A blog about economics, politics and the random interests of forty-something professors
Interesting WashPo article re Germany truck attack:
Islamic State officials have explicitly sought to link such attacks to the larger goal of making Europe intolerable for faithful Muslims. A 2015 article in the group’s English-language magazine, Dabiq, warned that the terrorists would soon begin targeting the West with the aim of deliberately provoking a backlash against Muslims living there.
“Muslims in the West,” the article said, “will quickly find themselves between one of two choices: they either apostatize and adopt the [Western] religion . . . or they emigrate to the Islamic State and thereby escape persecution.”
Somewhat consistent with our paper but generates some new questions – unlike Al Qaeda, ISIS is a near state not a terrorist group. The main threat to its survival is Western tacit support to a Putin-Assad (and Trump?) coalition against ISIS. If these terrorists attacks lead to such a coalition, provocation will backfire.
My prediction for the Trump Presidency is still that it will be a Bush Presidency with some Trumpian twists (e.g. infrastructure spending). But there is a worse scenario.
Who thinks that President Obama will say on January 20 that he is NOT stepping down because his “replacement” lost the popular vote and won the electoral college because of Russian hacking? The whole idea seems farfetched. On the other hand, if PEOTUS Trump loses the election in four years, who thinks he might say the election was rigged and try to stay on? This does not seem farfetched.
So the most important job of Congress is to check-and-balance PEOTUS’s excesses. How should Congress do so? As usual, Roger Myerson is ahead of the rest of us in thinking about this. In a blog post he writes:
America’s constitutional system depends fundamentally on a balanced distribution of power between the separate branches of government. Over the past century, a long expansion in the size and scope of federal agencies has entailed a steady growth of presidential power. Now, with a President-elect who has never exercised public power within constitutional limits, our best hope is that the next four years should be a time for strengthening the effective authority of Congress. For this vital goal, Democrats today should support the constitutional right of congressional majorities to legally direct the policies and actions of the federal government, even when those majorities happen to be Republican.
His blog post makes many points including regarding the paradoxical impact of term limits for Congress and the misuse of the filibuster.
Eat at Tacqueria El Milagro:
Chile Relleno tacos
State outcomes are highly correlated with one another, so polling errors in one state are likely to be replicated in other, similar states….If Clinton loses Pennsylvania despite having a big lead in the polls there, for instance, she might also have problems in Michigan, North Carolina and other swing states.
The correlating factor appears to be the white working class vote which abandoned Clinton in the Rust Belt States. For reasons we do not yet fully understand, this vote for Trump did not appear in polls. The polls were then all off the mark in all Rust Belt states.
The others poll aggregators assumed independence and gave less thought to a simple theory of voting that might generate independence let alone whether such a theory might be plausible. If they hand, it would have led them to a more plausible way to look at the data, like Silver, and hence better predictions.
(HT Georgy Egorov though I may not be doing justice to his point.)
The most likely outcome for the Trump Presidency is that it will Bush 2.0 with some Trumpian twists. Specifically:
President-elect Trump main framework for organizing human interaction is the zero-sum game. If he gives you anything, he wants something in return. He will soon be able to apply this deal-making philosophy to our strategic partners like Japan and South Korea.
We can measure the costs of the bases, the personnel and the nuclear weapons that are helping given them security. The benefits – stopping nuclear proliferation – are hard to measure. Are we giving them something for free? That is Trump’s perspective it seems. Can he get a better deal? If not, why not let these countries go nuclear? From the perspective of out strategic partners, if the US is not holding them up, why not go nuclear?
So, chances are, we will see nuclear proliferation among our “allies” in the Trump Presidency.
Evangelical Christians knew who Trump was, had seen the videos and ads and yet still voted for Trump. Their main issue is the make-up of the Supreme Court and Trump gave them a list of potential nominees they liked . He was more likely to choose an anti-abortion justice than Hillary. So, the vast majority worked out their constrained optimal choice and went for it.
