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Austerity and the Reinhart-Rogoff Fiasco

April 25, 2013 Leave a comment

You may have heard recently about how an obscure graduate student from UMass debunked a very influential paper from very influential professors at very influential Harvard recently. Indeed, it was a takedown.

Empirical economists Carmen Reinhart and Kenneth Rogoff’s oft-cited paper “showed” that governments reaching or exceeding a debt-to-GDP figure of 90% experience comparatively much lower growth. Turns out the whole thing was riddled with errors. I happen to agree that bad things are coming to countries that over-leverage themselves, but there is simply no way that a study like this was going to be correct, from its very inception.

Put aside for the moment the fact that the word austerity seems to have no useful meaning outside of rigid ideological parameters, meaning those who care more about politics than reality (read: 99% of economists) are talking at cross purposes. The real problem here is methodological. There is simply no way a spreadsheet of math problems based on aggregations of trillions of data points can tell you anything useful about whether a very general fiscal policy, with no set definition anyway, will have particular effects. It is all fantasy.

The most important point, though, is that we learn the right lesson from this. On the one hand, fancy math does not have the ability to tell us whether austerity, as a general matter, is correct. Anyone who thinks so is probably an idiot.

On the other hand, anyone who thinks that errors in fancy math prove the opposite position, is an even bigger idiot.

This is because they make a compounding error – on top of assuming that the methodology could give us useful evidence if it didn’t have its errors, they also assume that the absence of this evidence is evidence of their opposing position. This is a logical fallacy: absence of evidence for position A will never be evidence for position B. (If you’re interested in seeing a prime example of such massive idiocy, feel free to click on this link. I warn you, it isn’t for those with fragile stomachs.)

Ultimately, it is critical not to get caught up in the economic flame war without evaluating first principles. Neither side is right. And neither side seems to know why. In the meantime, I suppose we could just stand back and enjoy the show.

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Driverless Cars and Systemic Vulnerabilities

December 29, 2012 2 comments

drivlscarSometimes it seems that the uncontrolled and non-systemic is more stable than the systemically controlled environments deliberately aimed at stability.

While the systemic model, with its top-down, consequentialist policies put in place specifically to produce stability, often produces stability over the short run, it at least as often produces unimaginably wild instability over the long run.

This is a problem that crosses platforms. A common analogy is the fires in managed forests. While top-down policies designed to systematically control and extinguish small fires prevent problems in the short run, the lack of fires to clean out the dried brush ultimately leads to uncontrollable infernos.

I am more likely to write about an almost identical problem on this blog: the Federal Reserve. While top-down policies designed to systematically control and extinguish market phenomena like inflation and unemployment often allow for stability in the short run, the lack of market responsiveness ultimately leads to catastrophic crashes, runaway inflation, and heavy unemployment.

This is something that I have been thinking on quite a bit recently, and I have come to the conclusion that we have to embrace the chaos. Ultimately, we’re in for a wild ride no matter what, so why delay the reckoning? Let’s deal with the problems in incremental and manageable ways, preferably at the level of the individual. The only alternative seems to be waiting for intractable problems later.

The reason I bring this up now is because Motor Trend magazine recently published an article called “The Beginning of the End of Driving.” Read the following excerpt and try to tell me you remain unworried about the systemic vulnerabilities.

Continental plans to have autonomous assistance available for limited freeway driving and for construction areas by 2015, says senior vice president Ralf Lenninger. It will add low-speed city capability in 2017, followed by two-lane highway and country road driverless car technology about the end of the decade. The company calls this “the car you can’t crash,” and it will meet the company’s goal for a zero-percent accident rate.
 
Zero percent accident rate? Kind of like the Titanic was unsinkable? The potential for systemic vulnerability to me seems greater than the individual vulnerabilities. If we go to a top-down system of driverless cars, what is to stop a rogue programmer from redirecting all of our vehicles into each other at once?
 
This is not to say that the technology is not potentially useful, or that it can never work. But when the impulse in government is emphatically interference, I doubt the likelihood of independent, individual driverless cars. Far more likely, we will be shunted into a system of “rational regulation,” which may very well end up shunting all of our cars into a ditch one day.
 
