The Ambrosini Critique

“Markets don’t seek efficiency because investors aren’t rational.” Yeah, well, gas molecules aren’t rational either, but they obey very simple regularities in large numbers. Rational-expectations theory doesn’t actually require individual investors to be rational, it merely predicts that en masse they will behave as if they are.

— esr

I’ve made this analogy before and I think its good. Psychologists and economists, like physicists and chemists, study things that exist at much different levels of abstraction. An important implication of this is that behavior at the lower level doesn’t easily translate into behavior at the higher level. For example, the fact that individual molecules move in patterns that are called Brownian motion has little baring on the fact that when you put a few billion molecules of oxygen and a few billion molecules of hydrogen together you get a few billion molecules of water. Brownian motion is way neat, but if in some other universe it turned out that molecules just sat there laying still, it’s possible to imagine that it wouldn’t change the chemistry.

In fact, the chemistry was discovered before Brownian motion. In other words, we knew about the higher level behavior before we knew about the underlying mechanisms and this didn’t hamper our ability to do analysis at the higher level.

If this analogy works, then all this talk about animal spirits and psychology’s supposed obvious implications for economics is mis-guided. Its perfectly possible for individual humans to be irrational, idiotic twits and for the economic system that emerges from their individual actions to appear as though it is rational. If fact, the experiments of Vernon Smith show that this possibility is actually probable. In many experiments¹, Smith shows the behavior of idiots, when aggregated, quickly converges to market outcomes that look like those outcomes predicted by neoclassical theory. In other words, behavior at the lower level of abstraction doesn’t necessarily impact behavior at the higher level of abstraction.

Here’s why, however, this might not be such a great analogy. In the case of physics and chemistry, the higher level abstraction, chemistry, is much more intuitive than the lower level abstraction, physics. We see chemistry every day; its very easy to create chemical reactions in your kitchen. The behavior and structure of atoms, on the other hand, is really strange and inaccessible. The solar system analogy helps, but atoms are still very strange places to think about. In the case of psychology and economics, on the other hand, the lower level abstraction is more accessible and the higher level abstraction is, well, more abstract. We all experience individual psychology and irrationality. Its so obvious. Economics — as I can attest to now having taught it for four years — is less obvious.

1. Here’s a counter-example; a paper on asset bubbles that shows price theory doesn’t seem to hold… asset price bubbles are common in the lab. Smith says his experiments show that the problem with theory is that it assumes common knowledge of rationality. It assumes people believe other people will do what’s in their best interest. Asset bubbles don’t arise in the lab after the same set of subjects repeat the experiment a few times and thus know that the others are rational. [↩]

Prof. Swenson telling us the U.S. doesn’t need a car industry.

I knew it reminded me of something… I’ve plugged it before as the best economics movie. You should see Being There if you haven’t already.

There won’t be a contest this year. This post wins.

There’s good macro criticism, cultural criticism (with swipes at intellectual elitism), stellar political analysis and fawning over Tyler Cowen.

From whitehouse.gov:

The President brings representatives from the credit card industry in to talk about changing their relationships with their customers, and announces his principles for consumer protections.

I don’t remember voting for the CEO of visa or mastercard. Not to step on Don Boudreaux’s territory, but here’s a gem:

Q Is there a balance between protecting consumers and letting the credit card companies have revenue here?

THE PRESIDENT: We think that it’s been out of balance. And so we think we need to create a new equilibrium where credit is slowing, those who are issuing credit are able to make a reasonable profit — but they’re doing so in a way that is responsible and consumers are not finding themselves in a bad situation that they didn’t anticipate.

The credit card stocks didn’t tumble or anything so my question is with all this cheap talk who is Obama pandering to? Even if the terms of sub-prime mortgages are a big mystery, the terms of credit cards aren’t. Everybody knows cards have high interest rates and that they always have. Who has accumulated large balances on their cards by making purchase after purchase, not paying down the balance every month and yet thinks these large debt burdens are somehow the credit card company’s fault?

I think it would be neat if this movie became a cult classic for the same reason most cult classics get their status: its sooo bad its good.

