Class 1 falls is the bottom quintile (the 0 to 20th percentile) and Class 5 is the top (the 80 to 100th percentile). So even if you're born into the top of the distribution, you have a 9.5% chance of ending up at the bottom. That's probably much higher than many of the other risks that we insure against. (Lest one underestimate what it means to land in the bottom quintile: according to this U.S. Census Bureau report, people in the percentile made $17,984 in 2003.)

So everyone, by the lottery of birth, faces a risk of facing poverty. Above this, people who are born into non-poor families face the risk of falling into poverty; or those born into poverty who manage to exit it face a non-trivial risk of falling back into poverty. The more severe the poverty, the more anxious people are to mitigate these risks; hence the need for insurance.

Claim #2: Government can provide poverty insurance more effectively than the private sector.

In a private poverty insurance market, I imagine that parents would buy policies that would cover themselves and their children. The premiums would probably be determined by a number of factors, such as general macroeconomic conditions, and also the policy holder's likelihood of falling into poverty. Rival plans would compete on, perhaps, how many generations they cover, or how generous the benefits are.

Now, why couldn't such a market work? In short, for many of the same reasons that completely private health insurance doesn't work (or more accurately, unpalatable). Prof. Kenneth Arrow already showed in the 1960s why the market for medical care has certain characteristics that make for "the laissez-faire solution for medicine [to be] intolerable." A market for poverty insurance would suffer from many of the same defects. Specifically:

1. Moral Hazard. As Arrow notes, "What is desired in the case of insurance is that the event against which insurance is taken be out of the control of the individual." But this is clearly not the case with poverty insurance. An individual who takes a poverty insurance policy can afford to be less careful about staying out of poverty, perhaps to the point of abuse. Insurance companies, of course, will write contracts that stipulate that they can deny coverage in the case of recklessness, but it's very difficult for the insurance company to make a reliable decision about the degree of culpability for someone who has fallen into poverty. As with health insurance, the lack of reliable procedures in a poverty insurance business will lead to mistakes: some people deserving of insurance will be denied, and some who should be denied will receive the benefits.

2. Adverse Selection. The people who are most likely to get covered are the ones who need it least. In the same way health insurance companies screen out people with unhealthy lifestyles, or with a predisposition for disease, poverty insurance companies will likely vet out people who seem likely to fall into poverty (being an artist will be the new preexisting condition).

3. Other-regarding preferences. Just as we are concerned about the health of others, we also care about their living standards. People prefer a healthier society to a less healthy one, and a less poor society to a more poor one. In economics, we say that health and poverty are externalities: that is, an individual's private good health or good fortune is not just a benefit to himself, but also seen by others as a benefit to themselves. In the face of positive externalities, the market will provide a level of insurance below the optimal amount (and significantly so, since our preferences for the well-being of others are generally quite strong).

Of course, showing that a certain market has defects does not necessarily imply a need for government provisioning. The electronics market, for example, also contains asymmetry of information, a market defect, but there's no one is calling for government intervention there.

The key difference is the severity of the consequences. In the electronics market, the worst that could happen is to leave the store dissatisfied. Severe poverty, however, can lead to death—or, at the least, it inhibits an individual's ability to receive the nutrition and education necessary to reach her potential, which results in a loss not just to herself but to all of society. That is why failings in the poverty insurance market would take on a certain moral urgency, and would be much more harshly criticized than failings in other markets.

Government, unlike private companies, is in a position to address most of the problems caused by the three aforementioned defects of a poverty insurance market. By offering automatic universal coverage, for example, the government can circumvent the adverse selection problem altogether. Universal coverage would also provide a level of welfare provisioning more consistent with our other-regarding preferences.

Admittedly, universal coverage does not solve all problems. Specifically, universal coverage by itself does not change the moral hazard of insuring another person for risks he has some control over. This is part of a major source of the frustration over welfare that lead to the overhaul of welfare in the U.S. in 1994. Welfare reform was meant to address the perception that welfare made people lazy, or went to undeserving candidates (such as so-called "welfare queens"). These are legitimate concerns, and they require that the government, like any private insurance company, craft its policy carefully. But then we enter the debate of what kind of poverty insurance we should have, and we're no longer discussing whether or not we should have it in the first place.

Claim #3: The majority of people in a sufficiently affluent society will rationally choose to vote for some level of poverty insurance.

Whether or not people would freely contribute to a poverty insurance program is not the relevant kind of rational choice in this case. After all, the main risk of poverty comes from the lottery of birth, so it doesn't make sense to collect payment for insurance after the main risk event has already happened. A welfare program needs the money of rich people in order to work, but since the rich have avoided the main risk (that of being born poor), they would significantly undervalue the benefit of poverty insurance, and hence underpay its true value.