By all means, let’s let technology surge forward, but let’s ensure that we avoid the impulse toward systematic regulatory systems to go with it. I would hate to see driverless cars with the same track record as the Fed.

Complexity, the “Do Something” Instinct, and the Sandy Hook Shooting

December 27, 2012 1 comment

I have as yet avoided writing about the Sandy Hook shooting, partly because I dislike rushing to rash decisions, and partly because I believe the narrative has focused on unimportant ideology as opposed to the important ideas underlying the situation and the reaction to it. Now, however, with the benefit of some distance, I will weigh in.

What happened was horrible. There is simply no way around that. On the other hand, frantic reactions, calls to political action, and statements claiming that what happened was “obvious” do nothing but exacerbate the problem.

In reality, while it is easy to deconstruct the event with the benefit of hindsight, it is simply impossible to claim some sort of valid foresight. It is not enough to say “I knew that something like this would happen,” because that is a statement without verifiability until the proof is at hand. And when the proof is at hand, such a statement is already useless. If you had any real knowledge, you would have stopped it from happening. If you had no ability to stop it, you had had no real knowledge – simply baseless speculation masquerading as knowledge.

One can analogize this “foresight problem” to other occurrences. For example, if someone gets in a car accident, he might say later on “if only I hadn’t slept in and left 20 minutes later than I usually do, I would never have been in this mess.” This is the functional equivalent of claiming foresight about Sandy Hook. If either were valid, the problematic situation would never have obtained.

Nor is it possible to claim that, despite the lack of specific foresight, there was enough knowledge to have stopped the tragedy via preventive action. This kind of claim usually follows the “if only we had this law…” form, and it is the functional equivalent of the above. This also fails to account for the foresight problem, and it suffers from a debilitating case of confirmation bias.

The foresight problem can be extended through thought experiment. Consider a chess game.* The number of possible chess games that can be played is somewhere in the order of 10^120, or many multiples of the number of atoms in the universe. Once the chess game is, say, 50 moves in, and the chesspieces are arrayed just so, it is relatively easy to reconstruct what happened. Before the game began, however, there was an infinitesimal chance of predicting just such an arrangement. And remember, this is chess: as complicated as its game-tree complexity is, it pales in comparison to the complexity of an hour, even a minute, of human action.

We have no useful foresight, but neither does our hindsight yield much when faced with the multitude of competing and interacting causes and effects that a chessboard simplifies but real life makes manifest. After all, if the “obvious” solutions were actually obvious in hindsight, this would not be a recurring problem. We would have corrected it after the last time.

For example, getting rid of guns does not solve the problem, as countries such as Russia continue to see mass violence despite heavy gun control, while Switzerland’s rate of gun violence is comparatively miniscule despite enormous rates of gun ownership. Britain found that gun violence increased 40% after its gun ban in the late 1990s. Unlike poorly-informed pundits, I will not speculate as to why. And indeed, a majority of the mass shootings that have occurred in the United States have occurred in states, localities, and even schools that are “gun-free” or gun-restricted zones. Real life does not cooperate with our strictures. (QED.)

Nor is lack of guns an obvious problem, as the just-as-reactive NRA has suggested. What earthly purpose would stationing the equivalent of TSA agents (who, by the way, are not armed) at schools be, when the TSA has shown nothing but incompetence? Why would one expect an armed policeman to stop a shooter when armed policemen are already commonly at schools and haven’t helped? Why would a national guardsman or combat veteran be effective? Remember that one of the worst mass shootings in history took place on a military installation in Texas. No shortage of guns on a military base.

What are we to do with ourselves, then, if there are no solutions to the problem? (And, emphatically, there are none.) We do the best we can to defend ourselves, but we also accept that the real world is a dangerous, messy place and circumstances beyond our control may end our lives abruptly.

Callous? I call it realistic.

