Broken Actions in Broken Systems

            There are a very few broad concepts that economists have identified as being problems that are quite difficult to solve.  They go by dramatic and ominous names like “adverse selection”, “moral hazard”, and most difficultly, “tragedy of the commons”.  One such problem that I’ve encountered recently is the principal-agent problem, the idea that non-optimal outcomes will result when the person acting is different than the one who will take the consequences of the action.

            In economics, we often solve problems by creating incentive structures that will make it in the best interest of a person to alter his behavior.  Too much pollution? Carbon tax.  This makes it more costly to pollute (the new incentive structure) and so incents companies to find greener practices (the altered behavior) that are cheaper than paying the tax.  These kinds of schemes work in the business world too as we see compensation tied to performance.  If a salesman doesn’t sell, he makes very little money, and vice versa, thus incenting hard work.  These solutions work because people are self-interested and will do what is best for themselves.  Ideally, incentive schemes are constructed in such a way that those self-interests are aligned with socially beneficial ones as well, lower pollution and more sales for the company in the former cases.

            A problem, which we say is the “Principal-Agent Problem”, arises when the consequences of actions are divorced from the ones doing them.  While the name may conjure up an image of school headmasters conferring with CIA members, we use these words in a different sense. So what are principals and agents?  A principal is one who enlists the services of an agent to act on his behalf.  So by extension, an agent is one who acts on behalf of a principal.  People buying and selling houses are principals and the ones who broker the transactions are called “real estate agents”.  Take this following story as an example.  One of my friends works in the Air Force as a bomb technician and he said that the screws that they use on a particular bomb cost over 100 dollars each and that the only way that they are different than the screws at Home Depot, besides the fact that they only cost 10 cents there, is that they are stamped with a serial number. 

The problem arises when there is a mismatch between the consequences of the principal (the general public who enlists and funds the defense services of the military by paying taxes) and the agent (the military, which can use all the money its collective heart desires without any regard to future stability or practicality of its methods).  The military can spend indiscriminately because it knows that the tax payers will always be around to foot the bill and so they have no incentive to change their ways.  Tax payers end up buying screws for a thousand times as much than if they were a private contractors getting those screws from a hardware store.  See the problem?  Luckily the government doesn’t yet have monopolies in too many industries besides defense (for good reason, I suppose) and free market competition is allowed to prevail.  The average contractor will get his screws at Home Depot because the cheaper he can get them, the cheaper he can pass his services on to customers.  There is no principal-agent problem here because the contractor’s actions affect him only.  The same applies to practitioners in other industries as well. 

But I ask you this, that as we come to a time of eventual governmental dominance of the health care system, what new principal-agent problems will be created?  If divorced incentives allow an entity to thrive even when it spends a thousand times as much as it could on a screw, what does that tell you about the people, incentive structures, practices, policies, etc. of the rest of that entity?  You must extrapolate because I don’t have the words to express it all.  In light of this, imagine that we’re talking about peoples’ lives and not metal fasteners: who’s screwed then?  

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Why Data Matters

The final frontier of the human race is proving to be less intergalactic than Star Trek would suggest and much closer to home.  Advances in the physical sciences have taught us great and marvelous things about the world we live in and about worlds beyond our own.  In the place where science and business collide, a new “space” has emerged that has already begun to revolutionize the way we work, play, stay healthy and safe, and innovate in science and technology. 

            The idea of “Big Data”, which is the up and coming game changer, will seem foreign without looking at what data is on a small scale and why it matters.  Data is collected and organized bits of attributes for the subject being studied.  People collect data about where, how fast, and how far they walk when they wear a GPS pedometer.  One of my friends keeps a log of the money he spends on gas, etc.  All these data collections are good, but are not the end to themselves.  Here’s what I mean.  If I said that the average tariff rate for a given product in a given country in a given year is 5%, that would be an interesting fact to know, but would probably be a useless fact unless you were in the habit of learning tariff data for countries.  Data, when correctly used, can be used to create information.  Take tariff data for this country over the course of time and you can make a trend line to support your informative claim that “tariffs in Indonesia have been falling for the past several decades”.  If you pool that information with other information learned from other places, you can arrive at the end goal of data: insight.  We’ve established that tariffs have been falling, and say that we learned from other data that exports have been on the rise.  Then we can turn the information into insight when we compare them and find through analysis that tariff rates and export levels are inversely correlated or when we apply that information and suggest that a country should lower its tariffs if it wants to encourage international business in a given industry.

            So data is a precious commodity because it turns to information and information turns into insight.  It has the potential to change the way we live and work and, as I said, has started to do so already.  Retail businesses have been using data to track inventories and shipments for decades, but now a new level of insight has been made possible through the advent of Big Data science.  Companies can now track a particular customer’s purchases and then send targeted marketing materials that are relevant to them.  Some might find this invasive, but whether it is or is for the sophists to decide.  The advantages of a business knowing itself and its customers are inestimably and undeniably valuable.

