Posts Tagged ‘economics’

Social Engineering: Mystery Guest Events

December 21, 2008

Market failure makes me sad. Surplus stolen. Transaction thwarted. As Pareto would say: “Inefficient!”

There are few more persistent market failures I can think of in my daily life than social interaction. I like meeting new people. You like meeting new people. But…. put us in the same room and chances are we won’t meet.

Why not?

Say we are at a party standing on opposite sides of the room. There are three reasons we WON’T talk to each other. Let’s call these the “Three Why Nots“:

Why Not 1) Randomness: Do I want to meet this person? Is this person actually worth my effort?
Why Not 2) Uncertain intention: Does that person want to meet me / anyone?
Why Not 3) Initiative: One of us has to “make a move”

In economics language the first two “Why Nots” are instances of information asymmetry: Each party not knowing exactly what the other is offering and what the other is seeking. The third Why Not is an example of a transaction cost: The “transaction” of us meeting incurs a cost of one of us having to introduce ourselves, which causes discomfort.

Transaction costs and information asymmetries are well-established culprits in causing market failures. But fortunately, economists have devised a few ways to overcome these barriers. I have become increasingly interested in using social engineering and the economic principles of “signaling” and “screening” to devise ways to vanquish the Three Why Nots. Here’s one example (also see Building a Better Bar).

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“Mystery Guest” Events: Using signaling to overcome informational asymmetries and reduce transaction costs. I will describe two below.

(Like most edgy / genius ideas, this one came from Julia N.)

The Mystery Guest Dinner went like this: Julia, a third friend and I (the Hosts) each invited one friend that the others do not know (the Mystery Guests). The six people have a meal out. Each person either meets 2 or 4 new people that night.

dinner

The Mystery Guest Mixer went like this: Julia and I each asked 5 -7 of our friends that the other did not know (the Agents) to invite 2-3 of their friends (the Mystery Guests) to a wine cocktail party in my apartment. The result is a room full of people who know at most 4 other people (hosts excluded), but everyone knows at least one.

mixer1

 

The elements shared by each event are a) no one knows anyone, b) everyone KNOWS that everyone wants to meet people, and c) each guest is hand-picked.

Let’s look at how these events help weaken the “Three Why Nots”

“Uncertain Intention” is easily overcome by d). Everyone in the room is there with the same intention and, just as importantly, everyone is aware of that fact. Compare this to a bar where a fraction of people are there to meet others and it is difficult to identity who is and who isn’t.

“Randomness” is also somewhat blunted by the invite-only premise of the event (c). You are maximum 4 degrees of separation from anyone in the room. And there is a strong social incentive to bring fun / cool / interesting / compatible Mystery Guests. Chances are good the Mystery Guests are worth your time.

“Initiative” is forced by a).There is no one to sit in the corner with! You have no choice but to talk to others. And it’s easier to meet others when everyone else is doing the same.

Overall, the events were a success. Everyone enjoyed themselves and I would guess most still have contact with at least one person they met that night. Compare that to your last night out in the Meatpacking.

Reader, I ask two things of you. Comment / email me more ideas to outmaneuver the “Three Why Nots.” And also email me if you want in on the next Mystery Guest event.

Instead of a $25 bn bailout …

November 21, 2008

… of the auto industry, how about a $25 billion Treasury-managed automotive venture fund?

The new ventures would claw back some of the jobs that Detroit is shedding. And it would position the US as the center of 21st century automotive technology and innovation.

And, hey, if GM/Ford are indeed the best recipients of capital for innovation (especially green innovation), as some of the bailout supporters claim,  they would still win the funds. But they are probably not, of course.

Seth Godin agrees, I think.

How to kill the magic of human relationships with mathematical precision

November 13, 2008

My friends are pretty cool. Your friends are probably pretty cool too.

Sometimes I feel like mine are the best in the world and you probably feel the same way about yours.

You probably stop there, move on and continue to enjoy your life. The tragically rational among us stop and realize that’s mathematically impossible or at least statistically improbable.

How can you not be overwhelmed by the number of people you don’t know? Or even the people you do know but have not developed a relationship and past history with?

But then again if you spend all your time meeting new people you never develop meaningful relationships with anyone. Clearly there is some appropriate balance between developing relationships you already have and expanding your social horizons. But how do you find that balance?

Not knowing where the correct balance, we can turn to a mathematical model. To make our lives easier, let’s examine a particular type of relationship: Marriage. The rules are you get to pick one person from the set of people you’ve met (no mail order brides) and can not divorce.

Today’s question: What is the appropriate age to get married (or more precisely pick a partner from the set of people that you already know)? Until what age do you continue to search and when do you … for lack of a better word … settle with the best you have?

I put the rest under the fold because it involves a fair but of math and even some integrals .

For those who don’t care about math, the answer is 50 years. You can stop reading now. For the geeks, onward we go…..

