Tag Archives: economics

Robustness is a form of efficiency

Efficiency means using the best way to achieve a goal. Mathematically, selecting the maximizer of an objective function. The goal may be anything. For example, the objective function may be a weighted average of performance across various situations.

Robustness means performing well in a wide variety of circumstances. Mathematically, performing well may mean maximizing the weighted average performance across situations, where the weights are the probabilities of the situations. Performing well may also mean maximizing the probability of meeting a minimum standard – this probability sums the probabilities of situations in which the (situation-specific) minimum standard is reached. In any case, some objective function is being maximized for robustness. The best way to achieve a goal is being found. The goal is either a weighted average performance, the probability of exceeding a minimum standard or some similar objective. Thus robustness is efficiency for a particular objective.

The robustness-efficiency tradeoff is just a tradeoff between different objective functions. One objective function in this case is a weighted average that puts positive weight on the other objective function.

Whatever the goal, working towards it efficiently is by definition the best thing to do. The goal usually changes over time, but most of this change is a slow drift. Reevaluating the probabilities of situations usually changes the goal, in particular if the goal is a weighted average or a sum of probabilities that includes some of these situations. A rare event occurring causes a reevaluation of the probability of this event, thus necessarily the probability of at least one other event. If the probabilities of rare events are revised up, then the goal tends to shift away from single-situation efficiency, or performance in a small number of situations, towards robustness (efficiency for a combination of a large number of situations).

To be better prepared for emergencies and crises, the society should prepare efficiently. The most efficient method may be difficult to determine in the short term. If the expected time until the next crisis is long, then the best way includes gathering resources and storing these in a large number of distributed depots. These resources include human capital – the skills of solving emergencies. Such skills are produced using training, stored in people’s brains, kept fresh with training. Both the physical and mental resources are part of the economic production in the country. Economic growth is helpful for creating emergency supplies, raising the medical capacity, freeing up time in which to train preparedness. Unfortunately, economic growth is often wasted on frivolous consumption of goods and services, often to impress others. Resources wasted in this way may reduce preparedness by causing people to go soft physically and mentally.

Solving a crisis requires cooperation. Consumption of social media may polarize a society, reducing collaboration and thus preparedness.

Less inspiring people in universities than in early school

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A student claimed that fewer inspiring people are found in universities than in early school. Empirical checks of this would be interesting and would need a measure of inspiringness. A theoretical explanation is a tradeoff between multiple dimensions: subject matter competence, integrity, reliability, communication skills, being inspiring, etc. The tradeoff is on both the demand and the supply side. An inspiring competent person has many career options (CEO, politician, entrepreneur) besides academia, so fewer such people end up supplying their labour to the education sector.

On the demand side, a university has to prioritise dimensions on which to rank candidates and hire, given its salary budget and capacity constraints on how many job positions it has. Weighting competence more leaves less emphasis on inspiringness. Competing universities may prioritise different dimensions (be horizontally differentiated), in which case on average each institution gets candidates who have more of its preferred dimension and less of other dimensions.

As a side note, what an organisation says its priorities are may differ from its actual priorities, which are evidenced by behaviour, e.g., who it hires. It may say it values teaching with passion, but hire based on research success instead.

A constraint is a special case of a tradeoff. Suppose that given the minimum required competence, an employer wants to hire the most inspiring person. The higher this level of competence (teaching PhD courses vs kindergarten), the fewer people satisfy the constraint. At a high enough level of the constraint, there may be insufficient candidates in the world to fill all the vacant jobs. Some employers cannot fill the position, others will have just one candidate. Maximising inspiringness over an empty set, or a set of one, is unlikely to yield very inspiring people.

It may be inherently simpler to inspire with easier material, in which case even with equally inspiring people throughout all levels of education, the later stages will seem less inspiring.

