Maxine Udall (girl economist)

A Conversation About Health Reform

I was having lunch last week with two colleagues, a fellow economist and a business school professor (and former physician assistant), when the discussion turned to the likely effects of health reform. The B-School prof mentioned that he knew of physicians who were planning to retire prior to 2014 rather than face the market force that is health reform. In a similar vein, a regular reader just sent me this article about docs fleeing Medicare's low payments and onerous rules.

Here's Dr. Juliette Madrigal-Dersch, an internist in Marble Falls, Texas, who has left Medicare altogether, and whose patients pay cash and cannot claim payment from Medicare for her services.

"The reason I opted out is because the reimbursement rates were low, the amount of paperwork was exceptionally high, and the fees -- even if you made an innocent error -- could be up to $10,000 per incident," she told American Medical News. "Why would you sign up for something that would guarantee to pay you less over time when you`re expected to work harder? We want to be able to spend our time caring for patients instead of assigning codes to them and filling out paperwork."

My first reaction was "At last, someone who is actually willing to be voluntarily under- or unemployed!" Followed almost immediately by, "Oh dear, this will rejuvenate rational expectations."

My second reaction was "I wonder how any of the roughly 10% of US workers who are unemployed feel when they read things like this?" I'm betting that even as I type some of them are considering "signing up" for a job that will probably "pay them less and expect them to work harder." I'm guessing most of them would like to spend their time doing whatever it is that they used to do at their old salary (and on their own terms, no less), instead of dealing with the vagaries of a changing economy.

And that got me thinking about changing economies, because even in the best of all possible worlds, change is what a well-functioning economy grounded in commercial enterprise and a well-functioning financial sector is supposed to deliver: the right mix of innovation and creative destruction. "Creative" because it promotes the necessary failures or resource shifts that must occur in order for technology, supply chains, and consumer products to evolve both in quality, in the characteristics and mix that best serve consumer preferences, and (if the market is doing its job) in lower prices, all else held constant.

I found myself contemplating the kind of market power one must have to tailor one's job, one's customers, the prices one charges, the means by which the prices are paid, and one's work load to one's very own preferences, even as the market shifts in new directions. There's a lot of economics and ethics in this, probably too much to cover in a single blog. And a frank discussion of it will almost certainly make your blogger very unpopular with some of her physician friends. So let me see if I can raise some issues without raising too many hackles.

For starters, during the conversation over lunch last week, I opined that paying physicians a salary rather than by piecework would do much to shift incentives away from "more is always and everywhere better," which almost certainly accounts for some of the reason that the US spends twice as much per capita on health as any other developed country (for which we obtain worse population health indicators than any other developed country). The former PA, now B-School prof, responded with an argument akin to those I have become accustomed to hearing from investment bankers and CEO's of large corporations. "How can we expect them to stay up all night with a sick patient, if they're on salary?" he asked.

The investment banker/CEO version of the question is some variant of "How can we expect innovation and shareholder value if we limit compensation?" Which in essence seems to ask: Why would anyone do their job well if they weren't paid astronomically? To which I say: Gosh, I don't know. Maybe we should ask the other 90% of the country who have seen their real wages fall while their real productivity has risen? Why do they do that, I wonder? Why don't they know that if you're not well-paid, then you should slack off, or charge more, or retire early? Are they unaware of a backward bending supply curve?

But I digress.

One possible answer to my colleague's question is: we'll pay nurses to stay up all night with sick patients. They've been doing it for years. I have nurse friends who actually become so invested in caring for a sick patient that they will stay on after their shift is over if the patient is in crisis. Last time I checked, they do this without receiving a bonus or even a particularly high salary in compensation for it. And they'll even call a doc if it seems a doc is needed.

Another possible answer is that maybe, just maybe, health care will evolve, finally, to a different, less physician-centric, physician intensive model, at least for acute primary care and chronic disease management. If so, health reform could be viewed as a "market force" in the sense that if it is done right it should mimic the results of a competitive market and produce a more efficient mix of inputs to health production. In what competitive market would management allow output to be constrained by skewing the production process toward the most expensive, most constrained input when other lower priced substitutes were available, at least for some products? (No, I'm not suggesting that docs and nurses are perfect substitutes in all cases. I'm suggesting that over some range of services they are probably near perfect substitutes and if health care markets were not characterized by a long history of physician rent-seeking, we would see different production processes that combined inputs differently and less expensively.)

A final possible answer is that maybe the way we've structured health care financing has induced selection bias in physicians in much the same way that CEO and investment banker compensation schemes may have altered the types of individuals attracted to those jobs. If this is the case, then a little correction in the selection effect may be just what the doctor ordered for US health care (and investment banking). I'm willing to bet that most good docs will stay with a patient in crisis even when they're salaried and they won't mind being salaried as long as we figure out how to reduce their med school indebtedness. The evidence from Cleveland Clinic, Mayo Clinic, and Geisinger suggest that improved quality and reduced costs using salaried physicians is a viable model.

