Friday, October 30, 2009

Happy Halloween

Halloween is an awesomely fun holiday. I like it. My kids like it. And young women use it as a temporary insanity defense for acting slutty, much to young men's benefit.

Too bad my kid's elementary school canceled Halloween costumes because the new Somali immigrants find it offensive to their sensibilities.

Thursday, October 29, 2009

The Scientific Conceit

This interview with David Berlinski contains this precious observation:
The idea that science is a uniquely self critical institution is of course preposterous..scientists are no more self critical than anyone else, they hate to be criticized and never criticize themselves...There are local mechanisms of criticisms in science, within established theories if somebody publishes data that don't work out in a certain way, if there are mathematical flaws in a certain theory, these tend to get know, but large global criticisms of the scientific enterprise are very difficult to find, and certainly not being promulgated by the scientists with any ebullience or enthusiasm ... these people are only human, they hate criticism--me too! The idea that scientists are absolutely eager to get beaten up that's one of the myths, put out by the scientists, and it works out splendidly so that they can avoid criticism.

You know a naive or tendentious science writer when they start talking about how science is so different than other professions in how they objectively present their work for criticism. The journal publication process does filter out a lot of errors and unsubstantiated assertions that a journalist might get away with, but that's really a very narrow domain, it's like noting a New Yorker piece is meticulously checks for grammar (unlike my blog!). It's ruthless criticism in a very specific domain.

Look at Freakonomic's author Steve Levitt's work on the abortion-crime link. No referee thought, gee, how does this relate to the different black-white abortion rate relate to the difference in Black-White crime rate over the next 20 years? How did that relate the crime rate differential between 17 year olds and 35 year olds, 17 years after Roe? How does the small difference in fertility post Roe relate to an selectivity effect (clearly, as abortions went up, so did conceptions)? What if you adjusted for population growth? All of these are large, glaring points against Levitt, really common sense type rebuttals, yet he never had to address them because he presented a panel regression with interaction terms.

I have refereed papers with interaction terms, and they are almost always garbage, because they generate a lot of collinearity, and the nonlinear correlations manifest themselves in a bunch of significant coefficients in linear regressions, because if the 'true' relation is y=x^2, and x=A+2B+e, then a regression on y with A and B will have a positive coefficient on A, and a negative on B. Levitt's study has state*age, year*age, and state*year as explanatory variables. Why stop there, why not state*year*age? With tens of regressors, many product terms, you get garbage. Yet, I've refereed reports from professors at Harvard with this stuff, so it's not something that's necessarily wrong, just practically stupid. There has been no important result that shows up only via interaction terms in regressions, just as there has never been an important relationship evinced solely via 3-stage least squares, or the Generalize Method of Moments (GMM). Ever. Rather than correcting error terms for heteroskedasticity or something inside-the-box, there should be more skepticism applied to these kitchen-sink approaches.

But, Levitt is still considered a top-level researcher, and he has a very thin skin. For example, reading his coauthor's response to criticism of his Global Warming chapter in their new book, the tone seemed very defensive, like someone unused to criticism. In sum, Levitt, like most scientists, is exposed to a very narrow set of criticisms, ones that most laypeople could not counter to be sure (must get one's standard errors correct), but that's really no different than the fact that most people (me included) could not write prose for the New Yorker with their syntax errors. In most ways he is unexposed to real criticism and acts accordingly.

Wednesday, October 28, 2009

Obama's Alpha Delusion

From the WSJ:
The Obama administration launched a clean-energy blitz Tuesday, with President Barack Obama sweeping into this Central Florida hamlet to unveil $3.4 billion in stimulus grants for advanced electricity-grid projects

This PR parade relies on the idea that this administration, if not Obama himself, gets into details, and chooses the right cutting edge technologies and methods. Look at Obama above, with his sleeves rolled up, giving pointers to an appreciative bunch of field managers (perhaps the NEA can get to work on some Soviet Realism in this context). In this case, Obama merely has to allocate some of our money to a select list of projects that are aligned with the buzzwords 'clean energy', and we get the increasing returns to scale that Paul Krugman won his Nobel Prize for (too bad Ann Krueger didn't win a Nobel for showing the same 'infant industry' argument has been a pretext to protect inefficient industries for over 200 years).

It never occured to any of these guys that there aren't any magic solutions to our energy problem. They act as if we only tried to develop batteries, we could have ten times the power. See this video from Zocalo, and at the end of the critical discussion about the oil industry an audience member earnestly asks: "can't we develop energy out of water?" as if the only reason we use oil is because the Rich Uncle Pennybags character from the Monopoly Game is not letting us do anything else. The electric car predates the internal combustion engine. My laptop and cell phone routinely run out of energy, highlighting the high reward waiting for the next battery innovation. There has been and continues to be research, and incentives, to increase the efficiencies of batteries.

Obama hates being compared to socialists, so I'll refrain and compare him to a communist. In the state published hagiography, Divine Stories About the Dear Leader, Kim Jong-Il is presented as someone excellent at golf, pistol shooting, technology, and battlefield courage. He's basically better than everyone at everything. For a communist state that belief is necessary, otherwise their system is too centralized.

Obama and his experts are presumably more efficient than the market at allocating more resources to productive technologies. The idea that since the market won't provide funds, perhaps the informed expected return on battery investment is truly low, seems absurd: how could selfish oafs who run business know better than an articulate, caring, public servant? It's The Secret writ large: think it true, and it becomes so. No wonder it's a popular idea: would that it were true.

Unfortunately, the bien pensants who adore Obama (or really, adore that they adore Obama), see his value add being multifaceted micromanagement. There are countless $3.4B special investment targets to do, each one with dreams of cold-fusion, high-speed trains, and the end to the achievement gap. Most people think that 'good smart people' are better in almost every way than your average businessman, and most people think they vote for such people, thus these politicians should be directing activities the way a coach directs a football team.

Alas, the value of extreme intelligence and knowledge of detail, does not scale at the managerial level. It runs out of benefit to a ruler, because they cannot and should not try to micromanage things. Thus, the best developer of a new technology is often a lousy director for a state or large corporation, and the best managers are often not the best developers. Indeed, a key advantage of those who are smart—but not too smart—is they know they don't know more than everyone. The Barak Obamas and Paul Krugmans, having excelled at Harvard or MIT, can more easily think they actually know more than everyone else, leading to the classic Fatal Conceit of planners everywhere.

The idea that the only feasible alpha for a leader of a large collective, is to enforce rules and get out of the way, is simply preposterous for those who think the Invisible Hand is merely a theory used by conservatives to excuse their indifference. This reflects a failure to appreciate the complex, homeostatic mechanisms of self interested agents within a free market, and the infinite number of ways top-down rules are worked around when applied to the masses. As Hayek noted, the biggest flaw with the free market is that it wasn't designed, it emerged spontaneously, which causes people to dismiss its value. Thus, they have 1000 page plans like our health care bill, or ideas about new committees that will assess issues intelligently and disinterestedly.