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Homer Simpson’s line should now read…

October 11, 2008

… “in theory Capitalism works. In theory.” 

What will the economic crisis do to:

1) The age at which we “settle down,” marriage or otherwise? (Jana’s question)

2) The allocation of talent between industries and professions?

3) The rate of innovation, financially or otherwise?

4) Worldwide economic integration?

My initial guesses would be 1) reduce it slightly 2) better align it to the optimal 3) stagnation over the next year, rapid acceleration of the next five 4) further integration as worldwide capital gushes to shore up financial institutions everywhere.

It is not immediately obvious to me that a dislocation and rebuilding of our economic infrastructure is necessarily a bad thing. Although it certainly won’t be pretty in the short term.

Reader responses: BIP! cards

September 30, 2008
Some time ago, I posted an open question about why Chileans keep such low account balances on their subway “BIP!” cards.
Glen and Alisha came back with fantastic responses, each worthy of their own post.
Alisha offers the cultural explanation (so like her..):
I’m sure that Glen gave you some rational explanation, but given that I’m a mere aspiring political scientist, I will give you a more interpretive response:
1)  Chileans love waiting in lines.  It gives them another form of oppression to discuss at work–I waited in line for 10 hours today and finally got on the metro…then I walked 8 miles through the pouring rain and smog after working a 15 hour day (with a 4 hour lunch break).

2) Chileans are irrationally afraid of crime.  Despite the safety of Santiago, they go nuts about crime, especially on the metro.  Maybe they think flashing a 10.000 peso bill will set them up to be pick pocketed (or at least get their Bip card ripped off)??  So maybe it’s strategic (or cool) to look poor among the rich, and then the poor are just poor so everyone gets miniscule sums on their metro cards.

Glen’s response was worthy for publication in minor journals of economics. He shows that it is economically rational for a Chilean to keep account balances as low as 1414 pesos. The full analysis is below — warning: The words “first-order conditions suffice for optimization” do appear. And .. oh lordy … it is glorious.

glens-response

Thanks Glen and Alisha!

Assorted thoughts on the financial crisis

September 26, 2008
  1. I don’t understand the crisis. You don’t understand the crisis. 90% of the people writing about the crisis don’t understand the crisis (most guilty: Matthew Yglesias). You need a PhD and lifetime of work in finance / economics to understand the crisis and if this isn’t you then you don’t have the answers.
  2. My work mates were discussing whether this signals the beginning of the end for US hegemony.  Startlingly, the consensus was “yes” and no one challenged it. Laura volunteered “can we turn it back or is it too late?” Opinions were mixed. To me the other important question is “as a global society, do we want to turn it back?”
  3. Disruption always creates some chaos. Often it is followed by innovation. Call me optimistic, but I see this spurring a wave of innovation in the financial sector.  Katie sent me a quote: “Every financial system tests every regulatory system to destruction.” The idea that the financial system grows to put pressure on the bounds of the regularity system, requiring a new regulatory system seems very healthy to me. One step back, two steps forward. I hope.
  4. The executive compensation discussion is a red herring
  5. Related to 1) — given that our elected officials (who really have no more of a financial /economic background than you or I) are voting on this, I hope they have some smart advisers. Who is actually crafting these plans? Sure as hell isn’t the Senators themselves.
  6. $700 billion is a cartoonish and meaningless amount of money. Per taxpayer it is a few thousand dollars. We are not going to be sent a bill from the US government though. It will be debt financed like the Iraq War and pretty much everything else. If there was feedback between government apppropriations and tax bills, there might be more appetite for fiscal restraint. As it stands, this has more in common with personal credit card debt or a home equity line.  It feels like free money. If our tax bill went up in accordance to government expenditure (or if the future tax incidence was indicated on our tax form), this would all be more real.
  7. If enterprises are not, occasionally, failing are we being too risk-averse as a society and curtailing our potential economic growth? Occasional failure is probably healthy. Widespread failure certainly isn’t.
  8. Better safe than sorry: I am going to start building an Ark. Anyone selling 15,000 cubits of gopher wood?

The real villian

July 2, 2008

In the vein of Richard Posner, Thomas Sowell can be a arch-conservative whackjob, but he can also be quite insightful. One of my favorites is his thoughts on the “Animistic Fallacy”:

The simplest and most psychologically satisfying explanation of any observed phenomenon is that it happened that way because someone wanted it to happen that way.

What the animistic fallacy yields is the invention of “villians” and “heroes” to explain large-scale phenenema: If it happened, someone or something powerful must have willed it to be.

Generally you hear about the villians more. From gas prices (greedy oil CEOs) the housing bubble (speculators?) campaign idiocy (it’s the media!) . Or here in Latin America Argentines blame fallow soy fields on Bush (US soy demand leads to poor crop rotations). Of course, the world simply doesn’t concentrate power in a way that individuals can perpetrate large-scale phenomena.