What are some of the obstacles that impede changing the way physicians (and investment bankers)are paid? Well, certainly concentrated (and self-interested) economic and political power are important obstacles, but in a democracy they should be surmountable. I suspect that the obstacle that matters most (because it undermines democratic response in opposition to concentrated economic and political power) is cultural beliefs that enable the incomes of the top of the US income distribution to outpace the incomes of the middle and bottom. We teach in Econ 101 that people's wage rates reflect the value of their marginal product (give or take some positional effects that may tend to shrink the wage distribution when fairness matters). The cultural narrative that resonates with increased wage disparity says that people who are paid more are more productive, more innovative, create more wealth. The high wages compensate them and keep them working to the benefit of us all. Let's repeat that last part: to the benefit of us all. The discrepancy is fair because we all benefit from their increased skill, ability, productivity, and work effort.

The problem is that we now have clear counter-examples. The financial sector has siphoned off trillions of dollars that could have been used to improve all of our lives: investments in health and human capital and investments in physical capital would all have improved our society and our economy for generations to come. The high salaries paid in that sector do not reflect wealth creation, except for those receiving the salaries. At present, the health care sector is distorting resources in much the same way, but on a smaller scale. Roughly $3,000 per US resident is wasted each year on health care that does not yield a comparable rise in benefit as measured by population health indicators. In fact, many US health indicators are worse than those of other developed countries. This almost certainly implies negative marginal product from some inputs (for those of you who speak the econ lingo) or waste (for those of you who don't). It's probably no coincidence that both sectors are characterized by information asymmetries and agency problems. Changing how docs are compensated won't fix all that ails the health care sector, but it should reduce some of the agency problems.

Health reform is aimed at correcting some of these problems.  I don't know how it will ultimately shape US health care, but I'm pretty confident that changing how docs are compensated and creating a larger role for nurses and physician assistants, particularly in primary care and chronic disease management, will not only reduce health care costs, it will improve access to and quality of care. That most nurses will stay up all night with a sick patient at half or even three quarters of the cost of having a doc do it seems to be just what a well-functioning competitive market would reward.

David Coates on Why Elizabeth Warren Should Head CFPA

Professor David Coates, Worrell Chair of Anglo-American Studies at Wake Forest University, asks

So why is the possible appointment of Elizabeth Warren to head the agency whose creation she championed now causing such waves? What unwritten codes might Elizabeth Warren inadvertently have broken?

He goes on to review and summarize Professor Warren's reports for the Congressional TARP oversight panel as well as a news interview, concluding that

...Elizabeth Warren has proved over and over again that she will fight for the full implementation of programs designed to promote the health of Main Street, not just that of Wall Street.... in 2009 she had both the capacity and the courage to turn a small but empowered Oversight Panel into a major watchdog for the interests of ordinary Americans. ...since she has performed that task once, she can legitimately be expected to do it again.

There is no gain in giving teeth to a watch-dog if the watch-dog will not bite. Elizabeth Warren clearly bites. It is not much fun for those being bitten, but then they shouldn’t have needed biting in the first place. Biting is good when the cause is right. Tim Geithner might not want Elizabeth Warren to head up the Consumer Financial Protection Agency; but the rest of us definitely should.

Read the full blog here please.

Trickle Down Meanness

Linda Beale over at ataxingmatter had a really excellent post a few days ago about a study by Sreedhari Desai, Arthur Brief, and Jennifer George that examines

...a heretofore ignored consequence of rising executive compensation. Specifically, we claim that higher income inequality between executives and ordinary workers results in executives perceiving themselves as being all-powerful and this perception of power leads them to maltreat rank and file workers. We present findings from two studies - an archival study and a laboratory experiment – that show that increasing executive compensation results in executives behaving meanly toward those lower down the hierarchy.

The study conclusions are consistent with my own conjectures that there are ethical as well as economic consequences that result from dysfunctional financial markets and the dysfunctional labor markets they induce. The economic consequences include gross misallocations of financial, physical and human capital, away from activities that would promote long run economic growth and well being and to activities that will promote rising income inequality. The ethical consequences are erosion of trust and compassion, both prerequisites to fairness in rewarding contributions to long run growth and prosperity. If the above study is right, we can add frank meanness to the list of ethical consequences.

Adam Smith wrote about the influence of prevailing custom and fashion on moral sentiments in Theory of Moral Sentiments.

The different situations of different ages and countries are apt, in the same manner, to give different characters to the generality of those who live in them, and their sentiments concerning the particular degree of each quality, that is either blamable or praise-worthy, vary, according to that degree which is usual in their own country, and in their own times. 

Nowadays, most of us would object to what appears to be cultural or ethnic stereotyping in some of what Smith wrote. I am unable to say to what extent Smith's views reflected then existing national and cultural heterogeneity that will have no doubt been rendered by economic development more homogeneous over time. Smith was a sound thinker and critical observer, which causes me to attribute his generalizations about different nationalities somewhat to Scots-Anglo ethnocentrism and somewhat to possible real national differences. Nevertheless, his main point seems valid: that what is "either blamable or praiseworthy" varies "according to that degree which is usual" in our own country and own times, that our moral sentiments and behavior are shaped to some extent by the culture in which we dwell.

Smith goes on to discuss "customary characters" of professions and stages of life, conjecturing that they are shaped by the moral sentiments that accompany and promote the duties of a given profession or of a specific stage in the life cycle. Thus, some professions and life stages are more reticent or staid than others. But, while Smith sees custom in the form of social and professional norms reinforcing good moral sentiments and behavior, he also sees it as something that can erode the same.

It is not therefore in the general style of conduct or behaviour that custom authorises the widest departure from what is the natural propriety of action. With regard to particular usages, its influence is often much more destructive of good morals, and it is capable of establishing, as lawful and blameless, particular actions, which shock the plainest principles of right and wrong.