In order for people to truly gauge the full risks of poverty, we would need to ask them how much they would be willing to contribute before their position in the income distribution is decided. This pre-birth state is similar to Rawls's idea of the "original position," except in this case I allow information about the structure of the society, such as the income distribution, the degree of income mobility, and the like. From there, then, just as in Rawls's original position, people in this pre-birth state would try to advance their own best interest, but in good-faith, knowing full well that whatever position that is adopted there would be binding once they find out their place in the income distribution.

What stance towards welfare would participants in this pre-birth position adopt? Unlike Rawls, I don't think that there will be unanimous consent, at the very least because people face varying levels of aversion towards risk. Since we don't have unanimity, it makes sense then to take a vote. The result of the vote will fall according to the preferences of the median voter.

Of course the choice of the median voter will depend on the factors specific to the country: the level of income mobility and the severity of the poverty, as noted above, but also the national income the degree to which the culture values equality.

In the developed world, I believe that the median voter will almost certainly opt for a level of poverty insurance greater than zero, for the very reasons that Prof. Kenworthy pointed out at the beginning of the discussion: as people grow richer, they become more willing to spend their money on insurance (that is, they would be willing to forgo a higher GDP in exchange for a welfare program, or they would be willing to pay the taxes necessary to fund the program if they were wealthy). In fact, it is probably even rational to do so: since individuals face diminishing returns to wealth and income, they would likely face a higher expected utility, given the right conditions, from shoring up their income in the event they end up poor rather than betting on making even more money if they end up rich.

Claim #4: Collective decision making does not violate the liberty of dissenters.

There will likely be some participants in the pre-birth position who will opt for no poverty insurance. But since the majority carries, and the majority will most likely opt for some non-zero amount, these dissenters will be forced to contribute to a program that they do not want. How is their liberty not violated? (Note that dissenting to contribute in the pre-birth position is radically different then dissenting to contribute in real life.)

This question is similar to a problem that Ronald Dworkin has posed in his article "The Majoritarian Premise and Constitutionalism" (In Philosophy and Democracy: An Anthology, edited by Thomas Christiano, pgs. 241-257): In a democracy we like to think of ourselves as a self-governing people. But how can that make any sense if you're on the losing side of the vote? That is, how can one reasonably think of himself as self-governing if he has to follow the majority will, which may not be his own?

The answer, Dworkin says, is that it depends on what view of collective action you take.

Now, government is required because there is a need for collective action. But Dworkin notes that there are two views of collective action: one, which he calls statistical, is where the group action is just some agglomeration of individual action with no sense of acting as a group. The example he gives is the stock market; when the "stock market" falls 20 points, there's no concerted effort behind it. The second kind of collective action is communal, where the group action cannot be understood as anything but as a group. We cannot make sense of a member of an orchestra, for example, except by considering her role in terms of the whole piece.

Dworkin thinks this distinction is very important. The only way for a person on the losing side of a vote to still think of himself as self-governing is if he adopts a communal view of the collective action of voting. He needs to think of himself as a genuine member of the political community, such that collective act of the group is also my act as well, in the same way that the victory or defeat of a sports team is the victory or defeat of each player, even if their individual contribution did not make a difference one way or another.

Now, to be a genuine member of a democracy, what Dworkin calls a "moral member," certain conditions must be satisfied. People need to be a part of the decision-making process (i.e. they should have a vote, a say); they need to have a stake in the decision (i.e. they need to consider themselves as a respected part of the group, and other people should also see them as a respected part of the group); and they need to be morally independent of the decision (i.e. they should be allowed certain private space to make personal decisions). Dworkin explains these concepts in more detail in the article. The upshot, though, is that once one is a moral member, one is then, in fact, self-governing. There is no meaningful loss of liberty when a moral member ends up on the losing side of a fair and inclusive vote on a problem that requires collective action (and poverty insurance is one of those problems).

The pre-birth position described in section three is a position of perfect equality, set up in such a way that it already establishes all the conditions necessary to make all parties a moral members of the political body. Therefore, even though some individuals in the pre-birth position would perhaps vote for zero poverty insurance, when the majority passes a non-zero level of insurance, they cannot claim that they were unjustly or unfairly treated.

I'm Kicking the Habit

I cherish good writing. It's absolutely one of my favorite things in the world. Every time I read good, clean, limpid, effortless, honest prose a smile comes to my face. I can't help it.