The real power of economics is that it provides an alternative to the animistic fallacy. And this is why it should be taught to everyone (e.g. a high school requirement, not a college elective)

Economics teaches an inevitability of large-scale phenomena. Things happen, bad and good. And it’s not always because someone wanted it to be that way. It’s a democratic conspiracy — the sum of the small individual choices we all make day-to-day in pursuit of our individual best interest. And the writing is already on the wall long before the event.

The animistic fallacy gives hope to those that try to turn back the effects of inevitable large-scale phenomena. Globalization, shifting comparative advantage, commodity prices. The fallacy is this: Someone is making it happen and someone can stop it! Unfortunately for those adversely affected, this is simply not true.

As Sam often points out, economists turn a blind eye to the disadvantages of a more globalized world. I agree with him completely, but to me it’s a moot point. It’s happening and there’s nothing any one entity can do about it. The only question in my mind is how we should react.

BIP cards and the value of money

June 3, 2008

Sam and I have been far too benevolent in sparing you from unrepetant econ geekery. That is until now.

Similar to New York and Washington DC, residents of Santiago use stored value cards to pay for public transportation — the onomatopoeically named “BIP” cards (based on the beeping sound the machines make after you pay).

(Sidenote: The subject of public transport in Santiago is actually quite fascinating. In 2007, the city undertook a top-level wholesale redesign of the entire system, which was formally largely decentralized. The results have been disastrous, resulting in a precipitous drop in the President Michelle Bachelet’s approval rating. Transantiago is her Iraq War from a public approval standpoint. Some thoughts from the Antiplanner here.).

Anyhoo … an observation that I am currently having difficulty explaining:

When people scan their BIP card, the remaining account balance is displayed on the scanner screen. I’ve noticed that the average card balances are usually less than 1000 Pesos (about $2.20 or 2.5 trips). This means that people who commute on public transport everyday are constantly charging their cards. I usually load mine up with 10,000 pesos each time ($22 or 25 trips). Why waste the time filling it up so often?

What determines the “rational” amount to put on your card?. It must be a balancing act of three factors:
1) The pain you would feel if you lost the balance on your BIP card (i.e. how much you value money)
2) The probability you assign to losing your BIP card
3) The annoyance you personally feel at having to load up your card frequently

But it seems that my preference for keeping a 10X balance to the average Chilean can not be fully explained by 1) (my relative wealth) and there is no reason to believe that 2) and 3) would be so different for me. Chile is not an impoverished country. This can not be explained by working capital constraints. GDP per capita is around $14,000 and is probably much higher along my bus route in my wealthy neighborhood of Santiago. What gives? Any ideas? Why do people wait in line to charge these cards almost every day?

Also, is there an interesting natural experiment on how people value money hidden in the BIP card data? Seems so, but I’m having trouble formulating it.

Financing education on Wall Street?

May 22, 2008

Low education rates due to lack of financing (primary, secondary and tertiary) really bother me. And it’s not only because they perpetuate poverty, both domestic and international. It’s because it really doesn’t have to be that way.

Why?

Because the individual monetary returns on education (in increased future wages) usually far exceed the costs of providing the education. Toss aside any desire for social good and there is still profit to be made by financing education.

What’s implicit here is a challenge to whether education financing should be provided by the state at all. I would suggest that the private markets could step in and do a bang-up job. What they need is the right vehicle.

The right vehicle is this: Financing tuition with payback amounts based on the student’s future income. If you are a student, this could mean selling equity in your future income stream (on the extreme end). This may sound manipulative and predatory, but if you think about it, it’s really not. Low future earnings would mean that the loans are forgiven (or substantially reduced). High future income means you are subsidizing the low performers. It fundamentally operates the same way as progressive tax brackets.

Now there are questions of adverse selection and moral hazard (same sort of situation as microfinance) . But the investor, the student and society are all pretty well aligned on this. Harder study means higher wages for the student and greater returns for the investment and (directionally) more societal contribution. Artists might get a free ride on the back of the i-bankers — but maybe that’s the way it should be.

The role of the government in this system would be regulation, consumer protection and being the lender of last resort. Education is a human right. A system like the one above would be able to provide it to most. The state would need to provide for the rest.

Couple advantageous to consider
1) Increased competitive pressure would improve schools. Not only would schools be forced to compete for student tuition, but their ability to provide an education that lead to future high-income will be rewarded with higher tuition.
2) You can imagine this trickling down to our woefully underpaid teachers. Their ability to educate well means feedback in more demand for spots at a particular school, higher tuition and (hopefully) higher salaries to retain those teachers.
3) The market is allocating the resource, not government planners with imperfect information and perverse incentives. No more or less is spent on education than should be.