His point being that just as self-interest can prevent us seeing impropriety and injustice, so too can culture and custom. A slave holder in the antebellum US South had self-interested reasons for believing slavery to be morally acceptable. A poor white worker whose wages were depressed by the availability of slave labor might still find slavery acceptable and worth fighting to preserve because the norms and customs of his culture find no impropriety in slavery.

If the US norm becomes extreme income inequality and the custom becomes meanness trickled down from those who reap rewards disproportionate to their product, will it ultimately lead to establishment "as lawful and blameless, particular actions, which shock the plainest principles of right and wrong?"

Causal relationships are always difficult to establish in non-experimental settings. Desai, Brief and George provide results from a small experiment that lend support to their conclusion that increased wage disparity engenders meanness or as Smith might call it "lack of sympathy" among those at the top for those at the middle and bottom of the wage pyramid. Nevertheless, it remains difficult at the societal level to determine to what extent economics shapes ethics and to what extent ethics shapes economics and economic systems.

I would be willing to bet that just as disparity between worker and CEO pay has produced "meanness," so has growing US income inequality produced similar disruption of fellow feeling in the population generally. As the "distance" between the wage rates at the top of the US income distribution and the middle and bottom of the distribution has increased, so has grown the "distance" in sympathy one for the other.

This is not an argument for income equality. There is every reason to believe that most people in the US approve of income differences based on rewards for greater productivity or other merit. I happen to share those views. However, the current disproportionate increase in the percent of national output going to the top 1% of the population, despite increasing productivity among those of us still employed and those who were employed up until 2 years ago, suggests that merit is no longer the trait that is being rewarded.

The conclusion seems self-evident. There is more at stake here than our economy. We must, as a nation, decide whether we want to continue on the path we have been on since roughly 1980. Do we want to continue to reward disproportionately a small fraction of the population that (based on recent performance) seems better at misallocating financial, physical, and human capital through speculative endeavors? Do we want to continue the trickle down of meanness? Shall we live in a society in which trust and fellow feeling are lost, replaced by mindless (not rational, not productive) winner-take-all competition that favors one group disproportionately? If the answers to these questions are all "yes," then the social fabric may already be torn beyond repair and I fear we are about to learn firsthand how empires crumble.

Of Innovation and Confidence Tricks

For months now, I've been remembering my great uncle Oscar and some of my more distant relatives, usually when I hear someone assert that regulating consumer financial products will stifle innovation and creativity. 

I have mentioned before that I grew up among businessmen and women. When I have blogged about them, I have tended to focus on the immediate family for important reasons: 1) they are the ones I know best and 2) this blog more or less focuses on the intersection of economics and ethics. When I go further afield than aunts, uncles, first cousins, parents, and grandparents, the intersection of economics and ethics in some of the more distal branches of my family tree approaches the null set.

So let me tell you about great uncle Oscar. Great uncle Oscar is regarded as the family's itinerant "entrepreneur." He traveled throughout the US mid-west in the early 20th century selling "pillow ventilators." No one in the family has ever been sure what a pillow ventilator is (although thanks to Google books, I now know and you can, too), but we were all pretty well convinced that whatever it was it had no real value (use value as it used to be called). That didn't stop great uncle Oscar from selling them to people. And since people bought them, I have to assume (as an economist) that the price they paid corresponded in a money metric to some incremental gain in utility they expected to obtain from owning one (or a set for the entire family).

The point being that great uncle Oscar made a living selling something that may have had very little objective value (in terms of its purported abilities to freshen pillows). Nevertheless, (good salesman that he was) he was able to elicit in rational humans a desire to part with money in exchange for it. Were they better off? They thought they were or they wouldn't have parted with the cash and that's all that matters in economic theory. But I digress.

Now consider another of my great uncles (Oscar's brother). He owned a store that sold durable goods in a small Appalachian town during the Depression. Despite the depression, he managed to purchase a late-model car. How could he afford a new car during the Depression, you ask? Well, he was creative. He parked the new car in his sales window with a sign that announced that a chance for a free car would be given with each purchase of merchandise from the store. After a month or so of stronger than usual sales, my great uncle gave away a car. Minor detail: the car he gave away was his old car, not the new one in the window. It's a whole new nuance on bait and switch. 

And then there was second cousin Charlie, now departed. I loved second cousin Charlie. He was a sweet, generous man. I loved his wife and his kids. He was a charming raconteur and a wheeler dealer from way back. During the depression, he and his two brothers would place ads in local newspapers along the Appalachian spine of the east coast, occasionally making forays into the adjacent flatlands. The ads were for secretarial and clerical jobs. This guaranteed that only women would show up. They would rent a hotel room (no, this isn't going where you think it's going) and when some poor woman, desperate for work showed up, they would tell her the job had been filled. This usually elicited a hard luck story from the woman which allowed them to ask if she had any jewelry she would like to sell. Often she did, either on her (since she dressed for a job interview) or nearby. Charlie and his brothers bought the jewelry and sold it at a profit. This isn't necessarily a bad thing. After all, it provided the women with cash that they needed at a time when they needed it. I've always hoped the women didn't part with family heirlooms and I've always hoped that second cousin Charlie paid something that resembled a fair market price to them. Lest you think entirely badly of him, you need to know that Charlie went on to a very successful career in real estate (after WW II) and later devoted much of his income and time in his waning years to an orphanage and to getting kids with birth defects the surgery they needed to live normal lives. He was a businessman and he had a good heart.