Larger leaps through theory may be required as a subject gets more advanced, leaving less scope for inspiring anecdotes and real-life examples. The ivory tower is often accused of being out of touch with common experience. Parting with everyday life is partly inevitable for developing any specialised skill, otherwise the skill would be an everyday one, not specialised.

If inspiring people requires manipulating them, and more educated individuals resist manipulation better, then inspiring people gets more difficult with each level of education. Each stage of study selects on average the more intelligent graduates of the previous stage, so if smarter people are harder to manipulate, then those with higher levels of education are harder to inspire. On the other hand, if academics are naive and out of touch with the ways of the world, then they may be easier to manipulate and inspire than schoolchildren.

People accumulate interests and responsibilities in their first half of life. The more hobbies and duties, the less scope for adopting a goal proposed by some charismatic person, i.e., getting inspired by them. Later in life, many goals may have been achieved and people may have settled down for a comfortable existence. They are then less inclined to believe the need to follow a course that an inspiring person claims is a way of reaching their goals.

Exercise is better than working to buy health insurance

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Health insurance does not insure health, but wealth. Exercising to prevent disease is often better than working to buy health insurance to cover treating that disease. For example, cancer, stroke and cardiovascular disease predominantly occur in old age, so insurance against these is highly substitutable with exercise.

The American Association for Critical Illness Insurance in 2011 listed the following average annual premiums by age group for a male nonsmoker based on a $40,000 benefit for treatment of cancer, stroke or heart attack. Age 40: $575 to $610; age 45: $745 to $785; age 50: $940 to $980. Similar premiums in 2019 only buy cancer insurance.

At an after-tax hourly wage of $20, paying these premiums requires 30-50 work hours per year, about 0.6-1 hour per week, or 0.6-1% of waking hours. From a baseline of zero sports, one hour per week of exercise increases lifespan by one year, or by about 1/80 of life expectancy. Whether switching an hour per week from work to exercise (and cutting health insurance to compensate for the lost hourly wage) is a good investment in terms of lifespan depends on how much treatment lengthens life and how much health insurance increases the probability or quality of treatment. Data is difficult to find on both the effect of treatment on lifespan and the effect of health insurance on treatment.

The median survival rate to hospital discharge after EMS-treated out-of-hospital cardiac arrest with any first recorded rhythm is 7.9%. So for serious heart conditions, treatment and thus health insurance does not make much difference. Lung cancer treatment is said to prolong survival by about three months, which also seems small. Even if no health insurance implies no treatment, which is not the case because emergency care is still provided, investing worktime to buy health insurance seems to have a low benefit. People with cancer survive with a probability about 2/3 of the survival probability of a comparable population without cancer, so the upper bound on the benefit of treatment is 2/3 times the probability of getting cancer times the remaining life expectancy. This upper bound is loose, because zero treatment does not reduce the 5-year survival probability to zero.

Firms could short the stock of competitors

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If a firm designs a great new product, a more efficient production process or gains some other privately known competitive advantage, then the firm could financially profit by short selling its competitors’ stock before revealing its advantage. The revelation reduces the expected discounted profits of competitors, thus their stock price. Symmetrically, if a firm loses cheap suppliers, suffers a manufacturing breakdown or otherwise becomes less able to serve its customers, then its competitors will probably benefit and their stock will rise. The firm could mitigate its losses by buying rivals’ stocks, with leverage.

Shorting competitors does not seem to be illegal insider trading, as defined by the US courts: the purchasing or selling a security while in possession of material, non-public information concerning that security, where the information is obtained from a breach of fiduciary duty, or a duty arising from a relationship of trust or confidence. I am not a lawyer, so this is just a guess, but a firm usually does not possess inside information about its competitors and does not owe fiduciary duty or trust to its rivals. Maybe there is some other reason not to trade in competitors’ stock, but a casual web search did not reveal why.

