In my ongoing effort to make reading this site more pleasant for all users, I just changed the theme to a brand new one called Typominima. Please refer to the footer for a link.
UPDATE: Typominima broke the site. Back to the default. See the comment.
In a recent post in opendemocracy.net, Aristos Doxiadis presents a thoughtful and detailed look at the historical and structural features of the Greek economy that make Greek society so ineffective and, at least to people like me, one to be far, far away from. His article deserves thoughtful commentary, which I hope to have time for soon. Meanwhile, as a person who was born in Greece and spent the first 25 years of his life there, I can say with confidence that his observations on the Greek society and economy are on-target. I am really surprised that Doxiadis has chosen to continue living in Greece, given the clarity of his vision about the rottenness that pervades that society. I suppose it is admirable that he is trying to reform it for the better. I am more than a little pessimistic about the prospects of success of any such fundamental reform of a society so diseased.
This site looks good on Mac OS X and Linux computers. Due to limitations of the way Windows renders online text, the fancy fonts (Adobe Minion Pro for text and Adobe Myriad for headlines, both via typekit.com) appear pixellated on Windows, which forced me to use Windows-only fonts for visitors using Windows operating systems. To see the site in its full elegance, if you use a Windows machine, why not install Ubuntu Linux, side-by-side with Windows, and use the Linux side to browse? It’s safer, too! See http://www.ubuntulinux.org/ for details.
Microeconomic Theory II for PhD students starts again on Tuesday here at Temple University. I intend to talk about understanding economics as a way to (i) see clearly what the objectives are (whether they come from us as economists or not), (ii) see how the aggregation of many persons’ aims is fraught with terrible difficulties (Arrow’s impossibility theorem), and (iii) introduce the idea of incentives as something that needs alignment with the aims, which alignment may be very hard to achieve in a society (Gibbard-Satterthwaite theorem). I have made my lecture notes available here (warning: terse and notation-heavy stuff, be patient in reading).
Lest this sound like an impossible paragraph, let me hasten to follow it by one in plain English. To this end, I will point first to Princeton economics professor Uwe Reinhardt’s very recent posting in the Economix blog of the New York Times. Please do read it before continuing to read this post.
In this very good piece, Professor Reinhardt points out how often the term “efficiency” is trotted out to make audiences feel that the economist speaker/writer addressing them is making an objective, scientific claim. Not so fast! Efficiency, in the technical sense of economics (“Pareto efficiency”), means that a state of affairs prevails in the economy so that there is no feasible change that will improve the welfare of at least one person while harming no one.
Think about it for a second; it sounds appealing, at first. Why not aim to extinguish the “welfare waste” that inefficient states possess?
But it is not so easy. Nobel laureate Amartya K. Sen has classic criticisms (see his Nobel lecture, page 198 and onwards, or look up his 1977 classic paper, “Rational Fools”) of efficiency. (He is not the only one, but he is quite probably the most respected scholar, among economists, who has such criticisms.) The Rational Fools paper, if memory serves me right, is the one that pointed out that the state of affairs in which Roman Emperor Nero would have been prevented from having Rome set afire as a background to his lyre playing, would entail a loss of welfare for Nero (never mind that it would improve the welfare of thousands of Roman citizens) and therefore it would not be an improvement in efficiency over the historical state of affairs, in which Nero did enjoy performing his ode while Rome burned. Pretty much every person’s sense of fairness would find this repugnant, which points out one particular, often glaring, way that economic efficiency hides a strong value judgment, that says “don’t you dare hurt anyone, no matter privileged, to help any number of people, however non-privileged or deserving”.
Worse still, economists are blithely using “efficiency” to justify all sorts of policy suggestions, and as a benchmark in countless papers. I hope this post has helped at least one consumer of writings of economists become more critical of this practice.
For a bit more about this, please check out my writing on public economic on this page.
In a column that ran today in the Project Syndicate, Brad DeLong said this:
One of the dirty secrets of economics is that there is no such thing as “economic theory.” There is simply no set of bedrock principles on which one can base calculations that illuminate real-world economic outcomes. We should bear in mind this constraint on economic knowledge as the global drive for fiscal austerity shifts into top gear.
Unlike economists, biologists, for example, know that every cell functions according to instructions for protein synthesis encoded in its DNA. Chemists begin with what the Heisenberg and Pauli principles, plus the three-dimensionality of space, tell us about stable electron configurations. Physicists start with the four fundamental forces of nature.
Economists have none of that. The “economic principles” underpinning their theories are a fraud – not fundamental truths but mere knobs that are twiddled and tuned so that the “right” conclusions come out of the analysis.
I am of two minds about this. I certainly feel that the beautiful economic theories that have been created with the help of some serious mathematics in the last few decades have yielded valuable insights. Yet on the other hand, these insights are far from telling us unambiguously important things about economic reality and from giving us good recipes for economic policy. I don’t even feel we understand, as economists, how such a basic thing such as economic trade can emerge, based on trust among people. So we have ended up with “theory” as a plaything of political interests. For such reasons, I share DeLong’s frustration. Yes, Paul Seabright has written the wonderful book The Company of Strangers, but still we don’t have a good grasp of the fundamentals of economic trade at the level of really basic theory! Naturally, I am trying to do something about this in ongoing research with my long-time collaborator, Rob Gilles, or I would not be justified in airing my complaints on this theoretical lacuna.