Greens could register a protest vote for Jill Stein in the election or choose between one of two electable candidates. No doubt, Jill, if elected, would have tried to implement a first-best environmental policy (and failed to get it past a Republican Congress) but realistically it was choice between Hillary getting nothing done or Trump ripping up the Obama legacy. The obvious legacy of interest to Greens is the Paris agreement and this is now the Paris disagreement. And in Michigan and Wisconsin, Hillary’s margin of loss is smaller than Jill Stein’s vote. Of course, this is not enough – Robby Mook would have to have had the foresight to get Beyonce to come to Philly not Cleveland.
So why are Evangelicals better than Greens at this kind of reasoning? Are Greens just crazier? My colleague Jorg Spenkuch found a clever way to measure the fraction of crazy Greens in Germany – I think he finds it is 60%. Not sure if he has a way to measuring crazy German Evangelicals (if they exist)! Another theory would be based on learning. Evangelicals have been around the block a while and have learned the optimal strategy but Greens have not. But a counterargument is the Gore vs Bush Florida battle where Ralph Nader played a crucial role. Surely the Greens voters could remember having screwed up the election of the person who would have been the best President on the environment ever? I parry this thrust by positing the Greens who voted for Jill Stein are so young that Bush v Gore is not part of their recalled history.
I was discussing some forecasts of what might befall under a Trump Presidency with a friend. He was skeptical of one of them but it turns out Henry Kissinger agrees with me:
JG: So there is some chance of more instability.
HK: I would make a general statement: I think most of the world’s foreign policy has been in suspense for six to nine months, waiting for the outcome of our election. They have just watched us undergo a domestic revolution. They will want to study it for some period. But at some point, events will necessitate decision making once more. The only exception to this rule may be nonstate groups; they may have an incentive to provoke an American reaction that undermines our global position.
JG: The threat from isis is more serious now?
HK: Nonstate groups may make the assessment that Trump will react to a terror attack in a way that suits their purposes.
How do you assess whether a probabilistic forecast was successful? Put aside the question of sequential forecasts updated over time. That’s a puzzle in itself but on Monday night each forecaster will have its final probability estimate and there remains the question of deciding, on Wednesday morning, which one was “right.”
Give no credibility to pronouncements by, say 538, that they correctly forecasted X out of 50 states. According to 538’s own model these are not independent events. Indeed the distinctive feature of 538’s election model is that the statewide errors are highly correlated. That’s why they are putting Trump’s chances at 35% as of today when a forecast based on independence would put that probability closer to 1% based on the large number of states where Clinton has a significant (marginal) probability of winning.
So for 538 especially (but really for all the forecasters that assume even moderate correlation) Tuesday’s election is one data point. If I tell you the chance of a coin coming up
Armageddon Tails is 35%, you toss it once and it comes up Tails you certainly have not proven me right.
The best we can do is set up a horserace among the many forecasters. The question is how do you decide which forecaster was “more right” based on Tuesday’s outcome? Of course if Trump wins then 538 was more right than every other forecaster but we do have more to go on than just the binary outcome.
Each forecaster’s model defines a probability distribution over electoral maps. Indeed they produce their estimates by simulating their models to generate that distribution and then just count the fraction of maps that come out with an Electoral win for Trump. The outcome on Tuesday will be a map. And we can ask based on that map who was more right.
What yardstick should be used? I propose maximum likelihood. Each forecaster on Monday night should publish their final forecasted distribution of maps. Then on Wednesday morning we ask which forecaster assigned the highest probability to the realized map.
That’s not the only way to do it of course, but (if you are listening 538, etc) whatever criterion they are going to use to decide whether their model was a success they should announce it in advance.
It was great to wake up this morning and find that Oliver Hart and Bengt Holmström were awarded the Nobel Prize in Economics for 2016. Their research is the bread and butter of modern economic theory and hence is taught in all first-year PhD microeconomics courses and more applied versions are taught to MBAs in electives on organizational economics.
Let me begin with the work of Bengt Holmström. The prize announcement begins with his work on the principal-agent model with moral hazard: An agent privately chooses an action that impacts the welfare of a principal. The principal observes noisy signals of the action and rewards the agent as a function of the signals to align incentives. Holmström asks: Which variables should be included by the principal is her performance measure and which should be omitted? In the “sufficient statistic” result, he shows that variables should be included if and only if they contain information about the action. Adding more signals into a performance measure would add superfluous noise into payments which the a risk-averse agent would have to be compensated for. On the other hand, subtracting informative signals from a performance would eliminate useful information for aligning incentives.