Tuesday, October 27, 2009

What Does Something Really Cost?

Any large institution has problems allocating 'fixed costs'. That is, I remember going over budgets, and certain functions, like headquarters, the CEO's salary, Treasury, was a 'fixed cost'. More problematically, you had many sunk costs, businesses we were exiting, that were obviously losing money (otherwise we wouldn't be exiting them). Each individual unit could be making money, but once we paid for the fixed costs and costs of the businesses we were winding down, the corporation was underperforming on a Return-On-Equity basis. As a corporation, you have to allocate all your costs to see if you are doing right by your shareholders.

For a government, it is much worse, because they do not have a balance sheet. Very few in government know how much anything costs. They just pass the law, and look at the marginal expenditure. Like the Social Security Trust fund, they operate using rules that would be illegal if done in the private sector. The market is a heartless thing, but at its core it makes sure that when people get more out of what they put in (profits), they do more; if they get less (losses), the do less or not at all. That's efficiency.

So when a private study reported that each Amtrak passenger costs taxpayers(ie, over the passenger payment) $32, four times Amtrak's estimate of $8. Oops. Further, the subsidy ranged from $4 (Boston to Washington DC) to $462(LA to New Orleans). Clearly, the higher costing routes seem ripe for exit, but it would be naive to think that is being considered.

Ludwig von Mises said the main reason capitalism would outperform socialism, is because in socialism no one knows how much anything costs, which makes it impossible to allocate resources efficiently. The Amtrak study highlights they don't know, and they don't even think it matters.

Encouraging a frat party atmosphere?

From today's WSJ:
A former Anheuser-Busch Cos. executive who for years served as the company's public voice against critics has sued the beer giant for discrimination, saying she was paid less than male executives and that the company encouraged a "frat party" atmosphere.


Sunday, October 25, 2009

McDonald's Alpha Deception

I would estimate 90% of all alpha is misrepresented. Anyone in charge of a business line making money, is usually too embarrassed by the straightforward nature of their advantage to admit it, so they have to point out some nuance that makes absolutely no difference. Thus, every market maker, making money off order flow, will swear they are adding value 'reading the tape' or trading like a turtle, or some other such nonsense. Finance is probably the worst, because there's so little alpha and so much branding and 'sticky money', that truth-telling is a strictly dominated strategy. If you ask your average financial executive to explain what he does, chances are he won't tell you even if he knows. Further, many are actually clueless. They don't know their job is to provide the appearance of a method to the whims of the main decision-maker, that they fit the right diversity box, or their husband is a senator. Admitting the truth would be too depressing, and the mind is very good at protecting its self image.

Thus, it's fun to see market leader McDonald's brought down to the level of a Jim Cramer. I like McDonald's: it's clean, I like the burgers and fries, my kids enjoy their play areas and have a fairly nutritious lunch (hamburger with apple slices and milk). But their burgers tend to lose adult taste tests against Burger King. Why? McDonald's burgers are primarily loaded with ketchup, which appeals to kids, where BK has more mayo, which appeals to adults. The solution might seem easy, add an option to replace ketchup with mayo. But that would make the burger choice seem much less alpha-like. A burger chain has a reputation, and they carefully project one of having super quality and care, or something outside the box like a square shape, or flame broiling. Heaven forbid they state, these are hamburgers, not steak. They are cooked by people who have trouble remembering to wash their hands after using the bathroom (thus the prominent signs), let alone the ordinal ranking of rare, medium, and well-done. A multinational corporation can't produce a medium rare burger without generating a class action E. coli lawsuit, and a well-done piece of ground beef is about as nuanced (yet still enjoyable), as an ice-cold light beer.

But that's like a finance professor saying all investment analysts can't predict the market. A thriving industry goes on, acting as if they have alpha in every 'buy' recommendation, every burger. Thus, the newest McDonald's creation are their new Angus burgers. They have...lots of mayonnaise. Too much in fact. So, even though they know this is the true 'secret sauce' in the adult burger battle, they emphasize the Angus dimension, and then overload the key ingredient. I prefer the more predictable double quarter pounder with no pickle.

Taleb Confronts His Critics

The ever amusing Nassim Taleb has penned yet another response to his critics. He simply oozes defensiveness, which combined with his arrogance, strong opinions, and popularity, makes him incredibly fun to write about (if you haven't been accused of WEB VANDALISM by NNT, you are missing out).

So, here's his new summary, which he notes parenthetically, "I have had to repeat continuously" (perhaps his emphatic reassertion is not compelling?). Anyway, he notes that "theories fail most in the tails; some domains are more vulnerable to tail events." I agree. Newton's theories don't work at the Plank length, cosmology has trouble explaining the first minute of the universe, and evolutionary biologists have trouble explaining the Cambrian explosion 500MM years ago. Explaining most of the data is easier, and generally more important.

Now, one may protest, it's not a new point. However, Taleb argues that "nobody has examined this problem in the history of thought", highlighting the common problem of autodidact philosophers, that they tend to be too dismissive of the scientific literature. He notes what he is not talking about includes most everything that is directly related to extreme events and uncertainty: falsification, power laws, Hume's problem of induction, Knightian Uncertainty, Austrian Uncertainty, integrating fat tails into models, etc. He's aware of these arguments, but claims his idea is different

His big twist: that rare events can't be estimated, because they are rare, especially, when they are rare and have large impacts. Well, I would argue this issue is addressed in the literature he notes is unrelated to this point, as long disquisitions on the difficulty in estimating an event like WWI, or standard errors on order statistics, seems like the same subject to me. He can say these earlier discussions are flawed, but they address his key point. The more he explains himself, the more he sounds like some passage from Knight, Keynes, Hume, Minsky, etc. once you translate his neologisms (historia, ludic fallacy). I would argue Taleb is much less clear than these writers, because he's trying so hard to make the old sound new. Saying it's really new doesn't make it so.

He ends with a strong plea to not be wedded to a theory, to look at the facts and avoid fitting them into a preconceived theory. I'm sure the vast 'preconceived, untestable theory' crowd has a lot of soul searching to do. Yet, I think he's the best example of their kind. He has a theory: that he's saying something really 1)new, 2)true, and 3)important. He says many things, often contradictory, but he never manages more than 2 of those attributes in any assertion.

Thursday, October 22, 2009

The Fed's Latest on Risk Management

The Federal Reserve houses probably the brightest, most thoughtful bureaucrats in government. Many like to get published and participate in academic conferences, so their selfish attempts to raise their status in the economics guild has positive externalities.

I bet most of your average risk manager's job is not about measuring, monitoring and reporting, for decision-making, but for appearances: to investors, regulators, analysts. Most risk managers don't get invited to the 54th floor corporate board room until regulators appear, then magically they are praised to high heaven. Often this includes obtusely patronizing remarks about how smart they are by senior management in the face of these outsiders, as if, hiring some cast-offs from Los Alamos clearly means there are no problems here! You can't fool people who know lots of math! Bottom line: there are lots of clueless, but high IQ/Education risk managers out there in every firm, which clearly should comfort no one.