Why am I telling you all this?

Because, much as I love all of the entrepreneurs and innovators to whom I'm distantly related (I've always pictured Oscar and his brother as Garth and Hub in Secondhand Lions), they occasionally sailed a little close to the ethical winds. It is sometimes a very fine line between innovation and a confidence trick, between an innovator and a con artist. Many of us won't buy pillow ventilators at any price, but I'm pretty sure many of us are consuming prescription drugs that are of little or no incremental benefit compared to a cheaper generic or OTC drug. When we're down and out and desperate, many of us will not be "rational" and will be more easily parted from things of value, like jewelry or money, without receiving fair recompense. When it comes to complex, innovative financial products like mortgages, credit card agreements, and payday loans, the opportunities for rent-seeking by those with economic and political power and information asymmetries on their side are staggering to contemplate. 

Are all entrepreneurs and innovators outright or borderline con artists? Not by a long shot, but financial products seem to offer more opportunities for destructive innovation. As financial products get more complex you can't always rely on customers to know the difference between a product that is akin to a confidence trick and a product that is truly beneficial. Can we rely on the creators of financial products to innovate in ways that are truly beneficial (to both customer and society)? As we contemplate this question, we have a track record from which to extrapolate. Here's Joe Stiglitz (Nobel Memorial Prize in Economic Sciences, 2001)from his book, Freefall:

In all these go-go years of cheap money, Wall Street did not come up with a good mortgage product. A good mortgage product would have low transaction costs and low interest rates and would have helped people manage the risk of home ownership, including protection in the event their house loses value or borrowers lose their job. Homeowners also want monthly payments that are predictable, that don't shoot up without warning, and that don't have hidden costs. The US financial markets didn't look to construct these better products, even though they are in use in other countries. Instead Wall Street firms, focused on maximizing their returns, came up with mortgages that had high transaction costs and variable interest rates with payments that could suddenly spike, but with no protection against the risk of a loss in home value or the risk of job loss.

So now you know why lately I've been thinking more about my distant businessmen relatives. And you understand the dismay I feel when I read that Tim Geithner (and maybe Larry Summers) are opposed to Elizabeth Warren as head of the new Consumer Financial Protection Board . Yves Smith reports that Warren is not opposed by Treasury after all, but I'm not reassured.

We need someone who is clearly, unequivocally on the consumer's side, not the side of the firms that create and sell such products. At present, I suspect the average US resident would agree, regardless of political ideology, that the current administration appears to be altogether too much on the side of  and sympathetic to the creators of financial "innovation." Paul Krugman, blogging about Elizabeth Warren as a potential candidate to head the CFPB, said it best:

There’s also a political aspect. The Obama administration suffers from the perception that it’s been too much in the pocket of Wall Street — partly because there’s at least a grain of truth to the accusation. Appointing a prominent pro-consumer crusader would have to help repair the image, while appointing somebody unknown to the public, especially when expectations are running high, would hurt.

That's the politically expedient reason to appoint Warren. The economically sound reason is that not all innovation delivers benefits, either individually or socially. We know from recent experience that markets don't do such a good job of policing complex risk-obscured financial products.  I have every confidence that Wall Street and investment bank interests will be represented no matter who heads the CFPB. I want some assurance that Main Street's interests are also represented in deciding how financial products are packaged and marketed to my neighbors, my relatives, and to people I only pass in the street. Elizabeth Warren as head of the CFPB would be an important first step in tipping the scales toward Main Street and a more secure and growing middle class.

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Note: all family names have been changed to protect the culprits. It was a long time ago and they're all dead. RIP.

Size Matters

Whenever I think of markets and the businesses that (at least in theory) compete in them, I think of sailboats.

For many years, my small businessman father never took a day off, but in my teens he acquired a fourteen foot wooden sailboat. (A Blue Jay for those of you who care about such things.) In addition to a mainsail, it had a jib and spinnaker, which is why it took two people to sail her (at least when we were racing). On many Sundays (the only day he could take off thanks to Blue Laws) dad and I would head to the local lake to compete in races. We couldn't help ourselves. I think competition was in our blood.

And we were snobs. Not about the "yacht" club that we helped start (it had no clubhouse, no dues, it was just a way of organizing races). We were snobs about sailing a small boat. We knew that the smaller the boat, the more likely you were to turn turtle.  "Turn turtle" is much more descriptive than "capsize." It captures the helplessness of having one's mast on or under water, especially if one is sailing a non-self-righting boat as we were. The ignominy of being towed back to port haunted us. The knowledge that it had never happened buoyed our snobbishness about the superiority of small boat sailors.

We once gave the helm to an experienced owner of a 36 foot sailboat and he nearly turned turtle after an involuntary jibe in erratic winds. Fortunately, he ducked and the boom missed him. It would have been funnier if it hadn't been our boat we were watching from the shore. In a similar vein, my mother who was used to sailing our boat, borrowed a small(er) Sunfish thinking it would be fun to zip around the lake in it. So it would have been, if she could have kept it upright.  Fortunately, Sunfish are self-righting. She got a workout that day.

The point here is that, in general, the smaller the boat, the harder it is to keep it upright and underway.

