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The Romney campaign has been telegraphing that Mitt has been practicing zingers for the last two months.  This brings to mind lessons from macro.

According to the Friedman/Lucas theory of monetary policy, money supply changes are only effective if they are unexpected.  If they are expected, then nominal wages adjust to compensate for inflation so there is no change in the real wage and hence unemployment remains at the “natural rate” or the non-accelerating inflation rate of unemployment (NAIRU).  But an unexpected increase in the money supply leads to surprise inflation, a decrease in the real wage and less unemployment.  An unexpected decrease in the money supply leads to surprise deflation, an increase in the real wage and more unemployment.  This is the expectations augmented Philips’ curve if I remember my macro correctly.  And so it goes with zingers.

If Mitt’s zingers are unexpected, the audience responds with a better opinion of Mitt.  If Mitt meets expectations, then there is no gain on net because there is no surprise.  If he delivers fewer zingers than expected, then the audience is disappointed. (I believe Jeff, Emir Kamenica and Alex Frankel are working on a model of this sort of thing.  Hopefully, the model can easily be extended to offer a theory of zingers.)

So, the campaign has deliberately set a high “natural rate” of  zingers (NRZ) for Mitt.  Then, Mitt definitely has to deliver zingers to meet the NRZ to avoid deflation and really he should deliver a huge amount so he exceeds NRZ.  The Romney campaign should have downplayed zingers and Mitt’s NRZ, so their man is under less pressure.  In fact, that is what the Obama team has been doing for their candidate.

There is the possibility that the Romney team was bluffing to scare the Obama team or to focus their attention on zinger defense rather than answers to real issues of jobs, foreign policy etc. But such a strategy is not costless because zingers are graded on an expectations augmented zinger curve.


For the casual fan such as myself, the final second of the Packers-Seahawks game had the thrill of the Roman circus – an arbitrary, conflicted decision was handed down by emperor referees.  For the real fans and the teams, it must be torture.  But is it painful for the owners? After all, they will influence the decision in the labor dispute with referees.  Steve Young thinks not:

The NFL is “inelastic for demand,” Young said, meaning that nothing — including poor officiating — can deter a significant percentage of fans and corporate sponsors away from the most popular game in the country. It’s the primary reason the NFL has held steady in its labor impasse with regular officials: There is no sign that enough of the sporting public cares to make it a priority.

“There is nothing they can do to hurt the demand of the game,” Young said in the video. “So the bottom line is they don’t care. Player safety doesn’t matter in this case. Bring Division III officials? Doesn’t matter. Because in the end you’re still going to watch the game.”

But the NFL/referee dispute is partly about “pay for performance” – the NFL wants to bench referees who botch calls (the money issues are trifling as a fraction of NFL revenue).  This suggests the NFL does actually care about good officiating.  This makes them weak in the face of the current officiating.  They should cave sooner rather than later.

What Brown can’t do for you – if you are a Democrat – is give you control of the Senate.  From the last Public Policy Polling analysis of MA:

Things have been going Elizabeth Warren’s way in the Massachusetts Senate race over the last month. She’s gained 7 points and now leads Scott Brown 48-46
after trailing him by a 49-44 margin on our last poll.  Warren’s gaining because Democratic voters are coming back into the fold. Last month
she led only 73-20 with Democrats. Now she’s up 81-13. That explains basically the entire difference between the two polls. There are plenty of Democrats who like Scott Brown- 29% approve of him- but fewer are now willing to vote for him. That’s probably because of another finding on our poll- 53% of voters want Democrats to have control of the Senate compared to only 36% who want Republicans in charge. More and more Democrats who may like Brown are shifting to Warren because they don’t like the prospect of a GOP controlled Senate.


Mitt Romney and Paul Ryan have proposed a plan to allow private firms to compete with Medicare to provide healthcare to retirees. Beginning in 2023, all retirees would get a payment from the federal government to choose either Medicare or a private plan.  The contribution would be set at the second lowest bid made by any approved plan.

Competition has brought us cheap high definition TVs, personal computers and other electronic goods but it won’t give us cheap healthcare.  The healthcare market is complex because some individuals are more likely to require healthcare than others.  The first point is that as firms target their plans to the healthy, competition is more likely to increase costs than lower them.  David Cutler and Peter Orzag have made this argument.  But there is a second point: the same factors that lead to higher healthcare costs also work against competition between Medicare and private plans.  Unlike producers of HDTVs, private plans will not cut prices to attract more consumers so competition will not reduce the price of Medicare.  A simple example exposes the logic of these two arguments.

Suppose there are two couples, Harry and Louise and Larry and Harriet.  Harry and Louise have a healthy lifestyle and won’t need much healthcare but Larry and Harriet are unhealthy and are likely to require costly treatments in the future.  Let’s say the Medicare price is $25,000/head as this gives Medicare “zero profits”.  Harry and Louise incur much lower costs than this and Larry and Harriet much higher.  Therefore, at the federal contribution, private plans make a profit if they insure Harry and Louise and a loss if they insure Larry and Harriet.  So, private providers will insure the former and reject the latter. Or their plans deliberately exclude medical treatments that Larry and Harriet might need to discourage them from joining.  The overall effect will be to increase healthcare costs. This is because Harry and Louise get premium support of $50,00 total that is greater than the healthcare costs they incur now so they impose higher costs on the federal government than they do currently.  Larry and Harriet will be excluded by the private plans and will get coverage from Medicare.  This will cost more than $50,000 total so there will be no cost savings from them either.  Total costs will be higher than $100,00 as surplus is being handed over to Harry and Louise and their insurance companies.