The Fed's latest opus, done in conjunction with the G-12ish central banks, has created the Senior Supervisors Group Issues Report on Risk Management Practices, in the process highlighting that risks are still with us. Nothing it says is really untrue, but nothing is new to anyone with a little experience in the field. The specifics are very relevant to the subprime crisis, as if no-money-down mortgage pool CDOs are incipient. It's kind of like the airplane regulations: as if anyone could get away with 9/11 with mere box cutters today (the prospect of imminent death would create an avalanche of crazed vigilantes; pre 9/11 everyone thought it would be a layover in Cincinnati).

We learn that
Some firms’ business models also relied on excessive leverage.
ORLY? Would have been nice to read about that pre 2006.

Firms also failed to realize that two important sources of funding, securities lending and money market funds, could impose further demands on firm liquidity during periods of stress.

I doubt there's a banker with rank of VP or above who does not understand that now. Hindsight's pretty good everywhere.

Then there's the
the stature and influence of revenue producers clearly exceeded those of risk management and control functions.

Always has been, always will be. A full-time risk manager is like a figure skater. The best are well compensated, the other 99% are obscurities with status and power about the same as you average LAN administrator.

Alas, this is optimal! Consider a full time risk manager is paid to keep bankers honest, from taking too much risk. They are preventing people from taking on new business, because the risk of default is not 2%, but 4%. Now, such a warning is very difficult to validate, the power of any test to validate is beyond your average risk manager's business life in his current occupation. Thus, as quantitative as risk management is in theory, in practice it is very non quantitative, because the big risks presented by crises happen so infrequently.

This invites a lot of posturing. Many top risk managers are ex-regulators, esteemed academics, or have fancy degrees. When you can't measure the output, you measure inputs. The bottom line is and always has been the degree to which those directly affecting revenue, the business line managers, accurately amortize the expected losses of any capital investment. Their long run success depends on that outcome, which is often binary: heads they win, tails they are fired.

Of course, at the top, these executive's success is less dependent on actual success, because these people are managing people who manage businesses, and so, like Robert Rubin, you can make $100MM without actually knowing he had a lot of mortgage paper on his balance sheet (details!). That's an independent issue, why the managers of managers get paid so much (I'm think there's room for improvement here). For the business line, the guy actually creating the business, at least 3 layers below the CEO, his risk management is essential.

In contrast, the full time risk manager is a dilettante. He does cursory reviews of perhaps 20+ different business lines and so is clueless to the real issues, because anyone spending 1/20th the time on something you do that actually has alpha, and delivers profits (ie,is actually valuable, and so not obvious), cannot be understood with such minimal focus. Yet, he's the guy you show to regulators, or investors, when talking about risk management. Reality is very decentralized, and its a convenient fiction to think that risk can be centralized and managed by the Board, or someone not working in the business day in and day out. Clearly this problem is only worsened if we think about delegating risk management to regulators, who are even further removed.

I think it's a fiction to think one can meaningfully present the risk of any collective via a concise table of numbers. A senior executive should emphasize they prioritize the validation of expected loss forecasts within each business line (at KeyCorp, we had 130 lines of business, and many of these were composites), by obligor (counterparty) rating and collateral (eg, secured by property, or unsecured?). They should note new activities have extra layers of cushion applied to these expected loss estimates. They should then present a set of examples of how risk is broken down in a particular business line (say, indirect auto lending), including actual and expected loss rates by as much granularity as possible (crosstabbing by 5 risk grades, 3 collateral types). They should also highlight any changes to the methodology, because innovation involves change, and data will not be available; that is understandable. The changes should be based on some kind of theory or analogue, or story. This helps the outsider understand why they are doing this, and how it can be validate (ie, why shouldn't people make a down payment? Because house prices always rise!).

They should then invite the analyst to ask for another example, based on the business or product of their choosing, which would imply each line was ready to present their risk. The request would then entail someone from, say, Media Lending, to come up, and explain how they slice up risk, how they validate their loss forecasts by the granularity they present (including lines, loans, and letters of credit), and how pricing, revenue sharing with cash management, and costs of funds, relate (this can highlight conflicts of interest). The presentation should be amenable to a 30 minute presentation; if that is not possible, then clearly they do not have it under control. By letting the outsider choose, they can be confident their questions would be answered similarly if they did this on another business line.

They should note that no one gets a bonus for revenue generated the prior year, but rather, as that revenue is amortized over the life of its duration. If that's a day, fine, but no one walks away making a bonus off capitalized revenue that has not yet occurred.

Risk in any diverse financial organization cannot be summed up by a third party into a scalar. The essence of risk is like the essence of productivity: the parochial knowledge, processes, and incentives of very diverse activities. This is necessarily a detail oriented issue, and the big risks are bad assumptions, not bad math. That is, it was not copulas, or correlations, that screwed up subprime, but the assumption housing prices, in aggregate, would not fall. That's a bad assumption, based on understandable but flawed logic. You cannot appreciate these bad assumptions merely by adding up all their flawed implications and comparing them to total bank capital.

Wednesday, October 21, 2009

Is Levitt a Global Warming Denier?

Freakonomics was a highly popular book that appealed to both liberals and conservatives. Therefore, it carefully avoided polarizing topics, and instead uncovered the shocking truth about sumo wrestlers and other issues that are worthy of a standard 20/20 television show. Fun stuff, not what I would call economics (see the more esteemed economist Ariel Rubinstein for support).

So, this time they figured they would slay some fallacies in the Global Warming debate. They bend over backward to apply good faith to Global Warming proponents, and agree with many of it's propositions(it is not a singular hypothesis), yet try to have fun with some issues that appear ripe for debunking (eg, noting that horses generate more pollution than oil as an energy source). Unfortunately, the Global Warming Community does not approve of their shenanigans. They have too start action, now, and these issues hurt the cause. Levitt seems to like being against conventional wisdom only on areas where there are very few opinions, so he and his coauthor weaken their case by protesting too much, trying to have it both ways (I love the Weitzman argument that since a catastrophe could happen, we should spend trillions of dollars on it--it can be applied to anything, and indeed, he has used it to explain the equity premium puzzle).

Unfortunately, alternative energy sources that are currently most viable, like cleaner coal, or nuclear, are not popular with the Global Warming crowd. Even windmills, and solar, are coming into opposition for their noise or eye pollution. The only thing they really like are pie-in-the-sky battery research, and conservation. I think this highlights that most of this debate is not about Global Warming, but more power to regulate, because it adds another busy body to approve all sorts of things (like when I have to get permission from my city when I replace my old back patio with a new one).

The Global Warming debate is like many Big Issues. They are multifaceted, so debunking a point hardly makes a difference because most people's opinion has several several pillars. Given it will take my lifetime to provide any conclusive data one way or another, I don't expect this one to subside.