We were real amateurs at racing, but I remember one of the key strategies was not to let another sailboat block your wind (for obvious reasons). Much of my time as first mate (when I wasn't setting jib or hoisting the spinnaker) was spent watching the competition and letting the skipper aka dad (seated on the gunwale facing leeward) know if any other boats were maneuvering to cut off our wind. Because it was a small club, there weren't enough boats like ours to make up a class , which meant there were often larger boats in the race. Larger boats were even more of a threat because their larger sail area made them more effective at blocking a smaller boat's wind. Make no mistake, this was a strategy everyone used, but the big boats had an advantage. They were much more effective at it.

As someone who enjoys competition and has occasionally won or placed, I have always made a distinction between winning because you're faster and winning because you tripped the other guy. I don't think I'm alone in this.

The astute among you (and all my readers are astute) will now understand my title and my opening sentence.

The parts of economic theory that easily translate in soundbites to non-economists assume that the actors and agents in markets are all like small sailboats. Buffeted by competitive forces, the efficient, productive businesses remain upright, the inefficient, unproductive, inept businesses turn turtle to the benefit of us all (including, in the long-run, the inept because they are freed to pursue ends to which they are better suited). Competitive (free) markets we are told will sweep the inefficient (read unworthy) from the race to make room for efficient (read worthy) businesses that will lead us to greater economic growth and prosperity. The "creative destruction" of capitalism. We lose inefficiency and gain innovation and progress. Win-win.

Who could ask for anything more? It's a lovely idea that resonates both morally and practically. It has the beauty of a well-made watch and the elegance of a mathematical proof.

The problem is that like small sailboats with a competent helmsman in high or erratic winds, even efficient, innovative, well-run small businesses are easier to turn turtle in an economy-wide recession/depression. And just like small sailboats with a competent helmsman in a race, it easier for large firms to block the "wind" of small innovative, productive firms, stifling innovation, growth, progress, and sometimes even costing lives. It also costs us jobs. Small businesses power roughly 50% of job creation in the US.

Now that you understand small sailboats, I want you to read Mariah Blake's Washington Monthly article, Dirty Medicine. I want you to think about how large firms and large group purchasing organizations are blocking the financial "wind" that powers small start ups, innovation, and new jobs creation. I want you to think about all the "destructive destruction" that is occurring because small innovators and entrepreneurs are being hard hit by an economy-wide downturn and by larger firms blocking their "wind." And don't imagine that health is the only sector where wind is being blocked.

My one quibble with the article is the following:

This is hardly the first time Shaw has found his path to market blocked. In fact, he has spent the last fifteen years watching his potentially game-changing inventions collect dust on warehouse shelves. And the same is true of countless other small medical suppliers. Their plight is just the most visible outgrowth of the tangled system hospitals use to purchase their supplies—a system built on a seemingly minor provision in Medicare law that few people even know about. It’s a system that has stifled innovation and kept lifesaving medical devices off the market. And while it’s supposed to curb prices, it may actually be driving up the cost of medical supplies, the second largest expenditure for our nation’s hospitals and clinics and a major contributor to the ballooning cost of health care, which consumes nearly a fifth of our gross domestic product. [Emphasis added.]

I quibble with it because it seems to imply that the guvmint is the problem. And in a way it is. But the guvmint won't stop being a problem until we, the people, understand that the guvmint doesn't do anything unless there's a campaign contribution in it for someone. The campaign contributions come from large businesses and are aimed at fixing the sailboat race. As long as we continue to drink the guvmint-is-the-problem kool-aid, as long as we are determined to shrink the government that is of, by and for us to a size that cannot effectively regulate the big sailboats, as long as we continue to believe that a theory about small sailboats applies to an economy dominated by mega-multinational sailboats, small businesses will turn turtle, health care costs will continue to rise (read the article), large business will increase market power and become even more effective at blocking the winds of job creation, innovation and progress.

It isn't just the small sailboats that are losing the race. We are all losing. Sensible, effective regulation of markets dominated by large sailboats, empowered by an informed electorate in a country with a government of, by and for the people, is the obvious next step if the necessary destruction engendered by a capitalist economy characterized by competitive commercial enterprise is to remain creative and a benefit to us all.

Crises of Capitalism: The Animated Version

This came out while I was off traveling, so most of you have no doubt already seen it. I place it here simply because I think it's really quite good and I'm in the midst of meeting a deadline so don't have much time for a longer blog.

I pretty much hate it when Marxists make sense. All those years growing up among the bourgeoisie have ruined me, I fear. But I tend to pay attention to them because they're very good at noticing that there is a problem. This video is an excellent description of the problem. I was relieved that no (Marxist) solution was offered so that I could entirely agree that more informed, broader, more open discourse is needed as well as new perspectives.

I had to reduce the size to fit it on my blog page. If you view it on youtube you'll be able to read the writing. Here's the link

Hat tip, rjs.

There's Probably More Than One Road to Serfdom

Four days of R&R gave me time nearly to finish Merchants of Doubt: How a Handful of Scientists Obscured the Truth on Issues from Tobacco Smoke to Global Warming by Naomi Oreskes and Erick M. Conway. I was prompted to read it by this book review in the June 17 Economist and by some previous work I have done that required me to investigate documents contained in the Legacy Tobacco Documents Library, particularly as they related to US tobacco farmers.