To deal with this cream-skimming, we might regulate the marketplace.  It might seem to make sense to require open enrollment to all private plans and stipulate that all plans at a minimum have the same benefits as the traditional Medicare plan.  Indeed, the Romney/Ryan plan includes these two regulations.  But this just creates a new problem.

Suppose the Medicare plan and all the private plans are being sold at the same price.  The private plans target marketing at healthy individuals like Harry and Louise and include benefits such as “free” gym membership that are more likely to appeal to them. Hence, they still cream-skim to some extent and achieve a better selection of participants than the traditional public option.  (This is actually the kind of thing that happens in the current Medicare Advantage system. Sarah Kliff has an article about it and Mark Duggan et al have an academic working paper studying Medicare Advantage in some detail.)  So total healthcare costs will again be higher than in the traditional Medicare system.

But there is an additional effect.  Traditional competitive analysis would predict that one private plan or another will undercut the other plans to get more sales and make more profits. This is the process that gives us cheap HDTVs. The hope is that similar price competition should reduce the costs of healthcare. Unfortunately, competition will not work in this way in the healthcare market because of adverse selection.

Going back to our story, if one plan is cheaper than the others priced at say $20,000, it will attract huge interest, both from healthy Harry and Louise but also from unhealthy Larry and Harriet.  After all, by law, it must offer the same minimum basket of benefits as all the other plans.  So everyone will want to choose the cheaper plan because they get same minimum benefits anyway.  Also by law, the plan must accept everyone who applies including Larry and Harriet.  So, while the cheapest plan will get lots of demand, it will attract unhealthy individuals whom the insurer would prefer to exclude – this is adverse selection.  Insurers get a better shot at excluding Larry and Harriet if they keep their price high and dump them on Medicare.  This means profits of private plans might actually be higher if the price is kept high and equal to the other plans and the business strategy focused on ensuring good selection rather than low prices.  An HDTV producer doesn’t face any strange incentives like this– for them a sale is a sale and there is no threat of future costs from bad selection.

So, adverse selection prevents the kind of competition that lowers prices.  The invisible hand of the market cannot reduce costs of provision by replacing the visible hand of the government.

Romney advisor Richard Williamson says that the Middle East protests would not have happened under a President Romney:

“In Egypt and Libya and Yemen, again demonstrations — the respect for America has gone down, there’s not a sense of American resolve and we can’t even protect sovereign American property.”

The implicit logic is that the protests are caused by weakness on the part of America.  The protestors are taking advantage of us because they think we will not strike back.  If we are strong, the protestors would be deterred by the threat of American reprisals. So, as President Romney would be strong, foreign policy would be easier as there would be no events like this.

But there is an equally (more?) compelling reverse logic.  The protestors are weak.  They are extremists who have little support in the population.  But if America is aggressive even the moderates in the population will favor fighting fire with fire.  Of course the extremists attacking the embassies would be happy if we withdrew.  But their strategy would also succeed if we respond with aggression.   So, the right move is not to over-react.  Use proxies to fight this battle.  Perhaps the moderates in the local populations themselves would be willing to work with us as they have a lot to lose if tensions escalate and conditions worsen.

The situation calls for smart lateral thinking not a one-size-fits-all bellicosity.

Netanyahu is aggressively trying to persuade President Obama to draw a “red line” on Iran – if Iran crosses the line, presumably drawn on the level of uranium enrichment, they would face a US attack.  Such an attack would set back the Iranian nuclear program but it would likely unify the Iranian population behind the regime and make them redouble their efforts to go nuclear.  So, we should also evaluate what might happen if Iran does go nuclear before we commit to a strategy of a preemptive strike.  It turns out that Jim Fearon thought this through a while ago and did a little empirical work to flesh out the historical record.  He finds:

China, France, India, Israel, Pakistan, and the UK all saw declines in their total militarized dispute involvement in the years after they got nuclear weapons.  A number of these are big declines. USSR/Russia and South Africa have higher rates in their nuclear versus non-nuclear periods, though it should be kept in mind that for the USSR we only have four years in the sample with no nukes, just as the Cold War is starting.

The whole article is an interesting read.

Romney and Ryan’s weekend performances on TV generated much right wing angst.  They looked shady trying to dodge questions asking them to spell out which tax loopholes they would close.  There are similar issues with their healthcare plan: they would “repeal and replace” Obamacare, but replace it with what exactly?

There is an obvious advantage to policy ambiguity: if you are clear, the other side knows what to attack but if you are opaque, it is harder.  The disadvantage is that you opponent can then make something up as being our policy and hang you with that.  Your counter-argument is to claim that your policy is not what your opponent says it is etc etc.

The balance is weighed towards disadvantage when there is an obvious policy to use to fill in the blanks.  This is the issue Romney faced as soon as he picked Ryan.  Ryan has lots of plans for the budget, Medicare, privatizing Social Security etc.  These are obvious and credible policy options for a Romney-Ryan White House.  The fact that the VP candidate has embraced these policies undercuts your counter-argument to your opponent’s argument.  Policy ambiguity loses its strategic advantage.  If Romney had picked Pawlenty, it might have worked.  But with Ryan on board, Romney has to spell out his policies in greater detail and Ryan has to own them.  He has done this already with abortion and he has to start doing the same with his economic policies.