Tuesday, October 20, 2009

2000th Anniversary of Teutoberg Battle

In 9 AD, my ancestors kicked some Roman butt, allowing them to avoid civilization for a couple more centuries. After all, what have the Romans ever done for us? The Battle of the Teutoburg Forest (called the Varian disaster by Roman historians) took place in A.D. 9 when an alliance of Germanic tribes led by Hermann the German defeated three Roman legions led by Publius Quinctilius Varus. There's a Hermann the German statue here in Minnesota.

There's a really cool video on the battle here, part of the History Channel's most awesome Decisive Battles series.


Monday, October 19, 2009

Focus on the Ordinary

A WSJ article notes that people are intrigued by those peculiar people who have HIV, but not AIDS. In cancer research, five Nobel prizes have been won by researchers who studied tumor viruses (3 for a chicken virus! the Rous virus). This started in 1911 when Peyton Rous discovered a virus that was found to cause tumors in chickens. The hope is that these special cases highlights the essence of the puzzle, and being a virus, leads to an easy isolation. Unfortunately, this thread has not proven very successful. Viral cancers are rare and not very relevant for human cancer, which makes sense when you consider cancer is not contagious. With a few exceptions cancer survival rates remain much of what they were in the 1950s. The Mayo Clinic reports that for cancers diagnosed from 1974 to 1976, the five-year survival rate was 50 percent, now 65 percent. This is mainly because of early detection, as opposed to any great new drugs.

A common idea is that outliers are more important than averages, as this is the them of Taleb's Black Swan, or Gladwell's Outliers. Predicting one great outlier is worth predicting many ordinary outcomes, so on one hand it seems like an optimal focus. Also, the outliers should highlight the essence of something. A stock that has risen 10 fold, or a great athlete, supposedly lays bare the essence of its greatness.

But I think we forget how biased our view is on exceptional events and people. We watch sports and learn about Usain Bolt, a most unusual man. Or my kids read the Guiness Book of World Records, containing stories about 1200 lb men and giant frogs. News is biased towards the exceptional, it takes no effort to emphasize it. In fact, it takes effort to see the ordinary. It's too bad people think of heroes as those who, for a brief moment, offered their life in some battle or harrowing situation, compared to the much more common heroism of providing one's family, not complaining, and being charitable to friends and neighbors, for decades.

A problem is that for any extremum is caused by its unique intrinsic characteristics and also random chance. We hope that we can more clearly see the intrinsic qualities associated with, say, a rising stock, by looking at sthose stocks that went up 10-fold last year. Yet, any extremum is probably a large random error. We simply can't predict the future very well, say an R2 of only 10%. Thus, a 100% stock return contains, on average, a 90% error. Yet, conditional up rising this much, this is only the mean error, its standard error is at least as large, meaning, any singular 100% return is probably all randomness. In this case, more analysis is worthless, like trying to explain a lottery number. The explanatory characteristics are irrelevant for these cases.

I remember when I worked at Moody's working on default models. The CFA types liked to do case studies of famous financial catastrophes, and worked through all the sub-accounts of say, Boston Chicken, or Enron. Unfortunately, these were really poor archetypes, and we could found that complimenting these analyses with our default model made both look less relevant. The cases that made for a great narrative usually involved a good degree of fraud, which is difficult to detect in real time. In the end, the group that sold training seminars on credit analysis continued their program of exceptional case studies, our models simply grinded out boring probabilities independent of these examples, and they remain independent areas of interest.

I find it much more fruitful to look at averages, mainly between groupings of interesting explanatory variables, and their correlation with the desiderata--not the reverse. That is, instead of looking at the top 10 stocks from last year, look at things like the top decile of p/e ratios, which predict stock returns at a much more modest level. We know these things are inversely correlated with returns (the value effect), so then the question is, how can I take advantage of this? If I combine this with cashflow/assets, or momentum, how does this work? Sure, it may at best add a couple percent to your annualized return, but at least its feasible. Needless to say, the current focus leads to an excess focus on highly volatile stocks, which is why I argue that these risky stocks have lower returns on average than their more boring counterparts.

Extremums can be informative, but they tend to dominate our information set anyway because they lend themselves to interesting narratives. Sure it would be best to know the big events if you had a time machine, but living in the present, if you really want to predict, focus on those things that are potentially predictive, which generally means looking at how averages relate to averages, as opposed to how outliers related to averages. The latter is mainly selection bias and random error.

Saturday, October 17, 2009

The Continuing Lament

Many statements are often true, but old. So that makes them really interesting if you discover them for yourself, but boring if you have seen it before. For example, Eric Carmen's All By Myself is a beautiful melody, or a rip-off of Rachmaninoff's Piano Concerto No. 2, depending on your background. The Serenity Prayer is a profound saying of Protestant Christianity, or an old saying from Roman stoics. A perennial on the risk management conference circuit is the insight that "you can't replace common sense with mathematics", or something to that effect, as if independently discovered. Usually, this statement is made by either by an accomplished mathematician attempting to signal he has common sense, or a Dilbert-style boss excusing why he does not know any mathematics.

Thus, I found the following quote by Nikola Tesla amusing, because I have read literally hundreds of people make this point as if it were really new:
Today's scientists have substituted mathematics for experiments, and they wander off through equation after equation, and eventually build a structure which has no relation to reality.

I take that to mean, moderation in all things.

Thursday, October 15, 2009

Epictetus the Life Coach

Barbara Ehrenreich has a new book out about the perils of positive thinking, and it highlights a growing counter-movement in the self-help genre. Studies suggests all those 'Think to Win!' books are actually harmful to your health. Books like The Little Gold Book of YES! Attitude or The Secret are all about you getting you to be positive all the time to achieve, well, anything. Tony Robbins, Joel Osteen, Martin Seligman, Nathaniel Branden, all preach the power of positive thinking. Like methamphetamine this is invigorating at first, enervating in the end. Research has shown that depressed people are actually more realistic about their abilities than optimists. Woody Allen's joke about the secret of happiness being abject stupidity is funny because it's kinda true (as most jokes are). That just depresses me further.

The problem with optimism is that it's blatantly incorrect: we aren't all above average in everything, things do not always get better, and we can't always get what we want. The problem with realism is that by itself it is depressing, a demotivator that does not elevate.

As an altnernative to the Charbydis of Realism and the Scylla of Optimism, I present Stoicism, via Marcus Aurelius (Meditations, Book II, part 1):

Say to yourself in the early morning: I shall meet today ungrateful, violent, treacherous, envious, uncharitable men. All of these things have come upon them through ignorance of real good and ill... I can neither be harmed by any of them, for no man will involve me in wrong, nor can I be angry with my kinsman or hate him; for we have come into the world to work together

Now, this at first seems rather banal: don't sweat mean people. But this is actually quite important, because frustrations with people, not nature, causes most of our grief. Most of what causes people angst are not exogenous constraints of no one's fault, but rather, when people do things that seemingly are intended to harm you: someone cuts you off in traffic, privately belittles your contributions to colleagues. Recognize there are things you can control, and those you can't, and this include other people's actions: learn the difference, and don't worry about things you can't control (aka the Serenity Prayer).