I will confess that I came to tobacco research with a pretty open attitude regarding consumer sovereignty. I assumed (this was around 2004) that everyone who smoked understood that they were elevating their risk for lung and other cancers and cardio-vascular disease; that they had evaluated the trade offs and had made a fully-informed, rational decision to smoke. One study, done before the link between second hand smoke and negative health outcomes among "innocent bystanders" had been established, found that most of smoking's costs fell on the smoker, that smokers imposed few costs on non-smokers, mainly because smokers tended to die old enough to be on the downside of their productive output, but young enough to pay into things like Social Security, but not collect from them. I'm embarrassed to say that as an economist, I found a certain efficient beauty in this. However, as a person with mild allergic reactions to cigarette smoke, I wasn't convinced that all the externalities were adequately internalized.

It didn't take long to recognize how naive I was. It seemed reasonable to assume that all smokers were fully informed about the contents and risks of the product they were consuming. The link to lung cancer had been pretty well established since the mid 1950's (see here and here, for example). Then I read David Kessler's book, A Question of Intent: A Great American Battle with a Deadly Industry . Imagine my shock (yes, really) when I discovered that tobacco manufacturers had lied about the risks of smoking, deliberately attempted to cast doubt on consistent scientific findings of those risks, added substances to cigarettes that were designed to increase nicotine delivery and thereby addiction, understood that they were marketing an addictive substance, and were deliberately attempting to recruit younger people to smoke.(For a good review of tobacco industry documents pertaining to marketing and pricing strategies, see this article.)

Issues of consumer sovereignty and "personal freedom" become more difficult when information provided by a manufacturer about the potential harms associated with consumption of a good is intentionally distorted or when the good is addictive. Marketing an addictive substance to youth (who are notoriously myopic when it comes to evaluating potential future (bad) states of the world) surely deserves a special place in hell, yes? 

Talk about roads to serfdom.

The Oreskes and Conway book provides even more detail about the concerted efforts by tobacco companies to distort and obscure (in self-serving ways) information about health risks in order to maintain profits. Tobacco companies obscured risk primarily by exploiting the uncertainty inherent in population-based statistics when applied to individual outcomes. What do I mean by this? Let me give you a real world example.

Several years ago, a friend was diagnosed with cancer. His oncologist (at a leading medical center always at the top of the US News and World Report rankings) announced that my friend needed to know his "odds of survival." My friend, trained in biostatistics and epidemiology, interjected that there was virtually no individually relevant information in his "odds of survival" because the odds ratio is a population statistic. My friend was interested in whether or not he would be alive, say, one year from the time the conversation was taking place. He was not interested in how many out of 100 people with exactly the same type of cancer he had would be alive at the end of the year. He knew that his individual probability of survival was either zero or one (dead or alive). The population statistic told him nothing about his individual probability of survival.

The doc gave my friend very low (population) odds of survival. Eight years later, my friend is still disease free. You see the point? Population statistics do not perfectly predict anything about a single individual. Tobacco companies used this feature of population statistics to cast doubt on a causal link between smoking and lung cancer.

Practically speaking, risk that is elevated in combination with the lethality of most smoking-induced lung cancers represents the potential for significant individual harm. Most rational, risk-averse individuals, if given the correct information, would probably opt to avoid the elevation in risk. Correct estimates of the population odds can be very informative when making decisions about engaging in risky behavior prior to exposure.

Intentionally distorting information about risk seems like a road to worse than serfdom for those expected to make rational decisions based on the information.

Commercial exchange in transparent markets usually results in benefits to all parties. It is something every society should desire. However, tobacco is almost certainly an exception to this. I won't dispute Angus Deaton's point that smokers may well benefit in ways that offset (for them) their increased risk of a shorter life. I also agree that it is preferred, all else equal, that the individual be free to make such decisions. But, therein lies the rub, IMHO. The liberty of tobacco manufacturers, the liberty of smokers, and the liberty of people with asthma for whom tobacco smoke can be life threatening in more immediate ways than aggressive carcinomas all matter. There is almost certainly no way to assure unfettered, unprincipled liberty to all of these actors at all times.

Oreskes and Conway quote Isaiah Berlin: "Liberty for wolves means death to lambs." In their book, it's pretty clear that money and power directed by self-interest have worked overtime to confuse issues of risk and health with issues of freedom, liberty, and personal choice. Such efforts will almost assuredly give the "wolves" an advantage in any discussion about the merits of regulation. It's not unlike discussions about financial reform and regulation, consumer financial product protections, or corporate "free speech."  

Liberty (or consumer sovereignty, which seems often to be the sole embodiment of liberty in some discourse) is not so straightforward. Am I free and sovereign if I'm acting on manipulated, distorted information provided by the manufacturer of a (harmful) good?  Am I free and sovereign to impose costs on my neighbors, my community, and my nation by failing to purchase health insurance or by repealing health reform, and then expecting to be treated, at the expense of taxpayers or individuals who did purchase health insurance, when I show up at the emergency department? To what extent do ethical constraints restrict liberty and do such restrictions represent a loss of freedom or a gain? If individuals and corporations have a right to free political speech, do they also have ethical obligations or may they simply pursue single-minded, self-interested ends with little regard for the long-term consequences to the rest of us? What does profit represent? Is it a return to the ability to dupe amateurs or is it a return to the ability to provide expert information about a product and to help amateurs to identify the product that best fits their preferences, their budget constraint, and their long-term goals?