This approach has been tried a few times on a small scale — none have been too successful or replicated but I think it’s a matter of execution, not concept. MyRichUncle.com originally offered college loan interest rates based on future income, Yale Law School offered income-based loans payback with their Tuition Postponement Program. These models have all been either entirely or partially abandoned. (NB: The Australian Higher Education Contribution Scheme prices courses based on income grids, which is a form of this concept.)

Am I crazy here or does this make some sense? What do you think?

The economist in me is angry…

April 30, 2008

over obviously stupid water policy! The picture below is a household water tank, an all too common fixture on private properties throughout Nicaragua.

Depending on your neighborhood in Nicaragua, you’re pipes are likely to go dry for 10+ hours per day because there is not enough water for continuous service. Sometimes the dry periods follow a fixed schedule, but sometimes the dry times are random… for example when you’re coming back from a sweaty jog and you need to get ready for work.

I hired a maid to clean my house (which does not have a tank), and the first thing she did was to fill used containers (gallon jugs, bottles, etc) with water. Seemed like odd behaviour until I experienced an unexpected dry spell and needed the water to bathe.

Dry pipes make bad policy for several reasons:

  • Encourages a water tank “arms race,” in which people put effort into privately hoarding water
  • Leaves no incentive to save water while pipes are wet, which would allow more consistent water service
  • Denies consumers water even if they desperately need it (Just burned my finger! Need to shower before work!)

Note that if everyone had water tanks, making the pipes go dry would have no effect on saving water until at least some people’s tanks ran out. So dry spells would have to be longer and people would buy bigger tanks and dry spells would have to be longer still.

Better policy would be to raise the price of water, so that everyone thinks twice before letting it run. Revenues can be plowed into water investment. To protect poor people, water could be priced differently in disadvantaged neighborhoods (the cable company and the electricity company already do this in Nicaragua). The effect on farming should also be considered and policy perhaps modified appropriately.

The principle is clear: dry pipes make bad policy. Phil should write a haiku about market clearing prices.

Update:

David Zetland, Water Economist and author of Aguanomics, has provided more analysis on my post:

  • He describes possible causes of the water shortages
  • He suggests an alternate solution to protecting the poor against increasing prices

On the second point, while I suggested different prices in different neighborhoods, he suggests allocating a certain quantity of cheap water to each individual, with a sharply increasing price after the cheap water is consumed. That solution was the topic of his dissertation research.

Re trade divide: economists taking note

March 23, 2008

Just days after The invisible hand posted on the free trade divide, the conservative and influential Harvard economist Gregory Mankiw published on the subject in the New York Times, arguing essentially that:

  • All economists from Adam Smith to his own Harvard freshmen know that free trade is a no-brain win for all constituencies
  • Stupid Americans don’t understand free trade benefits because they prefer Lou Dobbs to economic literature
  • McCain is a sensible free-trade candidate while Democratic anti-trade rhetoric is pandering to aforementioned stupid Americans

The article is worth a read if you’re craving a healthy dose of:

  1. Elitism: Mankiw even refers to a caricature of working class Americans as “Joe Sixpack”
  2. Authoritative hand waving: within three paragraphs, Mankiw equates free trade with “greater overall prosperity”

It turns out that if blue collar workers did prefer economics literature, they would surely find some fuel for the anti-trade flame, although you’d never know it from glib public experts like Mankiw. Dani Rodrik, another very powerful Harvard economist has raised a flag. Rodrik argues that establishment economists’ public enthusiasm for trade ignores the nuanced economic literature and empirical evidence that show real disadvantages for some constituencies.

Professor Dean Baker’s recent trade paper provides an excellent and accessible review of existing studies. Specifically, we learn that American blue-collar workers have lost between $1,000 and $2,900 in yearly salary to free trade. Trade may be a large reason that blue collar wages have not kept pace with inflation for the past thirty years, despite high economic growth.

Of course there have also been winners from trade (note: this post treats costs and benefits in America, leaving important benefits to workers in developing countries for another discussion): specifically white collar workers and the owners of capital (rich people) have benefited. These are the “haves and the have-mores,” whom Bush famously addressed: “Some people call you the elite. I call you my base.” Mankiw has served as a top Bush adviser. As a consequence, Mankiw’s idea of “greater overall prosperity” may mean something different than it does for “Joe Sixpack.”

Ironically, this entire discussion supports a fundamental postulate of market ideologues like Mankiw: people act in their own self interest. Perhaps the majority of Americans are against free trade not because they are incapable of a lesson taught to Harvard freshman, but because it is against their self-interest. Perhaps some public economists ignore the disadvantages and nuances of empirical work on trade because of their position in society.

Personally, I tend to favor free trade, although I’m learning that there are many questions. We must challenge Mankiw and other econ 101 ideology. Most of all, economists need to speak up about mixed empirical evidence for the unfettered market fervor that has swept elite policy debate over the past twenty years.