If you remember that most people are mean out of ignorance and you can't really control that, you take their slights without offense. You still have to manage them, but you don't let these people anger you. Somehow, thinking about other's intentions raises hackles much more than any non-conscious constraints. This makes you more effective, and more pleasant to work with, because one of the most endearing qualities is someone with a thick skin.

As a practical matter, living one's life like Marcus Aurelius generates huge amounts of win. One must not merely love a select few people, but work with many one is much less fond of in a productive way. Modern life is intrinsically social, so either teach people or endure them. Accepting the sad fact that every day, some of our interactions will involve petty insults and slights, sometimes by colleagues and bosses, is much more constructive than either mooning about it (realism) or thinking it doesn't happen (optimism). If you replace annoying people's intent with poorly endowed assumptions or logic, an inanimate obstacle, it is not merely more fruitful but less stressful. Your lack of drama will be appreciated by those around you, even those who really don't like you, and winning them over is a good thing.

It's too bad 'The Classics' are so out of favor (no longer an AP course for high school). Their civilization created many great things, and lasted a lot longer than our 'Modern Times'. Sure, they didn't have soap, toilet paper, or buttons, and believed in slavery and supernatural forces, that's too much hindsight. If you consider that Archimedes figured out Pi to 5 significant digits using Roman Numerals, and look at their roads and aqueducts, I have the sense we have accumulated more knowledge, but aren't nearly as smart as those guys (the Idiocracy effect). If you look at the Bible or modern philosophy, or witty quotes, you can often see it's premonition in works of the Stoics.

"Man is disturbed not by things, but by the views he takes of them." ~Epictetus

"Everything is right for me, which is right for you, O Universe." ~ Marcus Aurelius

"How ridiculous and how strange to be surprised at anything which happens in life!" ~Marcus Aurelius

"Or is it your reputation that's bothering you? But look at how soon we're all forgotten. The abyss of endless time that swallows it all. The emptiness of those applauding hands." ~ Marcus Aurelius

Good ideas are worth repeating, and they not only make you appear smart, they actually make you smarter! A good stoic is not afraid of death, pain, or misfortune, only in not doing your best, losing your patience or your discipline. The virtues and true pleasures available to any man are available to every man (note Epictetus was born a slave, Aurelius an Emperor).

I don't think it is a complete philosophy of life,as I'm not into asceticism or radical fatalism, but like a flea market I can take what I want, and there's a lot there.

Tuesday, October 13, 2009

Why Health Care Reform is Doomed

In 1971, Henry Manne wrote The Parable of the Parking Lots. The lasting value of this article, along with Radford's Economic Organization of a POW Camp, probably outweighs all that discussion of supply and demand curves that makes up so much undergraduate micro.

The story describes what happens to a college town when parking lot owners decide to get together and squelch competition. Specifically, this was targeted towards those Saturdays when football games generated an abnormal number of cars, and many people and businesses sold space on their private driveways. The parking lot owners noted horror stories about 15-year olds parking cars, or the inability to fully insure the cars! They had a meeting where they said parking cars 'wasn't a business, it was a profession', and set up a slush fund for political action. The 'unfair and dangerous competition' was made illegal, by basically mandating fixed costs that made it uneconomic for small providers of parking spaces to operate. The new law allowed the parking lot owners to increases prices under the pretext of quality, yet the result was more congestion because the parking lot owners were not equipped, or incented, to deal with the new volume efficiently. Quality was merely redefined to mean fully licensed and bonded parking lots. Creative people got around the prohibitions by offering people $5 'car washes' on their driveways that lasted several hours, which then provoked new regulation. Each new regulation created a new problem, which then motivated more regulation.

The parable supports the principle that 'quality oriented' guild monopolies conspire with legislators under the banner of 'the public interest'. They then can raise their prices by outlawing all sorts of competition. The unanticipated inefficiencies created simply raise the cry for more regulation. The net result is worse for everyone except a few parking lot owners and the legislators they support. The analogy to our current health care system is pretty straightforward, such as when only doctors are allowed to perform certain functions that a physicians assistant or nurse could easily do. But for health care it is actually much worse, because at least with parking lots customers paid directly for their services; in health care we have people spending other people's money on other people, often indirectly via mandates that people would never pay for themselves.

The market is a complex system. It is not merely a means to an end, but often an end in itself, the name we give to how we go about much of our lives providing and procuring services. When we restrict the market, it invariably makes us worse off because prohibiting two people from a subjectively mutually beneficial transaction makes them better off only under extremely rare situations (the problem of asymmetric information and non-aligned incentives is only amplified in a bureaucratic government alternative).

The US health care system involves a myriad of regulations, rights, and tort liabilities, that conspire to make this market highly perverse. Any current health care provider is already playing the game, thus, doctors in the US average a salary of $150k/year, almost double that in other developed countries. Unions are growing in health care, with the common result of inflexible rules, high salaries, and an inability to fire workers. As with our education monopoly, expect the health care professionals to make out best in any solution (Michelle Obama, after all, was a $317k/year 'diversity outreach coordinator' for the University of Chicago Hospitals once her husband became a senator--we need more of those!).

The current modifications are just like the parking lot parable: more patches for problems created by prior patches. One law government obeys is the The Second Law of Thermodynamics, so the new system will certainly be more complex. Spending more money will not make it better, just create new inalienable rights and patronage jobs paid for via the magic of deficit spending. Some day the spigot will turn off (eg, Chinese investors), the Laffer curve will constrain tax increases, the demographics will no longer have several wage earners for each person on the dole, and all these off-balance sheet liabilities will be too expensive. Then things will really get interesting.

I hope to live in a gated community by then. With a moat.

Monday, October 12, 2009

Bloomberg Magazine Shows Market Bias

In the latest Bloomberg Markets Magazine, the cover story is on Research Renegages. As usual, they highlight some individual performers who very recently made very good calls. For example, Dana Telsey had a buy on J. Crew in January, and by September 14 it was up 154%. Betsy Graseck recommended a sell on Bank of America in the fourth quarter of 2008,, and by March it had fallen 80%. It's always that way, where the best analysts are those with a handful of awesome picks over the past year (some Bloomberg promotions explicitly exclude losers, looking just for biggest winners).

Yet, the outperformance of those stocks rated buy vs. sell is modest, about 4% annually, and after transaction costs this information is not significantly greater than zero (see here and here). The internet bubble exposed the naked quid pro quos between stock analysts and firms, as firms would reward investment banks who touted their stocks with investment banking business (issuing equity, debt, or doing mergers& acquisitions), so a better study would simply ignore the pre-2003 data. There are many screens in Bloomberg to look at changes in the buys and sells, as if not the ratio, but the difference in the ratio is predictive (see here). If you torture the data enough, some slice of analyst forecasts work, but I think it's reasonable to infer that there's no there there.