The last is the commercial exchange that I grew up with. It did not require regulation. We understood that we were the experts and that our expertise was why our customers were paying us a mark up above costs: not to dupe them, but to help them achieve that maximum of utility our economics textbooks extol.

The above are all questions that we as a society, as a nation, and as a discipline must start to ask and to answer (in more than the 25 word sound bites that play well at MSNBC and Fox news). Economics and economists understand better than most the impossibility of a Paretian liberal. We as a discipline must advance this dialogue in ways that move us ahead in resolving the necessary conflicts of a society that values individual freedom and choice, the social benefits of efficient allocations and prices, and some necessary, yet to be determined, level of collective well-being that enhances those same freedoms, choices, and efficiencies.

Yes, Let's Increase Financial Literacy

A recent New Yorker article by James Surowiecki on the Dangers of Financial Illiteracy is a must read, especially by the financially literate and the lucky "quants" among us. It is also a must read for anyone who believes that we can rely on (and blame when they default) individuals who "pick a loan payment".

Lest you read the article and assume that the financially illiterate are all at the bottom of the education-economic pyramid, let me assure you they are not. Twice during my lifetime, I have had friends approach me (I think because people often assume that a PhD in econ qualifies one to give financial advice) with a question about paying off credit card debt. The questions took the form of "should I pay off the balance on my credit card or should I (do something else)?" In one case the person was an extremely intelligent, well-read PhD candidate in a non-quantitative field. The other person was also smart and college educated.

In both cases, I explained in words how they would end up paying way more than their balance if they paid the minimum balance each month (which one was doing). In both cases they seemed unmoved by this so I had them plug their balance into the loan amortization spreadsheet that comes with MS excel along with whatever payment they had been making and then note 1) how long it would take them to pay off the balance and 2) the total amount they would pay. Both my friends were truly shocked when they saw the amount and the length of time. Granted these were nominal dollars, but inflation was relatively low (~2%) and the interest rates were quite high (~10%)in both cases. One friend had sufficient cash to pay off the loan in its entirety (about $5000) and did so immediately. He has never carried a balance since. The other adopted a payment schedule that resulted in a zero balance within 12 months.

My point here is that Surowiecki's suggestion that we adopt the "financial equivalent of 'driver's ed' " is right on and critical, IMHO. At least one undergrad program I'm familiar with provides exposure to interest/amortization in their basic required "math for poets" course. But, college is too late and interest/amortization is only a start. The material should be placed in a real world context, related directly and graphically to credit card balances as I did for my friends and to home loans.

In some ways this could be thought of as just one facet of a broader effort to improve the relevance of the math that most kids learn in high school and as undergrads. The areas where an informed electorate and informed consumers require math skills over the life cycle are in loans, credit, interest, investment and in probability and statistics, not calculus. This doesn't mean we should stop teaching calculus to the college bound. It means we should be arming everyone with the knowledge they need to avoid predatory lending practices and to make at least an educated stab at understanding and evaluating risk. The latter will matter if we are sincere about improving patient information and giving patients a greater role in medical decision-making.

Financial literacy is likely to yield real macroeconomic benefits for all of us. Until recently, the national savings rate had declined rather dramatically. It appears to be rising now, partly because consumers have finally confronted the true costs of borrowing. In an ideal world, household savings fuel rational, thoughtful, efficient investment and economic growth (as opposed to irrational, inefficient investment in dot.coms, excess housing, and derivatives). 

Assuming new financial regulations are adopted and "fix" the moral hazard the bailout has created on the "investment" side, increased financial literacy should contribute to greater efficiency on the savings side. This would almost certainly generate significant and positive side effects for everyone, including those of us who are already financially literate.

Ouch!

Still traveling (and catching up on reading), but had to post the following from the Telegraph's International Business Editor, Ambrose Evans-Pritchard, in response to poor (at best misguided, at worst brain-washed, now beleaguered) Richmond Va. Federal Reserve Economist, Kartik Athreya (link to paper here).You can get a sense of how beleaguered here, here, here and (I especially like this comment by Rajiv Sethi) here.

Evans-Pritchard is harsher on the profession than I would be:

Economics should never be treated as a science. Its claims are not falsifiable, which is why economists can disagree so violently among themselves: a rarer spectacle in science, where disputes are usually resolved one way or another by hard data.

It is a branch of anthropology and psychology, a moral discipline if you like. Anybody who loses sight of this is a public nuisance, starting with Dr Athreya.

I suspect he's harsher because he hasn't spent as much time among psychologists, sociologists, and anthropologists as I have. We may not bring much to the table, but at least economists have a strong sense of the potential value of efficient production and allocation. Recognizing the importance of a budget constraint is also not a bad place to start from in examining both human behavior, the aggregate behavior of markets and economic actors within them, and the welfare and wealth of nations. 

On the other hand, Evans-Pritchard's view that Athreya is advocating that

Matters of economic policy should be reserved to a priesthood with the correct post-doctoral credentials, which would of course have excluded David Hume, Adam Smith, and arguably John Maynard Keynes (a mathematics graduate, with a tripos foray in moral sciences).