Tyler Cowen:

I can only report that The End of Poverty, narrated throughout by Martin Sheen, puts Ayn Rand back on the map as an accurate and indeed insightful cultural commentator. If you were to take the most overdone and most caricatured cocktail-party scenes from Atlas Shrugged, if you were to put the content of Rand’s “whiners” on the screen, mixed in with at least halfway competent production values, you would get something resembling The End of Poverty. If you ever thought that Rand’s nemeses were pure caricature, this film will show you that they are not (if the stalking presence of Naomi Klein has not already done so). If you are looking to benchmark this judgment, consider this: I would not say anything similar even about the movies of Michael Moore.

To me, this recommends this movie. I’ve got to see something that’s worse than Michael Moore movies!

Those whose bumper stickers read “If you want peace, work for justice” simply take it for granted that there is no question what is just; if you want to find out, just ask them. The problem with the world as they see it is merely that other people are insufficiently virtuous to act accordingly.

— David Friedman being his brilliant self (but in the comments he uses that damned “webbed” adjective again!)

Here’s his “amoral and alegal” positive account of rights. The most important sentence: “To a mind of sufficient scope every number is unique.”¹ and the conclusion: “The social order, to the extent that it is evolved rather than legislated, is a set of rules that exist because it was in the interest of pairs of individuals to abide by them, not because they promote the general good of society.”.

1. His footnote: “The proof is by induction. If some positive integers are uninteresting, then there must be a smallest positive uninteresting integer. But this unique characteristic makes that number interesting. So there can be no smallest uninteresting positive integer, so there can be no uninteresting positive integers. Similarly, mutatis mutandis, for negative integers.” Awesome. [↩]

Mike asks for median wage-age profiles. I don’t know how to do quantile regressions for panel data, but I have a second best for him. Here’s wage-age profiles with the top 90th percentile wage earners removed:

And here’s the wage-age profile with both the bottom 10th percentile and the top 90th percentile removed:

Is this the best way to determine optimal policy?:

But the current magnitude of inequality in America strikes me as unfair.

Prof. Kenworthy goes on to say:

What’s the proper amount of income inequality? I don’t have a precise answer, but that doesn’t mean it’s wrong to feel that our current level is excessive.

With all due respect, except in dictatorships one person’s gut feelings about something doesn’t translate at all to optimal policy. In fact, there’s impossibility theorems that say one person’s gut feelings don’t have to monotonically effect aggregate gut feelings.

(Irony alert: to play with vote aggregation examples in writing that last sentence, I was, without realizing it, doodling on my just arrived voter information guide.)

Regarding Kenworthy’s point 2 about inequality causing harm. Besides the rhetoric of it, I’m not sure a consumption arms race causes harm. As for supposed “real” effects of inequality (e.g. health outcomes), I want to know how much of that is really an effect of poverty. I’m down to reduce poverty, but that’s not at all the same as reducing inequality.

They’ve been talking or it would appear. El Papa said:

I would say that this problem of Aids cannot be overcome merely with money, necessary though it is. If there is no human dimension, if Africans do not help [by responsible behaviour], the problem cannot be overcome by the distribution of prophylactics: on the contrary, they increase it. The solution must have two elements: firstly, bringing out the human dimension of sexuality, that is to say a spiritual and human renewal that would bring with it a new way of behaving towards others, and secondly, true friendship offered above all to those who are suffering, a willingness to make sacrifices and to practise self-denial, to be alongside the suffering.

If people have preferences for more sexual partners then they’ll weigh the costs of having more (the chance of getting infected with an STD) against those benefits. And if these preferences exist, Micheal Kremer says:

Surprisingly, the availability of an imperfect vaccine [wa: e.g. condoms] could reduce welfare, as well as increase prevalence. If the elasticity of the rate of partner change to the marginal probability of infection from an additional partner is greater than one, an individual who gains access to a partially effective vaccine will wind up with a higher risk of infection than without the vaccine. Although the individual benefits, others are made worse off, because prevalence in the pool of available partners will increase… The combined costs of the increased prevalence, plus the expense and side effects of the vaccine, could outweigh the benefits of a reduced risk of infection per partner and so introduction of an imperfect vaccine could make everybody worse off. This analysis suggests that one goal for empirical work should be to determine whether the elasticity of behavioral response to the probability of infection is less than or greater than one.

The Pope is saying people shouldn’t have such preferences. His wasn’t a statement about science (I think he knows condoms act as physical barriers to transmission to disease) its a statement about morals, aka optimal preferences. Does anyone know if that elasticity has been estimated?