If you look at who had the most credibility in the past crisis, it was those who predicted it. That seems natural enough, but here we are with a very rare event, and there are always permabears, so when a bear market happens, these guys are all geniuses?

I guess the problem is no one currently rolling up their sleeves and doing grunt work has a statistically valid sample size. It would be such a small sample of analysts with a valid sample, it would be bad for selling magazines, which are mainly read by those they are highlighting. So, taking those who were above average recently seems better than taking a random sample, even if the last year is a noisy estimate of true value. But these analysts are up against the much maligned Efficient Markets Hypothesis, and they generally don't do that well. Analyst stock reports, like economist forecasts, are mainly useful in rationalizing a decision you already made, but need to articulate better to your boss or clients.

An interesting effect implied by these winner-take-all contests, where annually only the 'top' analysts are given prominent exposure in financial industry publications, is to focus on sexy stocks, those that can rise a lot. A low-volatility company has little chance of producing a return that will win a 1-year contest even if it goes up, so you might as well ignore it. Thus, everyone is focused on the risky stocks. As most people do not short stocks, the inordinate attention to risky stocks leads to a winner's curse in risky stocks, inflating their price, lowering their future return. This, I argue, is why objectively risky stocks underperform their staid counterparts.

Williamson, Ostrom Win

Well, the Nobel brand isn't worth what it once was, especially given the Peace prize, but it's still all harmless fun. Oliver Williamson wrote a bunch of interesting stuff about the value of the firm--Ronald Coase stuff--and transaction costs. For instance, he highlights the 'own' rate of interest for owning commodities because it allows one to avoid transaction costs delivering the underlying commodity. This has relevance to the contango and normal backwardization of futures contracts.

He reads a lot like Frank Knight to me, with a strong respect for markets, and not highly mathematical. Yet, like Knight, it's hard to develop models based on his work, which makes him a surprising result. An idea that generates a model, no matter how abstract, seems the economic ideal. I think Williamson's work is very good for undergraduates, so hopefully this will get him read more.

I honestly have never heard of Elinor Ostrom before.

Update: I seemed to have confused Jeffrey Williams with Oliver Williamson. The former wrote on contango and futures. This work was consistent with Williamson's work, and I remember relating some ideas directly, but to my knowledge Williamson never applied his work to futures directly.

Sunday, October 11, 2009

Radical Uncertainty's Long History

A debate between Bryan Caplan and Peter Boettke on whether Austrian economics is really fruitful is available on sequence of YouTube videos. Austrian economics is based primarily on the works of Friedrich Hayek and Ludwig von Mises, (Carl Menger, Eugen von Böhm-Bawerk, Henry Hazlitt, and Murray Rothbard are also big). I like a lot of what the Austrians write about, and generally have their biases. But some areas of their focus I find less appealing.

What I found most interesting was the crux of the discussion seemed to be on how to treat uncertainty. Caplan finds the Austrian conception rather unhelpful. True uncertainty, to an Austrian economist is 'radical' uncertainty, not amenable to mathematical manipulation. If you look at the work of George Shackle, you see him defining uncertainty as that which generates a potential surprise in some mysterious way that seems only defined ex post. I tend to agree with Caplan that this isn't helpful.

Boettke, however, highlights the old saw that it's better to be approximately right than precisely wrong, yet a precise answer leads to corrections, whereas the fuzzy answers that are surely approximately right are so vague it is not clear how to make better forecasts. The bottom line is the Austrians have been talking about uncertainty of this kind for a couple generations now, with not much to show for it. In that way, it is identical to Keynesian or Knightian uncertainty, concepts that have a certain indubitably true idea, that the the uncertainty we face is quite different than the objective probabilities generated by a fair roulette wheel, yet ultimately I think one has to put this into some formal footing, say by introducing Bayesian priors.

This thread has a very long history (Keynes going back to 1921, Knight to 1919, I'm sure one could go back further), and so it's a main reason why I find Nassim Taleb rather tiresome, because he brings up these old arguments in new contexts as if they are a radical break, and so pregnant with practical application. It is a radical critique--outside standard probability models--but it is not new, so based on history, a rather barren insight by itself. The 'uncertainty' thread remains outside the canon because no one has figured out how to amend standard statistics to incorporate the realistic idea that sometimes we are 'wrong'. It seems reasonable to ask that such criticism can be formalized using the very general tools available in standard probability theory.

It is important to remember that a theory that is approximately right (ie, precisely wrong in some cases) is better than a vague criticism. What is needed is something constructive, something the Austrians, Post-Keynesians, or Taleb, have failed to do.

Thursday, October 08, 2009

The Nobel Goes To ...

Mankiw lists Eugene Fama and Paul Romer as huge favorites. If they give it to Fama, they should give it to French, even though Fama has a much deeper set of contributions (the definition of the Efficient Markets Theory in 1970), because for the past 20 years most of their papers have been joint, and they have really dominated the debate on issues from models of bonds to equities. I don't know much about Romer's work, but it's at least as influential as Krugman's in the idea that increasing returns to scale are very important in growth, so I presume that means he'll get it if he lives long enough.

As I note in my book, I'm a rather strong critic of Fama's work on equity risk factors. Yet, in terms of impact, Fama is clearly a force. Further, I truly admire his style, in that his articles are very clear, unlike most 'top' financial economists. Many financial economists in the 80's were focused on abstruse issues of econometrics that turned out irrelevant (eg, the simultaneous estimation of betas and the zero-beta return, exact finite sample distributions). After Fama-French 1992, where they introduced the three factor model (the market, value, and size factors) and basically made it safe to say the CAPM did not work (Fama graciously admits this paper merely consolidated what everyone knew studying the value and size 'anomalies' for the prior decade), finance became much more practically focused, more relevant.

But, I'd have to say, this isn't a good year for giving the prize to someone so closely identified with the Efficient Markets Hypothesis. Barro, Sargent, or Sims seem like good choices, as all are part of the cannon, each with essential insights. Sims really put the fork in the Keynesian Macro Model mania of the 1960s and 70s, showing that simple vector autoregressions outperformed these models (Macroeconomics and Reality, 1980). VARs remain a key tool for macroeconomists, and Sims did a lot of work in this area. I imagine few Fed briefings do not involve stimulus-response estimates generated via VARs. It's a very applied approach, because it basically says, don't be too specific in your causal model (like the Keynesian Macro models), yet, it does not suggest one use totally nonparametric, or unidentified models. He basically says, find the main variables that should affect things (like GDP) via theory, then look at how the past values of those predictors explain the predicted variables, and plot them in a graph.