Indeed, the possibility of being the victim of a mass shooting is quite similar to the possibility of being in a fatal car accident, except for the fact that the latter occurs with startling regularity by comparison. We seem to have no problem processing the idea that, while our lives might end on the road at any moment, we have balanced the risk and accepted that, dangerous as driving may be, we will carry on. We seem to completely lack the capacity to accept the idea that, while our lives may end in a mass shooting at any moment, we are capable of balancing the risks here too. Apparently, when guns are present, rationality goes out the window. This despite the fact that cars can be at least as lethal as guns.

And capable we are of balancing the risks inherent in life. After all, we do it literally all the time. Short of locking down the entire citizenry in individual padded cells, there is simply no way to prevent the next mass shooting. That may be hard to hear. But think of the risks you take every day that are greater. Driving is a good example, but also note that you are about as likely to be killed by lightning than be killed by a mass shooter. Shall we live our lives entirely indoors?

Or can we accept the fact that there is no solution?

Once we have accepted that the risk is intractable, we can begin to accept that calls to action, proposed laws, gun controls, the “do something” instinct – all are useless in the face of a tragedy like this. We can avoid the rush to judgment. We can avoid the poison of baseless ideology. We can begin the healing process. We can resume our lives.

While the complexity of the world denies us the ability to see into the future, we can see that the fruits of the “do something” instinct, be they legal or otherwise, are poisonous to liberty. We are faced with a choice. We can keep our liberties and our dignity intact, and live with a future where mass shootings are possible. Or we could pass laws taking away fundamental individual liberties, making the people servile and impotent, and thereafter live with a future where mass shootings are possible anyway.

These are our only two choices. We should choose wisely.

 

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*I have previously used the chess example to illustrate complexity here.

Explaining California “lifers,” or why people stay in a failed state.

November 13, 2012 3 comments

I have been a resident of several states across the United States, but two in particular stand out. One is California, to which I moved when I was ten, left at fifteen, and returned to for college. The other is Minnesota, where I was born, but to which I did not return until after college.

Just recently, my total time spent as a Minnesota resident surpassed my time as a Californian, capturing a plurality of my life’s years. Many have found it remarkable that I left a tropical paradise like California for the frigid tundra of Minnesota, but if you can look past the weather, California simply isn’t a great place to live. As I have been saying for years, “it’s a nice place to visit, but I don’t want to die there.”

Many of my friends disagree with me. One has spent nearly 70 years (aside from higher education back east) in the same beach community. Another calls himself a California “lifer,” which I find eerily similar to how prisoners with life sentences describe themselves.

In any case, while California has many things acting in its favor, it is nevertheless a failed state that I simply cannot find attractive as a home. To be fair, Minnesota is also heading in the wrong direction, but if California is just about to break the tape, Minnesota is still putting its running shoes on.

Victor Davis Hanson at the City Journal recently attempted to explain why he is a California “lifer,” in an article entitled “California, Here We Stay.” Many reasons he cites make perfect sense. Family heritage is one, and it is perfectly understandable. Indeed, it is the best reason I can think of for why I live in Minnesota and not Texas. There is the weather, of course. And there are certain cultural and educational institutions that are very attractive.

On the other hand, hegemony and inertia cannot prevail forever – just ask Britain, Rome, Greece, even Akkad. The general rule is that it is better to be present for the incline phase than the decline phase, and I can’t help but think that even the best of California has hit its peak. If UC Berkeley were a stock, it’d be Pets.com.

Hanson is honest about California’s shortcomings. Finances built on rainbows-and-unicorns accounting methods; poor primary and secondary education; hostile business climate running the productive out of state; environmental extremism – all of these things are conspiring to choke off the best of what the state has to offer the world.

On the other hand, he makes a point that I simply cannot get behind:

Another reason to feel hopeful about California is that it’s reaching the theoretical limits of statism. To pay for current pensioners, the state simply can’t continue to bestow comparable defined-benefit pension packages on new workers, no matter how stridently the public-sector unions claim otherwise. And as public insolvencies mount—with Stockton, Mammoth Lakes, and San Bernardino seeking bankruptcy protection a year after Vallejo emerged from it—public blame is finally shifting from supposedly heartless state taxpayers to the unions. The liberal unionism of an aging generation is proving untenable, as we saw in recent ballot referenda in which voters in San Diego and San Jose demanded that public-worker compensation plans be renegotiated.