The difficulty is that Romney has not embraced ambiguity enough to make it easy to embrace clarity.  He has promised various tax cuts (e.g. estate tax), and these tie him down.  Can he identify loopholes to raise revenue that covers the tax cuts he has promised without raising taxes on the middle class? If he can’t, he’s stuck using an outsider’s strategy but with an insider as his partner.

Mitt said that Israeli and Palestinian and Mexican and US economic outcomes differ because of cultural differences. This immediately brought to mind the recent book by Daron and Jim, “Why Nations Fail” because they begin by comparing Nogales Arizona and Nogales Mexico. These have quite similar geography, quite similar culture and yet very different GDPs. Daron and Jim argue this is because of vastly different political and economic institutions. Now Daron and Jim have addressed the issue themselves on their blog. They offer a couple of more examples:

But as we show in Why Nations Fail, cultural differences cannot explain differing levels of prosperity. Deng Xaioping didn´t change Chinese culture after 1978 to make the economy grow, but he did change economic institutions a lot. Indeed, many cultural differences we see are the outcomes of different institutional choices. This is surely the case between North and South Korea, for example. After all, does Mitt and David think that there were huge cultural differences between the north and the south of the 38th parallel before the separation of Korea into two?

I guess we need a convincing example of a situation where two countries have the same geography, the same institutions, but different cultures and vastly different economic outcomes.

Crown should get a copy of Acemoglu and Robinson’s “Why Nations Fail” over to the Romney campaign a.s.a.p. Speaking about the difference in income between Israelis and Palestinians, Romney suggested:

that cultural differences between the Israelis and the Palestinians were the reason the Israelis were so much more economically successful than the Palestinians. He also vastly understated the income disparities between the two groups.

Hin inspiration for the theory? Two books:

In his speech, Mr. Romney mentioned two books that had influenced his thinking about nations — “Guns, Germs and Steel,” by Jared Diamond, and “The Wealth and Poverty of Nations,” by David S. Landes. Mr. Diamond’s book, Mr. Romney said, argues that the physical characteristics of the land account for the success of the people living there, while Mr. Landes’s book, he continued, argues that culture is the defining factor.

“Culture makes all the difference,” Mr. Romney said. “And as I come here and I look out over this city and consider the accomplishments of the people of this nation, I recognize the power of at least culture and a few other things.”

After this caused some backlash:

[H]is campaign said that the Associated Press had “grossly mischaracterized” the remarks by not providing the full context. For instance, the campaign said, after mentioning the per capita G.D.P. of Israel and Palestine, Mr. Romney also said: “And that is also between other countries that are near or next to each other. Chile and Ecuador, Mexico and the United States.”

The Acemoglu and Robinson book begins with Nogales AZ (USA) vs Nogales Mexico and puts institutions at the center of an explanation of income disparities not culture or geography.

Things are not going smoothly for Romney’s London trip. First, he criticizes secuirty and attendance at the London Olympics only to draw a rebuke from Prime Mister David Cameron. The Telegraph reports:

Mitt Romney is perhaps the only politician who could start a trip that was supposed to be a charm offensive by being utterly devoid of charm and mildly offensive.

And now it seems tickets are not selling for his fundraiser so he has been forced to cut prices. According to the Guardian:

The Mitt Romney Summer 2012 World Tour to Three Countries is apparently having trouble moving tickets.
The London blogger Guido Fawkes reports that organizers of a Romney fundraising reception in the city this evening have slashed the original $2,500 ticket price to $1,000 for “a few last minute guests,” in an effort to drum up participation.

Your manager is a pain in the neck. He takes credit for your ideas, orders you around, second guesses himself and is horribly indecisive. His subordinates can’t stand him. But you are all too scared to complain to the Big Boss – who knows what the repercussions will be? But the Big Boss does get some sense that things are not going well. Some projects don’t work out because they are badly conceived and poorly executed. At one point, she just takes away some of the responsibilities of your manager. At the same time she heaps him with effusive praise. Why?

She and he know that her praise is insincere and that the manager has been demoted. What effect could her insincere praise have?

Even though you know the Big Boss’s statements are empty, does everyone else? You don’t know. Maybe some of them think she means every word she said. They will treat your former manager with respect. You could enlighten them. But that would ruin the workplace atmosphere and make you seem churlish. So you keep your mouth shut. So does everyone else. So you all act as if the Big Bos’s words were true. As you all live the big lie, so can your former manager. He does his work diligently and the Big Boss is happy.

CNN got the call wrong on the Supreme Court and the individual mandate. They then tweeted it, put it up on their website, put in as a banner onscreen etc etc. Then news began filtering in that the mandate had been upheld as a tax. What should they do now? There is an interesting blow by blow account of what happened by Tom Goldstein on SCOTUSblog. He adds:

Ironically, CNN reacted too slowly in part to avoid a second error.  The network did not want to be in the position of reporting that the mandate had been struck down, then reporting that it was upheld, then reverting to its initial report.  (That had happened to the media in the 2000 presidential election, and it had been a debacle.)  CNN gravitated to an intermediate position of uncertainty on the air, which of course was not decisive enough to correct viewers’ initial impressions.