Barro highlighted that if people were rational, borrowing money is the same as raising taxes, because people anticipate future taxes, extinguishing any stimulus via deficit spending (Are Government Bonds Net Wealth? 1974). The phrase, "Ricardian equivalence," has become well known among scholars in macroeconomics and public finance (James Buchanon noted some writing of Ricardo's that had some inklings of this back in the early 1800s). It refers to a situation in which taxation and government borrowing have the same effects on the economy. The equivalence can arise because government borrowing tends to increase future taxes (to pay interest and principal on the public debt) and, as long as the present value is the same, people may react to anticipated future taxes just as they do to current taxes. To put it another way, a reduction in the government's saving due to a current budget deficit may induce the private sector to save correspondingly more. The total of national saving is then invariant to the government's borrowing. No more Keynesian stimulus effect from government borrowing.

Lastly, Sargent is a cofounder of the new classical macroeconomics based on rational expectations and dynamic stochastic models. A lot of work he did was highly technical, but influential economists write for economists, and his books on Macroeconomic Theory and Dynamic Macroeconomic Theory really concisely described the macroeconomic toolkit better than any other books of his generation. In those books, he takes models like Robert Lucas's Island Model, the Modigliani-Miller Theory, or Barro's Ricardian Equivalence, and boils them down to their essentials. His paper Some Unpleasant Monetarist Arithmetic (1981) nicely shows via some simple algebra that if fiscal policy is independent of monetary policy it can generate inflation by basically forcing future seignorage to pay off debt. This is very relevant to countries in excessive deficit spending mode.

Interestingly, as technical as these guys are, their most influential work is much more accessible than work that came later. Many who saw their success incorrectly inferred that it was their technical expertise that made them successful, and so instead of extending their economic ideas, tried to simply create more complicated mathematics (eg, Kalman filters instead of VARs, Judd's growth models). Similarly, I remember in grad school my professors then thought of Fama as insufficiently rigorous compared to say Gibbons, Ross, or Shanken. I doubt they remember that now. I think Macro is a mess, but these guys kept it from being a whole lot less messier. I guess that's seeing the glass half full.

Update: it appears Barack Obama's chances of winning the Nobel for his stimulus plan is not insignificant.

Wednesday, October 07, 2009

Children's Pedagogy

Children learn more rapidly than adults, though they are also very ignorant. In a way, they are idiot savants, good at one kind of thinking (acquisition), poor at another (facts, judgment). A friend of mine had a foreign exchange student from Germany last year, I think she was a junior (ie, about 17). The girl thought of it as a sexual vacation and remarked to the shocked mom that the African American boys were much better in bed than the white boys. The mom was rather horrified by the example set for her own little snowflake; however, I was wondering how to interpret this lapse in judgment. In one scenario, the German exchange student was making stereotypes based on a few people, and this is a bad habit. On the other hand, she might have had statistically valid sample sizes and been inferring correctly. Either way it wasn't a good example for her little American sister.

My daughter is two, so I figure I have a decade or so until I give the 'when a mommy and daddy love each other very, very much...' talk.

My 8 year old son has a different learning quandary. His math homework from our public schools is rather incoherent. He's just getting his addition and subtraction down, and his latest homework had many questions on geometry: identify the isosceles triangle, the right triangle. Before algebra or trig I don't see the point of going over geometry because you really can't use these things, instead, you define things like 'parallelogram', and that's it. He should learn the point of a concept, like a right triangle, is to solve problems. Until he can do more math, these geometrical problems don't help him solve anything, so it's just pointless memorization.

One question showed a square. It then asked, what is the length of a side such that the area is equal to 36. Now I'm sure Terrance Tao could solve this when he was 4, but I'm not holding him to that standard (see the Field Medal winner's test he aced when he was 8 here). This involves reverse engineering a square root, and his knowledge of math tables is sketchy right now. This is why I love Kumon. They drill math mastery systematically using proven methods. They only move forward when a concept (such as subtracting by 4 for single digit numbers) is mastered. Each week there's steady progress, and more complicated concepts are not addressed until students have mastered concepts necessary for their understanding. It's all about overlearning, tracking, and a thoughtful sequential presentation of ideas.

In contrast, the public schools show a bunch of concepts, never long enough for students to really learn them. Their efforts to make math 'relevant' makes it irrelevant, because the best way to teach relevance is to have what you learned last month essential for what you are learning this month, ad infinitum. Instead, we have bizarre little segues to topics like 'lines of symmetry' that are applied to blocks and butterflies, but then forgotten.

My niece is getting a Master's in education and wants to be a teacher for young children. Part of her degree involves designing an experiment to test a hypothesis about learning. One would think, given hundreds of thousands of education Master's students--and their pet ideas for improving teaching--there would be progress in pedagogy out of all this, at least for straightforward subjects like math and reading. Alas, I don't think it is much better than what was taught in the early twentieth century, in spite of probably a million people formally exposed to teaching as a discipline, and studying this systematically, writing theses, journal articles.

We seem in a bad equilibrium. I think Kumon has figured it out, but society has constraints that keep such practices from becoming popular, often based on patronizing ideas about developing creativity of both the teacher and the student. In pandering to parents and teacher's unions, saying "we have a rather rigid process to maximize your kid's learning" is not as popular as saying "tests don't measure anything. We should treat each child as if they were their own special kind of genius." One thing our society is not learning, is how to learn.

Tuesday, October 06, 2009

2008 Re-Invigorates Macro?

Commenter 'Noah' posted on this blog:
At my university (University of Michigan, not a "top" school but no slouch either), macro - especially behavioral macro and financial macro - is the hot new thing for grad students, thanks to the crisis.

Nothing really sparks curiosity more than a big puzzle that is important and seemingly soluble. Many independent hypotheses have been offered for the 2008 crisis, and this has surely motivated many to make their case. Given the way this totally blindsided economists (and most everyone else), clearly this is appropriate.

Yet, I'm not sanguine that extrapolations from 2008 will give us broad, generalizable, useful macroeconomic models. The crisis, to me, seems a peculiar effect from a sector with a century of good results that was then overdone. I imagine any sector with such a run will be susceptible to such a problem, but I'm not sure what other sectors would be comparable (US debt?). It's like living your life as if you are about to be mugged: preventing this is important, expertise in this area can prevent an damage if attacked, but it is still irrelevant to most people because it is so rare.

Puzzles are fun for academics because merely explaining to the ignorant (eg, undergrads) how things work is hardly sufficient to sustain enthusiasm. There's a lot we don't know, and figuring these out is fun and important. Yet, many prominent puzzles are often highly misleading. For example, the equity premium puzzle was explaining why the equity risk premium was 8%, given what we know about utility functions and the volatility of the stock market. It turns out this equity premium puzzle was vastly overstated, now thought to be around only 3.5% (and as I have argued, effectively zero). Further, solutions to this problem just amplified the puzzle as to why there is no risk return relationship within most asset classes like equities in bonds; when you fix one problem by making others worse, it's not a good solution.