California is reaching the theoretical limits of statism? This strikes me as remarkably naive, and it sounds hauntingly similar to things like “it couldn’t happen here,” or “it can’t get any worse.” Or perhaps “there are no black swans.”

I for one prefer not to underestimate the statist impulses of a polity that has consistently pushed the once-bright beacon of hope that was California back into the dark ages of economic and social thought. And they did it in less than a century and a half to boot.

In my personal opinion, the decay in California is not over, and it is not close to being over. I know that making predictions is the easiest way to be proven wrong, but here goes nothing.

I think that California will continue to be held in a chokehold by statists until the situation becomes completely untenable on a state level. At that point, the citizens of California will become enraged – not at their elected Judas goats, but at the federal government for not bailing them out. Seeing the practical importance of California’s electoral votes to their parties, the statist kindred spirits in Washington will forge a bipartisan grand bargain to bail out California, complete with all the crony capitalism and blatant corruption that entails. California will then double down on its failed policies and things will get worse. Another bailout will happen in quick succession, and while token gestures may be made to restore fiscal sanity, the damage will have been done.

California’s future is not bright. Perhaps California “lifers” have a reason to stay if they are already wealthy or comfortable enough to avoid the worst of the coming catastrophe. But if you’re a common person, your odds are poor.  I fully expect to see the middle class, whose livelihoods are far more likely to hinge on the day-to-day health of the economy than the wealthy, to continue to flee.

My only hope is that they don’t bring the politics of old California with them when they go.

Lottery tickets and the AIG bailout

September 12, 2012 1 comment

Much ado has been made recently about the AIG bailout, and specifically about whether it has made or lost money for the U.S. Treasury. The latest numbers flying about are from Neil Barofsky, former special inspector general of TARP, and the Treasury Department itself. The New York Times, reporting on the war of words, comes down squarely on the side of Treasury.

The pat explanation is that the bailout of AIG “worked.” It is a cute story, even if it seems to be keyed to the election.

On the other hand, my contention is that is does not matter whose numbers you use, or how you massage the accounting. In point of fact, there is really no way of knowing how much the bailout really cost us; you can add and subtract stock prices and buy-in and sale, but how do you quantify moral hazard for example? Any accounting is bound to be inadequate

But more importantly, the math does not really tell us anything useful. It gives us hindsight bias, and nothing more. Compare the AIG bailout to buying a lottery ticket. (Perhaps an apt comparison, given the level of decisionmaking involved.)

It is a known and accepted fact that buying a lottery ticket is a mistake. The ex ante math tells us that we waste our dollar on the lottery ticket, because the odds are far too long to expect a payoff.

But somebody has to win. If you buy a winning lottery ticket, is it fair to declare that you made the correct decision in buying the ticket after the fact? I contend that it is not. Objectively, buying the ticket in the first place was a poor decision, and since there is no way of knowing ex ante whether you hold a winner, the decision must be deemed poor regardless of what you discover ex post.

It is the same with the AIG bailout. Ex ante, there was really no way of knowing whether Treasury would turn a profit, but we were nevertheless playing terrible odds on a tilted roulette wheel. With all of the negative consequences of this particular course of action, it is unwarranted to highlight a gain in stock price that was, ex ante, completely speculative.

Now if you’ll excuse me, I am going to go complain about how the general manager of my favorite baseball team is an idiot because he did not trade his star player before he got injured.

Peak China?

August 16, 2012 Leave a comment

Walter Russell Mead, writing at the American Interest, posits “peak China,” a concept much like peak oil. According to Mead:

It may be hard to believe, but it’s been a full four years since China hosted the Olympics. At the time, Beijing 2008 appeared to herald China’s return, after a 500 year hiatus, to great power status. Commentators were falling over themselves to pronounce the inevitability of China’s rise and its implications for American influence in Asia.

But is it possible we will look back on those Olympic Games as the peak of Chinese power, rather than the beginning of its rise?