CNN had also converted itself into an integrated circuit in which its electronic media teams were tied directly into the broadcast operation.  But not anticipating the possibility of an error or confusion, its first web, electronic, and Twitter reports did not hedge.  And the network did not have a clear plan to reverse the circuit on the electronic-media side and tell readers that its initial reports may have been wrong.

Once CNN made one mistake, it was hard to admit it because they were operating in an open environment with other players judging their actions. If CNN were operating in isolation – like an individual deciding whether to invest in a healthcare company – they would have reacted rapidly to correct their action given their latest information. But in an environment where others are watching them, they have to make future decisions which are consistent with their earlier error.

Chief Justice Roberts and four others found that the individual mandate could not be justified via the Commerce Clause (CC) in the Constitution. The CC allows the federal government to “regulate” interstate commerce. Roberts found that precedent allows the government to regulate activity via the CC but the individual mandate regulates inactivity and is hence unconstitutional (p. 20 of Roberts’ opinion):

The individual mandate, however, does not regulate existing commercial activity. It instead compels individuals to become active in commerce by purchasing a product, on the ground that their failure to do so affects interstate commerce. Construing the Commerce Clause to permit Congress to regulate individuals precisely because they are doing nothing would open a new and potentially vast domain to congressional authority.

Moreover (p. 22-23),

Indeed, the Government’s logic would justify a mandatory purchase to solve almost any problem…To consider a different example in the health care market, many Americans do not eat a balanced diet. That group makes up a larger percentage of the total population than those without health insurance…..The failure of that group to have a healthy diet increases health care costs, to a greater extent than the failure of the uninsured to purchase insurance….Those increased costs are borne in part by other Americans who must pay more, just as the uninsured shift costs to the insured….Congress addressed the insurance problem by ordering everyone to buy insurance. Under the Government’s theory, Congress could address the diet problem by ordering everyone to buy vegetables.

Let’s take a quick look at the broccoli market. At the prevailing price, absent regulation, some consumers are active in the market and buy broccoli and other are inactive and don’t buy broccoli. Similarly, there are some  producers who sell broccoli and other potential sellers who, given the prevailing price, produce chilis. Domestic broccoli growers are mainly in California but many broccoli consumers live in the Acela corridor so there is interstate commerce.

Then, the government enters the broccoli market. Some say this is because of the health benefits of broccoli, others say this is because the broccoli growers have formed an effective lobby, much like the sugar producers. The government intervention comes in the form of a subsidy to broccoli consumers. Consumers who consume 1 lb of broccoli/week get a $300 deduction on their taxes (Whole Foods immediately starts selling an annual contract which can easily be appended to your IRS form to get the broccoli deduction.)

Consumers who were active before still continue to buy: after all they are getting an extra incentive to buy. But also consumers who were inactive before now start to buy: after all the broccoli vs arugula margin now favors broccoli. In fact there is a new annual demand curve for broccoli D’(p) where D’(p)=D(p-300) where D was the original demand curve. There is higher demand at every price and the price of broccoli goes up. This changes the broccoli-chili margin for producers and inactive broccoli producers now switch to activity. (Also, profits go up for broccoli producers giving them the incentive to lobby for a consumer subsidy.)

Therefore, intervention in the “active” market changes the active-inactive decision and influences inactivity. An equivalent policy is to use to stick rather than a carrot and impose a penalty of $300 on consumers who are consuming less that 52 pounds of broccoli/year.  Appropriately chosen carrots and sticks are equivalent in terms of broccoli trade. (More broadly, a tax or subsidy to broccoli production could also implement the same output of broccoli.) This simple analysis has some implications for Democrats and Republicans.

First, many instruments can implement the same output so the fact that one kind of intervention has been deemed unconstitutional is not important. A carrot can replace a stick.

But, second, the instruments differ in their revenue implications. Carrots are expensive to the government and sticks raise revenue. More use of carrots means bigger deficits or distortionary taxes.

And, third, since penalizing inactivity is equivalent to incentivizing activity, we appear to have conflicting precedents. It is legal to regulate activity but not to regulate inactivity. But regulating activity impacts inactivity and if regulating inactivity is unconstitutional, in a roundabout way, the Roberts et al applies. On the other hand, there are plenty of precedents for regulating activity even if they influence inactivity. In the (in)famous Wickard case, quotas on farmers reduced activity and increased inactivity. I am not a lawyer so I can not sure what happens in this circumstance. I guess the Supremes get to vote and they can rationalize votes one way or the other based on conflicting precedents. All bets are off – will Roberts switch his vote at the last minute etc.?

Plenty of stuff for us citizens to contemplate on July 4. I’ll be grilling broccoli.

At an all-you-can-buffet lunch, the incentives are clear: go back again and again, refill your plate and guzzle away. You would eat less if each new plate came with another price tag. Add to that a lack of self control and you get overconsumption and a desperate desire for a nap in the afternoon.

A CEO has a salaried employee. The employee gets paid much the same however much work he does. So, the CEO asks him to sit on this committee or investigate that new market or run recruiting etc. etc. Add to that moral suasion so it is a duty to work hard for the firm and you get overwork and a desperate desire to avoid the CEO. There will be many task forces and layers of bureaucracy as the cost of each initiative is so small. Better to pay for performance and internalize some of the costs of each extra foray into administration and work.