So, I'm all for puzzles, but it's important to fixate on problems that are truly important. Not important with hindsight, but important for the future. Many commentators talk about the past as if it was so obvious. But the fact that 99% of stock brokers can tell you how best to invest last year still generates a useless forward looking strategy, as demonstrated by their record.

Monday, October 05, 2009

Krugman Puzzled by Asymmetry

Paul Krugman asks:
why, say, a housing boom — which requires shifting resources into housing — doesn’t produce the same kind of unemployment as a housing bust that shifts resources out of housing.

Well, if there's demand for housing, firms in that field are hiring people with specific skills related to building housing, and all the logistics that surround it (home appliances, landscaping, financing). Not, if we know people don't want housing, that merely tells us what not to do. So, if you know that making houses is not profitable, what should you do? That's highly ambiguous.

I don't see why he thinks doing X, and not doing X, are symmetric. There are always many more different ways to not do X, and most of them do not have value (eg, making buggy whips, building pyramids). It's not like people can short housing with their labor. The idea that the 'sets' A and not-A are 'the same' is an idea that has some logic, but shows an insane lack of practical intuition.

What would Krugman do if he could no longer write on economics and politics? I have no idea, and bet he would take a year to figure it out himself.

Kocherlakota Praises Macro, Leaves

Not two weeks after penning a stirring defense of macroeconomics, archetypal macroeconomist Narayana Kocherlakota packs it up to be an administrator (I blogged on his post here, but Kocherlakota has strangely removed his remarks from his homepage). Actually, he is President of the Minneapolis Fed, but given their narrow mandate this job does not require much strategic savvy. Your daily planner merely has your 4-dimensional coordinates for a speech, which must include 3% new material, and the instruction "don't say anything stupid!" Unfortunately, the Nash equilibrium to this game is to say nothing interesting.

Revealed preference is very, well, revealing. If you are studying physics in the early twentieth century they can't pay you to leave. If you are in the equivalent of the Peace Studies department, and you can get a cushy job making banal statements about current events on the rubber chicken circuit, the choice is obvious.

Sunday, October 04, 2009

The Wisdom of Mike Tyson

I bet Iron Mike has an IQ around 80 and couldn't find Mexico on a map. But as a public figure interviewed about his life for such a long time, he has had ample opportunity to reflect. His Id clearly dominates his Superego, and like Yogi Berra his quotes are sometimes inadvertently deep (he once said "everyone has a plan until they get punched in the face"). In the latest Tyson documentary he discusses his life with a touching amount of self-awareness. He realizes he is not very smart, that people can easily take advantage of his impetuosity and poor judgement. More importantly, he knows his vices cause him to hurt himself. That doesn't erase his flaws, but there's something profound about someone keenly aware of their limitations.

Socrates spent a lifetime learning and at the end remarked all he learned was that he was ignorant. Yet it's highly misleading to think that merely proclaiming your ignorance is profound, as clearly Socrates knew a lot of things, and he was aware of that. The wisdom of his statement is that he did not confuse the extent of his vision with the extent of reality; he knew there was a lot more out there.

In contrast, I note many of today's full-time intellectuals, those writing about ideas, have no such humility. They think everything they believe is simply true; there is no legitimate argument against their beliefs, in the way no one can argue for child porn. In a recent Blogging Heads, Michelle Goldberg states flatly that she can't imagine how anyone in good faith can oppose the public option in health care. Highlighting this stance, she noted that while she loves Whole Foods she will now never shop there again (their liberal CEO wrote an opinion piece skeptical of the public option, thus revealing his bad faith). She makes her points with straw man caricatures of her opponents, such as those at tea parties with Confederate Flags, or the idiot who said 'keep government off my Medicare', as if an opinion is defined by its most outrageous advocates.

In Chris Mooney's book The Republican War on Science (discounted to $3.99 at my local Barnes and Noble), the book jacket lists several examples of 'war' on science. Alas, I find myself sympathetic to all the arguments he thinks are self-evidently unscientific, so I guess he's arguing that I need to be re-educated. That is, anthropogenic global warming, evolution, stem cells, environmental regulation, all have some problems that I'm either skeptical about, or think don't matter. For instance, environmental regulation covers a vast set of laws, each with their own costs and benefits. Is it inconceivable there is a principled opposition to some of them? Is it really a huge problem that the US federal government does not fund all stem cell research, given that several states have earmarked hundreds of millions towards these select lines, and several other countries are massively funding this unproven thread?

For a professional pundit to think they write each day on issues as plain as the assertion that the Earth is an oblate spheroid strikes me as deserved punishment in itself. Their daily task seems absurd, but this is merely because they do not understand the issues as well as they think. They could learn something from Iron Mike.

Thursday, October 01, 2009

Africa and Macro

I saw some posts related to William Easterly's article on the recycling of development strategies in Africa, noting that many of today's suggestions are almost identical to those made in 1938: mosquito nets, cleaner water, better fertilizers. This lead me to an article by the British doctor Theodore Dalrymple published back in 2003. He highlights an interesting aspect of the 'big man' phenomenon, in that any successful man is expected to provide for a large circle of relations:
The young black doctors who earned the same salary as we whites could not achieve the same standard of living for a very simple reason: they had an immense number of social obligations to fulfill. They were expected to provide for an ever expanding circle of family members (some of whom may have invested in their education) and people from their village, tribe, and province. An income that allowed a white to live like a lord because of a lack of such obligations scarcely raised a black above the level of his family. Mere equality of salary, therefore, was quite insufficient to procure for them the standard of living that they saw the whites had and that it was only human nature for them to desire—and believe themselves entitled to, on account of the superior talent that had allowed them to raise themselves above their fellows. In fact, a salary a thousand times as great would hardly have been sufficient to procure it: for their social obligations increased pari passu with their incomes...

The thick network of social obligations explains why, while it would have been out of the question to bribe most Rhodesian bureaucrats, yet in only a few years it would have been out of the question not to try to bribe most Zimbabwean ones, whose relatives would have condemned them for failing to obtain on their behalf all the advantages their official opportunities might provide. Thus do the very same tasks in the very same offices carried out by people of different cultural and social backgrounds result in very different outcomes.

Now, I'm no Africa expert, but clearly Africa is a basket case (The term 'basket case' came from WWI, indicating a soldier missing both his arms and legs who needed to be literally carried around in a basket). To the extent this social dynamic, where individuals cannot become wealthy because they have so many contemporaneous obligations they can never accumulate savings, has serious implications for a growing economy. After all, most small business is funded via retained earnings, and if that is all going out to one's extended family, that won't happen.

Now consider if this is true and important. Macroeconomic variables will not capture it. This factor may not be operative, but it's plausible, and perhaps there's another such theory at work that is not captured by national income accounting or unemployment statistics. Macro thus appears like measuring someone's health using a thermometer, noting dead people are cold, sick people are hot, and healthy people are 98F (36C). But that metric is not very helpful in predicting, or even explaining, people's health.