Seems right on. Athreya's position is not that much different from the profession's own (implicit) attitudes about whose voice should count in economic policy (at least up until the recent financial sector problems). His specific critique of Elizabeth Warren as a voice that should be ignored seems remarkably similar to voices that urged that Brooksley Born be stopped from regulating derivatives in the late 1990s. The "priest" who is common to both the Rajan and Born episodes appears to be Larry Summers. (I'll leave it to my disciplinary brethren to decide whether there is information in that.)

The tempest within the econ blogosphere that poor Mr. Athreya has triggered has, IMHO, a much deeper and philosophical undercurrent that I am not able to do justice to in a brief post written between stops. It relates to very fundamental questions about economic methodology, about the ways in which conjectures about economic actors and economic outcomes become theory and how those theories are evaluated and judged relative to other theories.

Evans-Pritchard alludes to this when he says that "[economics'] claims are not falsibiable."

I will simply close by saying that within the discipline, a hard core of theory has evolved, with sometimes too little attention paid to the historical and institutional contexts that gave rise to the phenomena upon which the theory is based. Over time and in the absence of falsifiable propositions, the preservation of theoretical consistency has tended to dominate and counter trends that would otherwise tend to reconcile theory with reality. The isolation of theory from reality, bolstered by a liturgy conducted in a language that few outside the religion understand, may have, in turn, allowed certain aspects of the theory to be uncritically co-opted by certain groups to further their causes at the expense of the general public's interest and general welfare.

New eyes, untrained and unbiased by indoctrination into the hard core of economic theory and its accompanying heuristics and corollaries, may well be exactly what economics needs to become a true and more useful science.

******************

hat tip to rjs for supplying the Evans-Pritchard link.

Could We Require Bailed Out Investment Bankers & Auto Company CEOs to Sign an Affidavit?

I used a recent five hour train ride to a conference to catch up on non-academic reading. The July issue of Harpers Magazine has a pretty disturbing article by Ken Silverstein on the effect of tea party-like political "thought" on Arizona's political economy. (Subscription required unfortunately, but well worth the news stand price to also read Frederick Kaufman's article on Goldman Sachs' manipulation of commodities futures to their own advantage (and the disadvantage of anyone without much income who relies on food to survive)).

Anyone tempted to shrink government and drown it in a bathtub would do well to read the Silverstein article before committing the nation to such a course by their choices in the mid-term elections. (Unless you like the idea of auctioning the White House and Capitol Building to the highest bidder and then renting them back.)

But it was the players in this (now) state-level (maybe soon national-level) drama who really capture one's attention.

First, there's Sylvia Allen, real estate broker, who was appointed by the local GOP to finish the term of an AZ conservative who died in office. She's expected to win in the next election. She's been advocating increased uranium mining in AZ and said in a speech

"this earth has been here for 6,000 years, long before anybody had environmental laws, and somehow it hasn't been done away with."

Leaving aside the minor quibble over the real age of the Earth, does it occur to her that the technology has changed and with it the environmental risk, and that maybe, just maybe, Yahweh intended for us to use our brains not just to develop technology, but also to do it in a way that honored and preserved all else given to us? I believe she made the statement before the Gulf of BP disaster so I'll give her the benefit of the doubt and assume that even if she's intellectually unable to accept or process scientific evidence of the earth's real age, she is now aware that for most of those 6000 years (or whatever), our technology has not had quite the same capacity to inflict long-term harm with practically important economic side-effects that cannot be easily remedied after the fact.

Allen is also on record complaining that "trees are 'stealing Arizona's water supply.' "

Yeah, what's with those thieving trees anyhow? And "Arizona's water supply?" Last time I checked, AZ didn't have much of a water supply what with ground water depletion and having to share the Colorado River with six other states. Somehow I think population growth during the housing boom and the quaint custom still practiced in some of the older neighborhoods (at least last time I was there) of flooding one's yard every day might be a bigger threat than a palo verde tree. Or maybe she was referring to the deciduous and fruit trees imported by easterners and mid-westerners in an effort to simulate the flora of a temperate climate. Either way, it doesn't seem like the trees are the real problem.

But my favorite is AZ State Rep Frank Antenori, "recently appointed to a state senate seat," who proposed "that welfare recipients be required to sign an affidavit swearing they do not smoke, drink, use drugs, or have more than basic cable."

It got me wondering: what income does one have to exceed or what amount of bailout must one require before right wing politicians are no longer troubled by handing you money without an affidavit? And why are bailouts for rich bankers and executives so different from bailouts for poor people in this respect? And what would, say, an investment banker or auto company CEO affidavit look like?

"I swear that I do not smoke, drink, use drugs, have more than basic cable, do not belong to more than one country club, do not play golf more than once a month, and limit my daughter's horse showing to only the Florida circuit." Should we restrict the size of their yachts while we're at it? Let's make them drive Ford Focuses while we're at it. No Mercedes or BMW til the firm is solvent and lending again.

Here's my idea of a better affidavit for investment bankers: I will hold a higher minimum level of capital that will be determined by my risk exposure and I will restrict my trading practices with regard to obscure derivatives and any new derivative-like financial instruments I may create (and that benefit only my bank at the expense of both my investor clients and the larger society) and will provide a full and transparent accounting of the risk therein to all potential investors.

Oh, wait, that's not an affidavit. That's regulation. And thank goodness it looks like we will now have some of it after all. Regulation by regulators who believe in regulation is almost certainly better than an affidavit, but I sort of like the idea of an affidavit, too. It seems only fair.