This result poses a puzzle which Bengt turns to in later work: Real-world contracts are rarely as complex as the informativeness principle would suggest. Why is that the case? In joint work with Paul Milgrom, Holmström introduced the multi-task principal agent model. The main innovation was to allow the agent to perform multiple tasks and to substitute from one to the other. Holmström and Milgrom show that in certain circumstances it is better not to may pay responsive to performance. Suppose someone working in a fast food restaurant can look after the kitchen or sell burgers. Burger sales are measurable but time spent looking after the kitchen is not. Then making pay depend on burger sales can backfire as the agent substitutes away from looking after the kitchen. Better to have low-powered incentives which are relatively flat in burger sales.
Bengt has made at least two other seminal contributions to moral hazard models. In his work on moral hazard in teams he shows that it might be impossible achieve total value maximizing outcomes when joint output is measurable but individual output is not. In his career concerns model, he shows that an agent trying to prove he is high ability to a market might work too hard at the start of his career and then tail off at the end. All these papers are workhorses of applied theory. They show Holmström’s flair of coming up with models that serve as vehicles for others to make interesting contributions to understanding incentives.
I want to end my appreciation of Bengt Holmström by pointing out that several of these papers were written when he was an Assistant Professor in the MEDS Department at Kellogg. Roger Myerson has already won a Nobel Prize for the work he did when he was in MEDS.
Oliver Hart took contract theory in a different direction by emphasizing the role of property rights. In the principal-agent model, the principal might be an employer and the agent an employee. Or the principal might be one firm and the agent an independent subcontracter. In other words, the model cannot address the question of when trade should take place within a firm or across two firms. Building on some informal ideas of Oliver Williamson, Oliver Hart with Sandy Grossman and John Moore used the idea that contracts are incomplete to offer a unified theory of the optimal allocation of property rights. The key idea is that ownership of an asset confers residual rights of control so you can use it for production should a relationship break down. Suppose a buyer and a seller are trading a widget. They can both invest ex ante to increase the value of trade but because contracts are incomplete they must haggle over the price ex post. This means both are subject to hold-up: the benefit of any costly investment is shared with the other trading party. Hence, both will underinvest. This underinvestment is mitigated by the fact that if a player owns an asset he can use it to trade with others so at least he can capture some value from his investment. So, if one player’s investment is particularly important for value creation he should be own all the assets and employ the other – so we have an integrated firm. If both players’ investments are important, then they should both own assets and then we have trade across two independent firms.
Debt and equity confer decision rights in different ways. So, Oliver Hart’s way of looking at control rights has proved to be very fruitful in corporate finance. But there is a lot to be done. In particular, without a theory of why contracts are incomplete there is a tension between the lessons of mechanism design and the ideas in Grossman-Hart-Moore. This tension was pointed out by Maskin and Tirole. Eric Maskin was my PhD advisor at Harvard and Oliver arrived at Harvard just as I graduated. At that point, my friend, co-author and advisor Tomas Sjöström, who was sitting at the podium during the announcement as he is on the Nobel Committee, was an assistant professor at Harvard and I would visit to work with him. We became interested in Oliver’s ideas and also knew of the Maskin-Tirole critique. So, Tomas and I wrote a few papers studying optimal decision rights when agents can collude or renegotiate inefficient outcomes without falling afoul of the Maskin-Tirole critique. I continue to work on these questions still. I would never have worked on those papers without Oliver’s seminal insights to build on. So, I am particularly happy personally with this prize.
Trump excites the “base” but not independents or traditional Republicans who believe in free markets etc. The temptation for Congressional Republicans up for election is to use “strategic ambiguity” and have their cake and eat it. That is, say you support the Republican Presidential nominee but not embrace his positions, e.g like Ayotte and McCain. This way, you hope ticket-splitters vote for you to check and balance Hillary.