But is it really beauty and some insights of doubtful empirical relevance versus abandoning all hope of having an economic theory? I sincerely hope not. We have, in game theory, the mathematical theory of networks, and in the technology of simulation, some tools that should allow us to build a better theory. One that, although it will always be subject to criticism and will always create the longing for something better, will not be so easily dismissed as nonexistent by a leading economist.
I understand that DeLong is concerned about macroeconomics and one can read his nonexistence claim in terms of macroeconomic theory. But that is a cop-out. If we had a good theory of economic fundamentals, we would be able to build an, at least existent, theory of macroeconomics, by DeLong’s standards. So I addressed my remark here to basic economic theory, not its macroeconomic special case.
I have recently started taking quite seriously the need for economics to widen its scope away from the study of models that make individuals appear as autistic automata. This has meant that I am reading a lot of stuff and writing too little, for the time being only, I hope. This site is included in this slump. However, I do not feel totally unproductive. It is a bit of a challenge to think outside of the mathematics-encrusted box and I do still teach highly technical courses to my students. Being productive means at the moment to engage with this new world view even though it forces me to think in unfamiliar ways, which has its cost. But enough about me! Let me now send you to a great review of Akerlof and Kranton’s recent little book on identity and economics by Tom Slee (hat tip to Brad DeLong for sending me to this review). I like Slee’s slant a lot: equilibrium is something we should not abandon too readily in our dissatisfaction with the track record of game theory so far. Watch this space for more comments by yours truly on economics and mechanisms when norms, identities, trust, reciprocity, and generally social interactions, come into play in the economist’s schoolyard.
Well, make this a bad example if you must. It is an example of bad incentives that produce bad outcomes. I am referring to the article by Bebchuk, Cohen, and Spamann in the Project Syndicate web site, in which the authors discuss the compensation of the executives of Lehman Brothers.
The article discusses a report by a court-appointed examiner on the finances of Lehman Brothers prior to the bankruptcy of the company. The report shows that while the shareholders of Lehman Brothers lost plenty of money in the bankruptcy, the executives managed to stay in the black, because of the structure of their performance-compensation pay contracts.
The authors point out that the ability of executives to make lots of money by pursuing highly risky strategies and their ability to avoid losses when their risky strategies lead to financial disaster are very bad news for the shareholders. This is the point I want to emphasize here. The shareholders, the owners of the company, gave bad incentives to their managers, and once a fiscal panic came about, the owners lost big.
But they were not the only ones to lose. The risky actions of executives such as those at Lehman (and they were not the only ones to be overly aggressive in taking risks) magnified the financial panic, once it had started, which resulted in the major recession we are still enduring. All of us lost.
Bebchuk, Cohen, and Spamann conclude that executive compensation schemes should be changed to give executives better incentives. This is certainly correct but it does not go far enough. Since the bad incentives created by such pay structures affect everybody, it is really a general reform of the mechanisms for performance pay throughout the economy that is indicated. Mechanism design theorists have the tools to suggest possible solutions. These tools are not a panacea, but they would certainly result in a safer financial system if applied carefully.
The biggest problem is probably political. As the Democratic administration moves to consider financial reform, after getting health reform passed, the Republicans are likely to resist meaningful reform. This is a basic issue with all mechanism design. Indeed, mechanism design theory starts with the assumption that a plan on how the system should be made to work has been agreed upon by society and the remaining problem is only technical: how to give people the right incentives so that the plan is achieved. This, and the reliance of mechanism design theory on classical game theory with its hyper-rational model of players, are the two biggest hurdles in coming up with mechanisms that deliver optimal incentives.
Read this post by Daniel Little and weep. If you care about democracy and the public good, that is. This kind of thing is a main reason that standard economics has done a serious disservice to humanity by emphasizing the private motivations of individuals and not studying public mindedness and the “public good” in general very much. We can still hope to make strides to reverse this inattention to publicness in economics and also in the political sphere. At least, I sincerely hope so.
Recently, Gary Kasparov wrote an essay about humans and computers playing chess, under the guise of a book review. Andrew McAfee today published an essay on Kasparov’s ideas, with a specific focus on one observation by Kasparov.
Kasparov noted that recent matches have shown that weak human chess players with computers can beat a chess supercomputer, and, in addition, a chess grandmaster with a computer but a weak organization of the human-computer collaboration. In Kasparov’s words,
Weak human + machine + better process was superior to a strong computer alone and, more remarkably, superior to a strong human + machine + inferior process.
McAfee starts from this and says that Kasparov may have stumbled upon a better model of business processes. From my point of view, I see Kasparov’s insight as one example of the great benefit to be gotten if we can only adapt mechanism design theory to capture the fuzziness of humans and the precision of computers, acting in tandem, better. (I think there are many examples to urge us to change mechanism design towards more human-compatible decision-making models, on which I plan to blog more.)
I am making no grand claim that I know how we can approach this goal. I am simply noting that it seems a very worthy goal, one that I would rather see research in mechanism design aim for. Instead, the current thrust of the mainstream mechanism design research seems to be to get more and more refined mathematical results based on the assumption that the actors in the mechanisms studied, whether human or computer agents, behave with the precision of computers. I am aware of some work that attempts to introduce errors in the decision-making of agents in mechanism design theory, such as work by Kfir Eliaz, but I would certainly love it if more of the very clever mechanism theorists attacked the fuzziness problem head on.
Let us not leave the topic of a better business process to Harvard Business Review articles only. Some Econometrica articles on it, please.
The curious incident of DD on the Web 