            Sun Tzu famously said in his book, The Art of War, “If you know the enemy and know yourself, you need not fear the result of a hundred battles.  If you know yourself but not the enemy, for every victory gained you will also suffer a defeat.  If you know neither the enemy nor yourself, you will succumb in every battle.”  Data and its interpretation unlock the potential for knowing yourself on a business level and a personal level. 

            Let me use an example that is close to home.  This year, I started a used clothing store with some friends.  We have a database that records each item that is taken, where the customer is from, and other attributes.  At the end of the day, we can look back and know what items are popular, women’s shirts for example, that we’ve served people from nearly 30 states and countries all over the world.  We get comments and suggestions for improvements that we can take into account for future operation.  Now imagine that we have a massive customer base, huge resources, and are a multinational corporation.  Say we’re Target or Wal Mart with access to talented people in all industries.  I can attest to the benefit data has had for our operation, small as it is.  So I can imagine how it must be driving business elsewhere.  Business is not the other place where the Data revolution has been happening.  Medical research has grown by leaps and strides with the invention of new data collection technologies and the advent of distributed computing/crowdsourcing has allowed for dramatic cuts in processing time and costs.  The benefits of these new technologies have helped in counterterrorism operations and other law enforcement and more sectors than one could even name.

            Exabytes of new data are made at an increasingly growing rate and the full potential has yet to be seen.  But I suspect that as humanity explorers this new frontier, our newly gained level of self-knowledge gained will allow us to win victories in efficiency and quality of life that are an important par of building a better future. 

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A Broken Parachute for Fiscal Cliff Jumping

            We have some great news from Congress that the fiscal cliff has been averted, apparently.  The legislation that is estimated to raise $600,000,000,000 over the course of the next decade will raise taxes on individuals making more than $400,000 per year and couples making more than $450,000 per year.  It raises the estate tax from 35% to 40%.  It changes the alternative minimum tax to be adjusted for inflation every year (which was something that should have been written into the original AMT legislation, but better late than never). Other highlights that CNN points out are an extension of unemployment insurance for 2 million people and renewed tax credits for research and development, child care, and tuition.  Break open the champagne, folks, we wiggled out of that pickle!

            Or did we?  I would submit that America has been off a “fiscal cliff” since some time during the Bush Administration and that Obama has only tied an anchor to the country’s feet.  I submit also that this “fiscal cliff” of late 2012 was a paper tiger in light of the country’s real financial issues.  Would you care for me to back those claims up?  Here we go! When Clinton left office, the government enjoyed a “budget surplus”: tax revenue was greater than expenses so extra money could be used to chip away at the national debt.  Bush reversed this trend and the national debt has been growing ever since.  By the time he left office that debt had grown from $5,727,776,738,304.64 to $10,626,877,048,913.08.  That is no small amount of money, and I’m purposely writing the numbers out in their fully extended version because I think that the impact of these mind-blowingly large numbers is lost when using words like “billion” and “trillion”.  Now when Obama took office, the national debt was $10,626,877,048,913.08, as we see from above, and as of December 28th, 2012, the national debt was $16,336,461,552,606.35 (statistics from treasurydirect.org). So we’ve had two presidents in a row who have spent vast amounts of money and Obama has added even more to the national debt in one term of office than Bush did during his eight years combined.  It is no secret that spending more than you make is unwise on a personal level or company-level so it is kind of appalling that a country can get away with it.  There are obviously quite important differences that allow a country to continue in this bad behavior but the real consequences of borrowing money and accruing debt is the same for any level of entity.  

            If a bank calls the debt of someone with a home mortgage and the person can’t pay, the house is taken by the bank.  If a government’s debt is called by the entity that owns its debt, what happens?  I shudder to think considering that a lot of US debt is owned by foreign nations.  Luckily America doesn’t owe any single nation so much that it couldn’t be repaid through some difficult maneuvers, at least not yet.  As time goes on, this will not be the case and, as one Chinese professor told our class one day, “The Chinese know they’ll never be paid back”.  Infer as you will. 

            But back to the Fiscal Cliff: I said it was a paper tiger and so I hope you see that this scrambling and ballyhooing for an extra 4.6% of income tax revenue from less than one percent of the population is miniscule in light of the massive financial trouble we’re in already.  I grant that the insidious tax increases in Social Security will help in some way with that chunk of government spending, by impoverishing the rest of us to a 2% greater extent (the amount of the temporary reduction that expired).  What can be done though?  Surely we don’t expect the government to solve its financial woes like regular folks do: by spending less and saving more.  After all, it is much easier to raise taxes than to scrutinize spending and eliminate waste or inefficiency.  Why go through the trouble of becoming responsible when you can rob your populace of their money?  This is exactly what we saw in the 11th hour of congressional negotiations when all we heard from Washington was hateful rhetoric and the news that no spending would be cut, only that taxes would increase.  This was a huge political victory for the President who has always been clear that he wanted to tax the rich more.  Good for him!  I wish there was a silver lining here, folks, but this extra money raised through new tax revenue does little more than open a broken parachute as our government plummets ever closer to financial doom.    