Unfortunately, Obama moves second. He will say Trump is unfit to be President, is not a Republican and will tar supporters with the same brush. This way he will seek to slice off the base vote from the non-base. A vote for a supporter is a vote for Trump. How will they check and balance a demagogue when they are not splitting with him now? Also – and somewhat unexpectedly – Trump is helping Obama out here by refusing to endorse Congressional Republicans employing strategic ambiguity. He refuses to endorse Ayotte and McCain because of criticisms etc. Hence,he is signaling to his base not to support them (not sure if his strategy makes sense but I will take him at face value).
So, on the one hand, Obama will attack anyone on the fence by saying they support Trump (hoping to peel off independents, “real” Republicans and ticket-splitters) and Trump will attack anyone on the fence by saying they do not support him (hoping his base will not support them?!!).
So, strategic ambiguity is going to backfire so you have to pick a side. Which side? Can you win if you support him and he loses your state? If the answer is a likely Yes, you support Trump (e.g. Rubio) and if it is a No, you Dump Trump. The more likely your state is to go for Hillary, the more plausible your “I will check and balance Hillary” argument and the less costly it is to Dump Trump. Hence, Toomey and Ayotte are likely in this category. If the state is 50-50 like AZ, your choice is difficult, eg McCain, but you have to pick a side otherwise both may not vote for you.
Henry VIII (the right-wing of the Tory party) wanted to divorce his first wife (the EU) and marry Anne Boleyn (stop immigration and transfer payments to the EU ) but the Catholic Church (Angela Merkel) would not let him. So, he renounced Catholicism and became a Protestant, a new form of Christianity conceived by Martin Luther (Nigel Farage). But then Mary Queen of Scots (Nicola Sturgeon), a Catholic, married a French Prince when Elizabeth I (Boris Johnson) eventually came to the throne. Mary got beheaded and the Elizabeth’s reign turned out pretty well.
But here Boris’s and Elizabeth’s paths diverge. The Protestant Reformation was forward looking and emphasized the work ethic. Faragism – to the extent it is a philosophy – is backward-looking and is about denying globalization. Not clear then who gets beheaded, Boris or Nicola.
Trump is the Principal and a Republican Congress member is the Agent. Trump wants their support and wants to compel them to support him. There is no money to align incentives and all Trump can do is shower with praise (e.g. people who cave in to him are “brave” like Megyn Kelly who went to visit him in Trump Tower after their dustup) or rain down abuse (e.g. the Republican Governor Martinez of New Mexico who dared to text during one of his speeches).
From the Agent perspective, since there is no money, there is only re-election probability. This leads to two cases. In one case, the Agents reelection probability is increasing in being seen as pro-Trump. Then, Trump should allocate praise and abuse in the natural way. In the other case, the Agent’s re-election probability is decreasing in being seen as pro-Trump but Trump would still like Republican support to increases his election chances. Then, Trump should visit the Agent’s district if the Agent does not support Trump. He should say the Agent is brave and lie and say the Agent does support him. This threat maximizes compellence.
Marco Rubio provides the most interesting example. He has lumped in with Trump as he decides whether to run for re-election. If he throws his hat into the ring and Trump’s polls tank in Florida, Donald should threaten to campaign there heavily if Rubio shows signs of weakening in his support of Trump.
What I wrote yesterday:
When Fox broadcasts the Super Bowl they advertise for their shows, like American Idol. But those years in which, say, ABC has the Super Bowl you will never see an ad for American Idol during the Super Bowl broadcast.
This is that sort of puzzle whose degree of puzzliness is non-monotonic in how good your economic intuition is.
If you don’t think of it in economic terms at all it doesn’t seem at all like a puzzle. Try it: ask your grandpa if he thinks that its odd that you never see networks advertising their shows on other networks. Of course they don’t do that.
When you apply a little economics to it that’s when it starts to look like a puzzle. There is a price for advertising. The value of the ad is either higher or lower than the price. If its higher you advertise. If its another network that price is the cost of advertising. If its your own network that price is still a cost: the opportunity cost is the price you would earn if instead you sold the ad to a third-party. If it was worth it to advertise American Idol when your own network has the Super Bowl then it should be worth it when some other network has it too.