What is the difference between the Bowles-Simpson plan for deficit reduction vs President Obama’s plan? Ever wondered? I have. It seems the President’s plan calls for less cuts in Defense and Social Security but has more cuts in annual domestic spending. An Obama for America document summarizes the differences and of course does a comparison with the Romney plan. Romney’s plan is short on details so there is a lot of extrapolation. Is there an equivalent document put out by the Romney campaign?

So, we have found by Chris Bosh’s absence and then his presence that he is a significant part of the Miami Heat. But who is the fourth most important man on the team? An argument can be made that it is Shane Battier. A New Yorker story espouses the same theory. It led me to an old article by Michael Lewis. But just why is Battier so good? Lewis makes a telling point:

There is a tension, peculiar to basketball, between the interests of the team and the interests of the individual. The game continually tempts the people who play it to do things that are not in the interest of the group. On the baseball field, it would be hard for a player to sacrifice his team’s interest for his own. Baseball is an individual sport masquerading as a team one: by doing what’s best for himself, the player nearly always also does what is best for his team….It is in basketball where the problems are most likely to be in the game — where the player, in his play, faces choices between maximizing his own perceived self-interest and winning. The choices are sufficiently complex that there is a fair chance he doesn’t fully grasp that he is making them.

Taking a bad shot when you don’t need to is only the most obvious example. A point guard might selfishly give up an open shot for an assist. You can see it happen every night, when he’s racing down court for an open layup, and instead of taking it, he passes it back to a trailing teammate. The teammate usually finishes with some sensational dunk, but the likelihood of scoring nevertheless declined. “The marginal assist is worth more money to the point guard than the marginal point,” Morey says. Blocked shots — they look great, but unless you secure the ball afterward, you haven’t helped your team all that much. Players love the spectacle of a ball being swatted into the fifth row, and it becomes a matter of personal indifference that the other team still gets the ball back…

Having watched Battier play for the past two and a half years, Morey has come to think of him as an exception: the most abnormally unselfish basketball player he has ever seen. Or rather, the player who seems one step ahead of the analysts, helping the team in all sorts of subtle, hard-to-measure ways that appear to violate his own personal interests.

This has two Holmstrom and Milgrom ideas: tension between individual incentives and team incentives; use of easily identifiable measures of output distorting incentives to invest is less identifiable costly tasks. And in the absence of monetary incentives and market efficiency, the only solution to the moral hazard problem is in ethical behavior (Arrow made similar points many years ago).

Cogent analysis by James Surowiecki at New Yorker:

[P]olicymakers are seriously discussing a so-called Grexit—in which Greece would default on its debts and abandon the euro.

This isn’t an outcome that anyone wants. Even though a devalued currency would make Greece’s exports cheaper and attract tourists, it would do so at a terrible price, destroying huge amounts of wealth and seriously harming the country’s G.D.P. It would be costly for the rest of Europe, too. Greece owes almost half a trillion euros, and containing the damage would likely require the recapitalization of banks, continent-wide deposit insurance (to prevent bank runs), and more aid to Portugal, Spain, and Italy, which seem to be the next countries in line to default. That’s a very high price to pay for getting rid of Greece, and much more expensive than letting it stay……

But the catch is that Europe isn’t arguing just about what the most sensible economic policy is. It’s arguing about what is fair. German voters and politicians think it’s unfair to ask Germany to continue to foot the bill for countries that lived beyond their means and piled up huge debts they can’t repay. They think it’s unfair to expect Germany to make an open-ended commitment to support these countries in the absence of meaningful reform. But Greek voters are equally certain that it’s unfair for them to suffer years of slim government budgets and high unemployment in order to repay foreign banks and richer northern neighbors, which have reaped outsized benefits from closer European integration……

The basic problem is that we care so much about fairness that we are often willing to sacrifice economic well-being to enforce it…. a famous experiment known as the ultimatum game—one person offers another a cut of a sum of money and the second person decides whether or not to accept—shows that people will walk away from free money if they feel that an offer is unfair. Thus, even when there’s a solution that would leave everyone better off, a fixation on fairness can make agreement impossible.

Hart and Moore and Hart and Holmstrom have offered theories of centralization based on behavioral issues. I’m not familiar with the other work on behavioral contract theory. But my guess is there is plenty of room for interesting research in the area along lines implicit in this article.

Jean Tirole gave a paper on “Laws and Norms” as his Schwartz Lecture last week. He has been working on psychology and economics for many years with Roland Benabou. The presentation was an extension of that work. Consider a game where a costly action generates a positive externality. Agents are motivated to take such an action by a monetary reward and a private value from the action. However, they also care what others think of them. How can we think about this formally and what implications does it have for contributions to the public good?

Tirole’s (and Benabou’s) first contribution is to provide a simple, tractable model of this psychological effect. Each agent’s payoff is a function of others’ expectation of his private value given his action and monetary reward. Hence if you contributed to the public good but received no monetary reward, the expectation is different that if you contributed and got paid. From this simple formulation much can be deduced. If a contribution is elicited via a monetary reward, it carries less positive information about the contributor than one when there was no monetary reward. There might be a bigger contribution if there is no monetary reward. The less observable the contribution, the smaller is the incentive to make it etc.

The contribution was twofold. First, the mathematical modeling of the psychological effect requires some art and effort. Second, the model is intuitive and simple enough that others can use it to express their own ideas. One of my colleagues is thinking about two papers based on the basic Tirole model.