Yes. There are many reasons why, including demographics, which Mead elaborates upon. I prefer the monetary-governmental explanation.

China will have to confront a series of structural challenges if it is to continue to achieve the kind of dynamic growth that lifted the country from economic backwater to emerging great power in just three decades.

The most obvious challenge is demographics. A RAND study observed that the proportion of the Chinese population of working age peaked in 2011 and began slowing this year. The share of the elderly population is rising. Healthcare and pension costs will soar as a result. So will labor costs. Investment and savings will diminish. In short, China may face the prospect, unknown in human history, of growing old before it gets rich.

I think this is probable, mainly because the growth that China has shown has been a classic case of credit-fueled bubble inflation. (I have written about this before; search “China” on the homepage.)

Of course, my interest in this is theoretical as well as practical. On the practical side, the coming China cataclysm is going to toss the world economy into a crisis of similar proportions to Europe’s coming crackup. And the American government, without any changes, is utterly ill-equipped to deal with it, meaning that it may be the final straw. But that may just be me being a pessimist.

On the more theoretical side, I am at the very least worried that we will draw the wrong lessons from China’s coming massacre. The narrative will undoubtedly read: 1) China “adopted capitalism,” 2) China saw some growth, 3) China collapsed, and therefore 4) capitalism is to blame.

This is 180 degrees from the proper interpretation, and I hope to write more about this in the future. A state-controlled economy with capitalist-leaning reforms magnified by cheap credit absolutely does not make a free market.

But I feel like I’m a voice in the wilderness. Some still look to China as a beacon, while others, acknowledging China’s foundation made of sand, offer up the same tired Keynesian platitudes that put America $5 trillion more in debt over the last 4 years, while accomplishing nothing by way of recovery or sustainability.

Perhaps it’s time people starting acknowledging instead that money has consequences. Those consequences are wonderful when the money is sound; they are terrible when the money is ginned up by the state.

Do democracies work by being dysfunctional? Or are they unworkable?

March 8, 2012 2 comments

Leon Watson at the Daily Mail has a though-provoking article about the dysfunctionality of democracies.  It is called “Is this the reason democracy can’t work? Study find humans are too dumb to pick the right person to lead us.”

I find this to be an interesting question, and one that goes far beyond the implications of which useless politician we will pick to be our president this November. In fact, I think it goes straight to the foundations of democracy. We need to ask ourselves questions like, what are the things we universally (not individually) desire from our democracy? And, is anyone at all fit to make decisions for the rest of us?

Ultimately, I think Mr. Watson has an unstated premise here: that if we were in fact able to choose the “right” person to lead us, our democracies would function better, and people would be happier with them.

That is a premise I reject. Although I may not go so far as to say that the inevitable mediocrity of our politicians is a feature, rather than a bug, of our democratic processes, I will absolutely say that I would prefer as a leader a mediocre man who is aware of his limits than the smartest man in the history of the world who is unaware of his.

Is that too much to ask? Perhaps. Being aware of the extent of one’s limits is beneficial, but ultimately it is too nebulous a concept to lead to solid conclusions as a matter of policy. And so, as a tradeoff, I would prefer a government set up to reduce the pernicious impact of the hubristic technocrat, at the expense of possibly limiting the beneficial impact of the hypothetical benevolent dictator.

In other words, I respect what the U.S. Constitution set out to do, and I find discussions of who is the “best” person to lead a democracy to be generally moot.

Of course, that does not mean that choosing a Ron Paul over a Barack Obama would not lead to empirically provable better results, and I don’t accept the premise that choosing the person to be the executive of the polity is unimportant. However, those are questions about the margin, and they ought to be distinguished from questions about the “best.”

Again, however, this is exactly the sort of discussion that is far more fundamentally important to our democracy than is the discussion over who is to lead us for the next four years. So feel free to drop me a note if you have something to add. I welcome your comments.

Are people too stupid to choose their leader, or is our stupidity just another (possibly beneficial) limiting factor on the government? What do you want from your democracy? Do you think there ever has been, or ever will be, a single person to whom control of the state could be surrendered?

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