But a little more economics removes the puzzle. Networks have market power. The way to use that market power for profit is to artificially restrict quantity and set price above marginal cost. (The marginal cost of running another 30 second ad is the cost in terms of viewership that would come from shortening, say, the halftime show by 30 seconds.)
When a network chooses whether to run an ad for its own show on its own Super Bowl broadcast it compares the value of the ad to that marginal cost. When a network chooses whether to run an ad on another network’s Super Bowl broadcast it compares the value to the price.
Indeed even if the total time for ads is given and not under control of the network (i.e. total quantity is fixed) the profit maximizing price for ads will typically only sell a fraction of that ad time. Then the marginal (opportunity) cost of the additional ads to pad that time is zero and even very low value ads like for American Idol will be shown when Fox has the Super Bowl and not when any other network does.
In fact that last observation and the fact that you never ever see any network advertise its shows on another network tells us that the value of advertising television shows is very low. Perhaps that in fact tells us that the networks themselves understand (but their paying advertisers don’t) that the value of advertising in general is very low.
When Fox broadcasts the Super Bowl they advertise for their shows, like American Idol. But those years in which, say, ABC has the Super Bowl you will never see an ad for American Idol during the Super Bowl broadcast.
More generally, networks advertise their own shows on their own network but never pay to advertise their shows on other networks. I never understood this. But I think I finally figured it out, there’s some very simple economics behind this.
Right now at Primary.guide, you can read the current betting market odds for a “contested convention” and a “brokered convention.” The definitions are as follows. A contested convention means that no candidate has 1237 delegates by the end of the last primary. A brokered convention means that no candidate wins on the first ballot at the convention.
Right now the odds of a brokered convention are 50%. Note also that the odds of a Trump nomination are 50% as well. And Trump is the only candidate with any chance of winning a majority on the first ballot (even if he doesn’t get 1237 bound delegates he will be close and no other candidate could combine their bound delegates with unbound delegates to get to a majority.)
Thus, if there is no brokered convention Trump is the nominee. The probability of no brokered convention is 50%. Thus the entire 50% probability of a Trump nomination is accounted for by the event that he wins on the first ballot.
In other words there is zero probability, according to betting markets, that Trump wins a brokered convention.
The odds of a contested convention are 80%. That means that betting markets think there is a 30% chance Trump fails to get 1237 bound delegates but still wins on the first round. I.e. according to betting markets we have the following three mutually exclusive events:
You are a lifelong Republican and think Trump is not a conservative. You would never vote for him. You go into the voting both and see Clinton’s name and Trump’s name. What do you do? Either you bite the bullet and vote for Clinton or you abstain. Either way you have increased the probability that Hillary wins – OK not by much but since you are in the voting booth in the first place, you’re not a fully rational voter and so you care about the infinitesimal impact you have. So, you decide to make sure she’s hamstrung by a Republican Congress. You vote for the Republican Congressional candidates.
You would vote for Cruz but suspect he is a bit nuts. You vote for the Democratic Congressional candidates to make sure Cruz is ineffective.
(Kasich would actually be best all round but has no chance of making it.)
Suppose politician C goes negative on politician M. Politician’s M’s support declines..where do his supporters go? If there are just two candidates, they either go to politician C or stay at home. But if there are three or more candidates, they might go to politician A, B, or K etc etc. So, to a first order, it is less profitable to go negative the greater the number of candidates.
This resembles the Holmstrom teams model but with unproductive effort.
HENNIKER, New Hampshire — In town halls, pizzerias, and high school auditoriums, hundreds of voters are carefully evaluating the three governors who have pinned their presidential hopes on Tuesday’s primary in the Granite State — Jeb Bush, Chris Christie, and John Kasich.
Some have made their choice of the three; others are still undecided. But they all agree on one big thing: The Republican Party needs a strong contender coming out of New Hampshire to take down Donald Trump.
With the stakes so high, these “non-angry voters,” as described by some, are wrestling with whether to ultimately vote for their personal favorite — one of the three governors, or go by the polls in favor of a more practical favorite, Sen. Marco Rubio.
Of course, Ted Cruz and Donald Trump would disapprove or approval voting.
ISIL has taken war out of the Middle East by bombing a Russian plane and attacking Paris. These attacks follow increased Russian and Western involvement in Syria.