The American Economic Review publishes an unrefereed conference volume, Papers and Proceedings, in May of every year.  Of course, the AER also a publishes a refereed journal which rejects more than 95% of submissions. Someone with an AER P&P might be tempted to pass it off as an AER on their CV. There is a possible gain in prestige at the cost of being found out and facing a social sanction. Snyder and Zidar call this the obfuscation theory. Alternatively, perhaps these AER P&Ps have real academic value and those who describe their own such papers as real publications should also cite other such papers more. Different conventions of citation may develop among different subgroups. This is the convention model. Snyder and Zidar find support for the convention model in the data. They mention that AER P&Ps had more citations that AERs in the past and hence older economists tend to see P&Ps as real publications while younger economists do not. This should imply that younger economists should be more careful about distinguishing P&Ps from AERs on their CVs.

I have two questions/comments.

An economist who lists a P&P as a refereed publication faces dissonance. On the one hand, they would like to see themselves as good people, on the other they know they are doing something shady. One way to resolve the dissonance is to cite other researchers P&Ps more. This helps propagate the self-deception that P&Ps are legitimate pieces of refereed research and hence listing them as such is justified.

Second, another possible paper: Do P&Ps have more errors than refereed publications? One job of a referee is to catch errors after all. If so, how many cites come from people pointing out mistakes?

(Hat Tip: MR)

Michael Ostrovsky (Stanford GSB) and Michael Schwarz (Yahoo! Research) helped Yahoo! to improve its click price per ad. Yahoo! was charging 10c/click. Ostrovsky and Schwarz ran some field experiments:

Reserve prices in the randomly selected “treatment” group were set
based on the guidance provided by the theory of optimal auctions, while in the “control” group
they were left at the old level of 10 cents per click. The revenues in the treatment group have
increased substantially relative to the control group, showing that reserve prices in auctions can in
fact play an important role and that theory provides a useful guide for setting them.

It seems they made money for Yahoo!:

We conclude with a quote from a Yahoo! executive, describing the overall impact of
improved reserve prices on company revenues.
On the [revenue per search] front I mentioned we grew 11% year-over-year in the quarter
[. . . ], so thats north of a 20% gap search growth rate in the US and that is a factor of,
attributed to rolling out a number of the product upgrades we’ve been doing. [Market
Reserve Pricing] was probably the most signi cant in terms of its impact in the quarter.
We had a full quarter impact of that in Q3, but we still have the bene t of rolling that
around the world.
Sue Decker, President, Yahoo! Inc. Q3 2008 Earnings Call.

But it seems Yahoo! is eliminating the entire research group in its downsizing, including I suppose Michael Schwarz. Preston McAfee had already left for Google Research. I hope others also have a soft landing.

Derrick Rose is out for the season and a weekend that started badly might have ended sadly with another super dark episode of Mad Men. Instead, we got a few comedic rays of sunshine to break through the gloom – Pete tricking Megan’s pretentious father, Peggy’s mother’s surprise that Abe’s favorite dish is ham etc. Those of us looking to enliven our courses with the odd example here or there had to wait till the end.

Don is busy trying to drum up new business at his award dinner. He got the award for an anti-cancer ad he took out in the newspaper after losing the Lucky Strike cigarette account. But a colleague’s father rains on Don’s parade. He says that no-one will give Don any new business after he stabbed Lucky Strike in the back. Don signaled to the wrong audience in the last period of the Lucky Strike game. He tried to co-opt consumers by pretending to be concerned about their welfare. But consumers will not give his firm new accounts, firms selling crap to them will. And with them Don lost his reputation – will he also throw them under the bus if things turn sour? Life is an infinite horizon game with many bilateral interactions. Lose your reputation in one and, if your behavior is publicly observable, lose your reputation in all.

I am catching up on my Mad Men viewing after a spring break trip abroad. I watched three episodes in one sitting last night. In Episode 3, copywriter Peggy interviews candidates for an open position. She likes the work of Michael Ginsburg whose portfolio is labelled “judge not, lest you be judged”.  Her co-worker agrees with Peggy’s assessment of Ginsburg’s work but advises her not to hire him because, if Ginsburg turns out to be a better copywrite than Peggy, she risks losing her job to him. Later in the episode (or was in the next?), Pete humiliates Roger, taking credit for winning an account for the advertising company. Roger storms out. He says he was good to Pete when he was young, recruited him and look how he is lording it over Roger now. A portend of Peggy’s future?

Recruiting and peer review are plagued with incentive problems in the presence of career concerns. If you recruit somebody good, you risk the chance that they replace you later on. You have an incentive to select bad candidates. You have an incentive to denigrate other people’s good work (the NIH syndrome) for even deliberately promote their bad work in the hope that it fails dramatically and this allows you to leap over them in some career race. The solution in academia is tenure. If you have a job for life, you can feel free to hire great candidates. (Various psychological phenomena such as insecurity compromise this solution of course!) Peggy does not have tenure and even Roger who is a partner faces the ignominy of playing second fiddle to a young upstart. Watch out Peggy!

You are Chair of your Department and the Department hires two people at the senior level. It is hard to hire at the senior level and many people congratulate you on your success. But the candidates were proposed by others and wooed by others. One is moving because of a divorce and the other is a lemon who is despised by his former colleagues. All you did as Chair was handle the admin stuff and yet everyone still congratulates you. If you had failed to hire, they would have blamed you, even though all that happened was that a marriage worked out and a lemon went elsewhere.