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The Point of Economics

            I was talking about careers with a friend recently and was expounding in much detail about why I love economics so much, why I’m just so thrilled to be able to have it as a major, and why I’ll hopefully be able to be working in that field for a living eventually.  It was a good reminder to hear myself say it out loud too because I think that there is often, especially when doing the analysis of a given reading, chart, or data table at hand, there is a strong potential to get caught up in the numbers, the correlations and causations, and in the causes and effects.  In all that, we sometimes lose the bigger picture, the point and purpose, if you will.  I remember as a kid I used to watch Veggie Tales videos and at the beginning of each show, a white screen would appear and some panning footage of a child would appear on the screen.  Accompanied with suitable background music, these words appeared on the screen: why we do what we do.  So I’d like to take some time now to tell you, from an economist’s perspective, why we do what we do.

            Now I’m sure I’ve defined economics in some blog post in the past, but let me restate it in one sentence, and in the broadest sense.  Economics is the study of the allocation of scarce resources and how they can be directed to give humanity the greatest happiness.  “Economics” comes from the Greek word “oikonomia”, which means “the management of a household”.  Think of that, but applied to a whole region, or even the whole world.  There’s a lot to be learned about the things people do to get resources, to turn them into other products, and to then sell them to others.  There is a mind-boggling number of connections between people all over the world.  Consider this: I am wearing a shirt that was made in El Salvador and pants from China.  I’m writing on a computer that was made in Japan and is running software probably written by someone in California.  Mapping how all these parts of the world got together to give me the experience I’m having right now is beyond the scope of this piece, but mapping the global economy is one insurmountable task where the more we learn the more we realize how little we know, and our awe increases day by day.  But going back to the original question: what is the point of economics?

            Recall that it is the study of resource allocation.  Now we recognize that resources are not always allocated as efficiently as they could be and by extension the maximization of human happiness, is not maximized either (to the extent that it is dependent on material goods).  You would be surprised at how many things stand in the way of efficient resource allocation and the fallacies regarding it that pervade public discourse and governmental policy.  But our work is not only to study the resources, but to understand the people who direct their use. Economics is, in fact, nothing short of an attempt to understand the aspect of human nature related to the choices they make in buying and selling, saving and spending, working and playing.  Let it be known that people are quite complex and an economist’s awe of humanity only grows as he learns more and more.  F.A. Hayek famously said in his Nobel Prize acceptance speech that while we strive to know more and more, we must be aware of our limitations lest we fall into the trap of thinking that we know better than others and can rule over them.  So economists ought to ultimately possess a healthy humbleness.  They ought to realize that the end goal of our work is not to try to dictate the actions of others, but rather to serve them.  The goal economists is to paint a picture of the world and suggest possibilities of what can be done to make people freer, happier, and better off than they would otherwise be without us. The desire to make the world a better place compels us.  That is why we do what we do. 

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Site Changes: Welcome to the Research Portal

Ever wondered what the infant mortality rate of Serbia in the in the 1970s was? Or Pepsi's bottom line? Or the production of coffee in Indonesia for the last few decades? These are all available if you know where to look...and the place to look is the no further than the new research portal which you can find on the right side of the home page. There's enough low-hanging fruit to keep your hunger for knowledge at bay for a lifetime.

The old "Links and Resources" section is now the "Research Portal" and contains a generous helping of links to databases of statistics for all your economic research needs. If there are any notable data sources missing, please comment a link to it and I'll check it out. Enjoy!

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Human Expansion

After a long stint of not posting anything, I wanted to share this flow chart that I made last night. (Click to expand!) Essentially I'm pulling from works by Amartya Sen and Dwight H. Perkins ("Development as Freedom" from the former and "Economics of Development" from the latter.)  My reasoning in creating this, besides to use as a study guide for an exam on economic development that is fast-approaching, was to make something that would help visualize the process of human development, which can admittedly be a somewhat vague concept to grasp. So the middle bubble is the main topic: defining what the flow chart is going to be about, and what development itself is: the expansion of freedoms people enjoy.  We say that societies are progressing when they create an environment wherein the inhabitants are better off, or freer, than they were in the past.  But again, this is a very nebulous concept to grasp and so  In the sub-bubbles are four sections to address: Removal of sources of unfreedom, creation of new freedom, economic growth, and political development. Far from what the structure of the chart might imply, these four categories do not progress in isolation of one another. It is simply an artifact of the program that I used to map this that there aren't a dozen relationship lines connecting various bubbles and sub-bubbles to each other. Most of the concepts are pretty straightforward or can be easily explained though a Google search. I will leave you with this though, a quote our professor gave and explained to the class. "Freedom is of a piece." When there is a tear in fabric, it very obviously hurts the effectiveness of the whole cloth.  Yet when the fabric is whole, it can function beautifully. The same can be said of the various forms of freedom.

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