What was the purpose of these attacks? It is useful to examine two polar opposite cases : ISIL’s acts seek to provoke or seek to deter.
If they seek to provoke, the best case scenario for ISIL is that Russia and the West respond by repressing Muslims domestically. This anti-Muslim fervor will generate propaganda that is useful for recruitment. But of course, the attacks will provoke a strong counter-response by France, Russia and their allies in Syria. Finally, a Russia-Western coalition may even come into being. Al Qaeda’s diminished fate then awaits ISIL. A provocation cannot be targeted into only a domestic response and the international response will be so dramatic as to counterbalance any domestic response though, of course, it would also be wise not to give in to the temptation to cave in to anti-Muslim fervor.
If ISIL seek to deter – i.e. they are making us pay a price for increased involvement in Syria and giving us an incentive to retreat – well that’s totally going to backfire. The French, British and Russians are more likely to engage than less as I said above. In this case, ISIL’s strategy would be a complete misreading of the situation.
So, either way, the ISIL strategy is going to fail.
My colleagues are multi-talented:
HT: Bob McDonald for telling me first song is also by Dave Edmunds.
Uber drivers are competing with each for fares. The smaller the number of other drivers on the road, the greater the chance a driver get business. Also, when demand for rides outstrips supply of drivers, Uber might activate surge pricing to increase supply. Not only does a driver stand to get more business, he gets a higher fare/mile. The incentives to deviate from the strike are huge.
So, in Chicago, during the supposed strike, the number of Uber Drivers on the road was huge. Surge pricing was not activated because it was not necessary.
HT: An Uber driver.
I was on Chicago Tonight very briefly discussing Purple Pricing (see around 4 minute mark).
In 2008, the New South Wales government announced plans to build a coal mine here, promising jobs and cheap power. The coal business was booming because of demand from China. The government bought up 177 square miles of land for the mine project, boarding up 114 farms and homes.
Since then, coal prices have plummeted to their lowest level in years and the government has not been able to find a mining company willing to open a mine here. In 2013, the government abandoned its plans to develop the mine and last December appointed Goldman Sachs to sell the land.
By then, the district had lost 95 families, about 10 percent of its population. A sense of loss pervades the town, and residents feel blindsided by forces beyond their control.
Party A steals something of value to Party B and demands a ransom for its return. But once the ransom has been paid, what is to stop Party A from coming back and demanding more?
One mechanism that purchases commitment is reputation. Party A has more ransoms to extract in the future and seeks to be seen as a fair player despite being an extortionist. An interesting example is provided by Cryptowall. This “company” sends an email with a devious attachment, a virus that encrypts your harddrive if you click on it. They demand a ransom in Bitcoin to send the decryption key. The price changes over time.
The fact that they do not take your data means that they cannot come back and demand another ransom for the same data if you pay.
Because the price changes, there can be errors – you pay a ransom of 500 and by that time the price has gone up to 550 and you do not get the decryption key. What to do? A good credit card company would waive a late fee to keep a good reputation and so does Cryptowall. From the New York Times:
Use the CryptoWall message interface to tell the criminals exactly what happened. Be honest, in other words.
So she did. She explained that the virus had struck the same week that a major snowstorm hit Massachusetts and the Thanksgiving holiday shut down the banks. She told them about the unexpected Bitcoin shortfall and about dispatching her daughter to the Coin Cafe A.T.M. at the 11th hour. She swore she had really, really tried not to miss their deadline. And then a weird thing happened: Her decryption key arrived.
(HT: Alex Wearn)
You are debating a point with a colleague. Your colleague is wrong but to prove they are wrong you have to use information you know but cannot share. So, you leave things unsaid. Of course, someone who does not know the facts would also leave things unsaid by definition.
The listener knows that silence either conveys the fact that something is known but cannot be said or that nothing is known. Their inference takes the fact that you might know something but cannot say it into account. They should give you the benefit of the doubt. The benefit depends on how likely you are to know things that cannot be said. Hence, if the person leaving things unsaid is senior to the listener, the listener might defer to the speaker. Hence, seniority leads to authority via the inference content from leaving things unsaid.