This kind of stuff happens all the time. Why?

The simplest explanation comes from the Principal-Agent model with the Chair as the Agent and the Department as the Principal. In an optimal contract, the Agent is punished for low output and rewarded for high even though in equilibrium we know he has already sunk high effort and output reflects a random shock. If we forgave the agent low output – after all it was a random shock – it would undercut the Agent’s ex ante incentive to exert effort. Similarly, the Department should venerate or denigrate the Chair based on success or failure at senior hiring. Otherwise, you would never work at all on senior recruiting.

From a local paper,

The nationally recognized Piven Theatre Workshop would play a leading role in the revitalization of the Noyes Cultural Arts Center, occupying renovated space and a state-of-the-art theater in the building under a plan that received backing Monday from a city committee…

With past efforts to change things at the city owned building “not going as smoothly, as easily as we wanted,” the new plan seems to heading the city in the right direction, said Alderman Judy Fiske, in whose 1st Ward the building is located….

Piven Theatre officials are proposing to occupy the southern one-third of the building and would extensively renovate the area with new classrooms, rehearsal space, offices and a new theater, he said……

The building, which leases space at below-market rates to artists, faces substantial repairs, including a new roof and heating and air conditioning system.

City officials have looked at a new model for operating the center, a former school building, including asking tenants to take a greater role in the building’s upkeep.

Because of the ambiguity, Piven officials told [officials] last fall they were likely moving out of the building, and possibly out of Evanston…

Clear property rights are necessary to resolve the hold up problem.

But a battle to establish property rights can generate a war of attrition and hence the hold up problem. For the Church of thew Holy Sepulchre inthe Old City in Jerusalem:

The primary custodians are the Eastern OrthodoxArmenian Apostolic, and Roman Catholic Churches, with the Greek Orthodox Church having the lion’s share. In the 19th century, the Coptic Orthodox, the Ethiopian Orthodox and the Syriac Orthodox acquired lesser responsibilities…

Under the status quo, no part of what is designated as common territory may be so much as rearranged without consent from all communities. This often leads to the neglect of badly needed repairs when the communities cannot come to an agreement among themselves about the final shape of a project….A less grave sign of this state of affairs is located on a window ledge over the church’s entrance. Someone placed a wooden ladder there sometime before 1852, when the status quo defined both the doors and the window ledges as common ground. The ladder remains there to this day, in almost exactly the same position it can be seen to occupy in century-old photographs and engravings.

If one church fixes something, they then claim property rights over the thing they fix. Hence, all repair is vetoed

The big event of this week in the U.S. will be the Supreme Court discussion of the Affordable Care Act aka “ObamaCare”, a supposedly derogatory nickname now embraced by the Obama campaign. At the heart of the fight is the so-called individual mandate which requires everyone to purchase health insurance. A related and important argument is that additional provisions, such as requiring coverage for individuals with preexisting conditions, become prohibitively expensive without the individual mandate. This is because, without the mandate, healthy individuals will not buy insurance till they become sick and this drives up costs of insurance companies. So, if the individual mandate is struck down, the argument goes, the court should also strike down the requirement that insurance companies cover individuals with pre-existing conditions.

I am not a lawyer but the main argument for canceling the individual mandate turns on whether the federal government has the right to penalize an individual if they do NOT take a certain action. There is plenty of precedent for taxing “action” but can the federal government tax “inaction”? Many amicus briefs have been filed but there are two key ones by economists.

David Cutler, who worked in the Obama administration, has filed one with many co-signatories (including Akerlof, Arrow, Maskin, Diamond, Gruber, Athey, Goldin, Katz, Rabin, Skinner etc.). They say there is no such thing as inaction. A conscious decision to forego healthcare is an action and hence under the purview of existing law. Foregoing insurance also affects outcomes largely by shifting costs to others and hence is not a neutral decision.

The other side of the argument is filed by Doug Holtz-Eakin with co-signatories inclusing Prescott, Smith, Cochrane, Jensen, Anne Krueger, Meltzer etc.) First, they argue that if an individual does not want to buy converage it must be because the costs outweigh the benefits. Second, they argue about the numbers, claming the costs imposed by the uninsured on the insured (“cost-shifting”) are far below the $43 billion estimated by the Government Economists and are more like $13 billion.

The first part of the Holtz-Eakin argument is, to me at least, odd. Uninsured individuals can get healthcare for free in the emergency room. Hence, they can get the benefits of healthcare  -or at least healthcare in extreme circumstances – without the costs. So, of course for them the benefits are outweighed by the costs because they get the benefits anyway. The argument by Holtz-Eakin presumes that the individuals are not free-riding and so their private decisions fully reflect the costs and benefits but they do not. Then, the second part of the argument which admits there is cost-shifting going on basically makes the point I am making – if there is cost-shifting, there is free-riding and then individual’s decisions do not fully internalize costs and benefits.