We naturally imitate what we love, which means for me, in this case, that I spend a lot of time and effort trying to make my prose like that. Almost nothing to me is more satisfying than a paper that turns out well; but by the same token, nothing is more frustrating than when it doesn't.

In hopes of achieving the caliber of writing that I so admire, I've turned to style guides. I've read Strunk and White, of course, as well as Joseph Williams's Style. Plus there's a lot of rules and tips and tricks that I don't even remember where I've picked up, perhaps from classes or from the internet.

The point of all this help, as these style guides say themselves, is to shrink the gap between what we mean to say and what we actually say. As writers, we want the reader to access our mind, and we want the flow of ideas to be seamless. We want to feel at one with the written word.

But that's not how I feel at all. Instead, I'm completely paralyzed.

Every time I think up a sentence, I first have to run it by my filter. My filter is composed of all the rules and checks for good writing (sometimes conflicting) that I've built up over the years. Does it use the active voice? Does it have dangling antecedents, or floating "this"'s? Is it as simple as possible, but no simpler? All of these are good checks to keep in mind. But the more I think of these rules, the harder it is for me to think freely and naturally and uninhibited.

So you know, today's the day I kick my style addiction. No more worrying about parts of speech or sentence structure or clarity or grace. My only rule: say what you mean, and mean what you say. I think (I really hope) the rest will work out.

Economic Logic

Here an upset Michael Moore asks Milton Friedman a question that gets at the very heart of economic logic:

Milton Friedman's point is very subtle, but it's very powerful. Understanding it is fundamental to understanding the nature of human society.

Coping with Loss in a Democracy

Today Obama released his long-form birth certificate in an attempt to finally get the birthers to shut up. "We do not have time for this kind of silliness...I've got better stuff to do," he said.

Amen to that. I'm really worried at how lunatic-y this country is becoming.

But at the same time I'm wondering if the sentiment that's behind these allegations has actually become a constant part of U.S. democracy. Every time we've had an election in recent years, the losing side has always cried foul.

I remember three elections in my lifetime—2000, 2004, and 2008—and in all three cases, the losing side hasn't taken it lightly. If you google "bush 2000 election cheating" you get 23 million results, plus this Michael Moore video:

Similarly, if you google "bush 2004 election cheating" you get 21.4 million results—slightly less, but after all it was a less controversial election. The point is, a lot of people out there are convinced that there's no way Bush won fairly. One website, dedicated to exposing the myth that Bush won 2004 fairly, maintains,

Republicans can’t win straight up on the issues, because their policies are inimical to the best interests of 99% of Americans. To win, they have to cheat.

Sounds like the birthers know just how these people feel.

Losing in a democracy is paradoxical. The whole purpose and intent of the system is to make the rulers legitimate in the eyes of the citizens. But at the same time, each voter is asked for his opinion on who she thinks is right. If you're on the losing side, then you're forced to accept as legitimate a candidate that you don't think is right. But how legitimacy be separate from correctness?

To the extent that your belief in democracy depends on whether you think it gives the "right" results, it's uncomfortable to believe both that your candidate was the right choice and that he lost fair and square. One way of reconciling the conflict, as Rousseau did, is to drop the former assumption and stick with the latter—that is, to say that if I'm on the losing side, then I must be in the wrong:

Each man, in giving his vote, states his opinion on that point; and the general will is found by counting votes. When therefore the opinion that is contrary to my own prevails, this proves neither more nor less than that I was mistaken, and that what I thought to be the general will was not so. (On the Social Contract, Book IV)

But we're not inclined to think this way. Instead, most people would instead believe they're right (to the death perhaps; there's research that shows that incompetent people overstate their competence) and assume that the procedure was gimmicked in some way. The birthers, though they say they're just asking for evidence, really probably don't want it. As Prof. Redlawk put it,

It’s not the evidence that matters. Feelings come first, and evidence is used mostly in service of those feelings. Evidence that supports what is already believed is accepted, that which contradicts it is not. [link]

The Bush-deniers are, of course, not really as crazy as the birthers: they weren't nearly as distracting, and they're probably more justified. But both groups are strikingly similar in the way that they channel their resentment of the president by questioning his legitimacy. In a stable democracy like the U.S., where there's no hope of overthrowing the president, this is their way of coping with the loss.

As far as I know, this kind of denialism in the face of electoral defeats is a relatively recent phenomenon. If that's true, it seems to reflect one consequence of the undeniable growing polarization of U.S. politics. When people aren't so polarized, they're not so upset if their man doesn't win. But now it's become a matter of basic psychological integrity—and it's manifesting itself in bizarre ways.