There has to be a better argument against the individual mandate than this. I looked at Senator Rand Paul’s brief. The precedent for this case is a 1942 case involving an Ohio farmer who was exceeding his quota of wheat production. Footnote 6 caught my eye:

So infamous is the case, it has been set to music, to the
1970s tune of “Convoy”:
“His name was farmer Filburn, we looked in
on his wheat sales. We caught him exceeding
his quota. A criminal hard as nails. He said,
“I don’t sell none interstate.” I said, “That
don’t mean cow flop.” We think you’re
affecting commerce. And I set fire to his crop,
HOT DAMN! Cause we got interstate
commerce. Ain’t no where to run! We gone
regulate you. That’s how we have fun.”

Will this convince Justice Kennedy or is it cow flop?

Find all briefs here.

As the Americans and British pull out of Afghanistan, the Chinese and Indians are standing by to move in and extract its mineral wealth. But:

Dr Richard Weitz, Senior Fellow and Director of the Center for Political-Military Analysis at Hudson Institute said: “From our perspective, China should have done more in terms of security. From their perspective, they didn’t need to; they could free-ride, we were going to do it anyway. They didn’t see any point because all they would do is incur a lot of sacrifice and antagonise the Taliban and the global terrorist movement, and they’d rather let us incur that.”

Why aren’t Western countries going in there themselves?

Peter Galbraith, former deputy head of the UN mission in Afghanistan, said: “Western companies are exceptionally timid when it comes to operating in places where there is even the remotest hint that it might be a little risky, and the Chinese are not and are willing to go to these places. And the Chinese have business practices that Western countries … let’s just say that Chinese generosity towards local officials exceeds that of what Western companies are capable.”

I guess some might argue trade is good for Afghanistan and hence for us if trade leads to a stable prosperous economy. But as I have made it to Chapter 4 of Acemoglu and Robinson’s Why Nations Fail, I worry that Afghanistan will adopt “extractive political institutions” and all this trading will lead nowhere except a Swiss bank account.


A Generalist is good at many tasks, a Specialist only good at one. Demand for the output at each task fluctuates so it is good to have someone who can perform many tasks so “supply can match demand”. So, the Generalist is better for the firm than the Specialist.

But the Generalist’s life is hard – she is taking on a lot of risk. What will she be working on next? And she is the same rank as the specialist so she gets the same rewards. Better to coast on the tasks she likes least and work hard on one. More predictability and a better idea of what task to get better and better at performing.

So, generalists should disappear in the long run and the firm will just have specialists. Unless they can think of some way to reward generalists.

There are three divisions in a firm, A, B and C. Each makes a different kind of product. Resources are allocated from Center and the three divisions compete for them. Over time the members of each division generate ideas for new products that need funding. The ideas may be good or bad and the division members get an accurate signal of the quality of the idea. The members of other divisions get a noisy signal or no signal at all. The three divisions have to send a vote to the Center which will determine whether to fund the idea or not. The greater the number of divisions supporting an idea, the more likely it is to be funded by Center.

Division A is “honest”. They only push their ideas if they are good. They support the ideas of other divisions if and only they become convinced by objective arguments that they are good.

Division B is an “empire builder”. They push all their ideas as if they are all good. They thrash other divisions’ ideas if they feel threatened.

Division C is “honest yet strategic”. They  push their ideas if and only if they are good. How should they vote on other divisions’ ideas? Division A is likely to be on their side when they push an idea. After all, Division C only support their own ideas if they have a good signal. They can then convince Division A of the strength of their case. To convince Center, it would be even better to have a unanimous decision with Division B on board. So, Division C supports Division B’s ideas. If Division A proposes an idea for funding and Division B opposes it, Division C sides with Division B. A quid-pro-quo equilibrium develops between Divisions B and C.

In the long run, Division A will die out. This is bad for Center as Division A’s good products are good for profits and Division B’s bad products are not. So perhaps Center will intervene. Or Division A may also become strategic. They should deliberately destroy some of Division C’s good potential products and persuade them to switch their support to them over Division B.

In an under-caffeinated state yesterday morning, I picked up the NYT Travel section to see where I might escape once my teaching is over in a few weeks. Nogales, Mexico, seemed easy to get to – you just go to Nogales, Arizona, and walk across the border. Good for tacos and cheap dental work.

A few hours and several coffees later, I settled down to read Why Nations Fail, Daron Acemoglu and Jim Robinson’s new book. It summarizes their many years of research (some with Simon Johnson) on political and economic institutions and their impact on economic growth. The book has no equations, graphs or tables and is aimed at a popular audience. The book begins by comparing the colonial history of Mexico and the U.S.

Mexico was settled by Spanish conquistadores who extracted as much gold and silver as possible and used the population as slave labor. The British tried to take the same approach when they arrived in Virginia. But there was no gold or silver and the population density was low. They were forced to set up political institutions that fostered economic activity. Settlers eventually got to keep a large slice of any surplus they generated and got the right to vote on taxation (this led to trouble for the British in the long run!). All very interesting and yet it seemed familiar. Eventually it dawned on me that a key Acemoglu and Robinson motivating example, used to show the importance of institutions, is Nogales Arizona vs Mexico. The geography is the same and yet the political institutions are quite different. And so are the economic outcomes. So, geography is not the major determinant of economic outcomes (roughly the theory of Jared Diamond) and political institutions are at the core of economic development.

Serendipity, synchronicity, call it what you will, but the time seems ripe for this book. Acemoglu and Robinson have a blog to accompany their book. I suppose they will interpret comtemporary events through the lens of their theory.  I look forward to reading it on a regular basis.

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