More efficient use of rooms and equipment during the shutdown

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Instead of the labs, gyms and other rooms standing empty during the shutdown, the same isolation of people could be achieved by allocating each building or other resource to one person. Equipment from gyms or labs could be lent out for the duration of the shutdown, of course keeping a database of who borrowed what and making the borrower liable for its safe return. If only one person uses each object or building the whole time, then there is no cross-contamination or infection-spreading.

Excess demand could be rationed by lottery. Only the winner of the lottery for a resource would be allowed to use the resource, with large penalties for sharing. This would improve efficiency slightly, because one person instead of zero would be using each resource.

If the heat, water and electricity were turned off during the shutdown, then it might be more efficient to let the buildings stand empty, instead of having the utilities on and one person in each building or room. However, the lights in MIT buildings are still on at night, just like before the shutdown (and it seemed wasteful back then already).

Prefereeing increases the inequality of research output

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Why do top researchers in economics publish almost exclusively in the top 5 journals? Random idea generation and mistakes in the course of its implementation should imply significant variance of the quality of finished research projects even for the best scientists. So top people should have more of all quality levels of papers.

Nepotism is not necessary to explain why those at top universities find it easier to publish in top journals. Researchers at the best departments have frequent access to editors and referees of top journals (their colleagues), so can select ideas that the editors and referees like and further tailor the project to the tastes of these gatekeepers during writing. Researchers without such access to editors and referees choose their projects “blindly” and develop the ideas in directions that only match gatekeeper tastes by chance. This results in much “wasted work” if the goal is to publish well (which may or may not be correlated with the social welfare from the research).

In addition to selecting and tailoring projects, those with access can also better select journals, because they know the preferences of the editorial board. So for any given project, networking with the gatekeepers allows choosing a journal where editors are likely to like this project. This reduces the number of rejections before eventual acceptance, allowing accumulating publications quicker and saving the labour of some rounds of revision of the paper (at journals that reject after a revise-and-resubmit for example).

A similar rich-get-richer positive feedback operates in business, especially for firms that sell to other firms (B2B). Top businesspeople get access to decisionmakers at other organisations, so can learn what the market desires, thus can select and tailor products to the wants of potential customers. Better selection and targeting avoids wasting product development costs. The products may or may not increase social welfare.

Information about other business leaders’ preferences also helps target the marketing of any given product to those predisposed to like the product. Thus successful businesspeople (who have access to influential decisionmakers) have a more popular selection of products with lower development and marketing costs.

On the seller side, firms would not want their competitors to know what the buyers desire, but the buyer side has a clear incentive to inform all sellers, not just those with access. Empirically, few buyers publish on their websites any information about their desired products. One reason may be that info is costly to provide, e.g. requests for product characteristics reveal business secrets about the buyer. However, disclosure costs would also prevent revealing info via networking. Another reason buyers do not to publicly announce their desired products may be that the buyers are also sellers of other products, so trade information for information with their suppliers who are also their customers. The industry or economy as a whole would benefit from more information-sharing (saving the cost of unwanted products), so some trading friction must prevent this mutually beneficial exchange.

One friction is an agency conflict between managers and shareholders. If managers are evaluated based on relative performance, then the managers of some firms may collude to only share useful information with each other, not with those outside their circle. The firms managed by the circle would benefit from wider sharing of their product needs, because outside companies would enter the competition to supply them, reducing their costs. However, those outside firms would get extra profit, making their managers look good, thus lowering the relative standing of the managers in the circle.

Avoiding the Bulow and Rogoff 1988 result on the impossibility of borrowing

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Bulow and Rogoff 1988 NBER working paper 2623 proves that countries cannot borrow, due to their inability to credibly commit to repay, if after default they can still buy insurance. The punishment of defaulting on debt is being excluded from future borrowing. This punishment is not severe enough to motivate a country to repay, by the following argument. A country has two reasons to borrow: it is less patient than the lenders (values current consumption or investment opportunities relatively more) and it is risk-averse (either because the utility of consumption is concave, or because good investment opportunities appear randomly). Debt can be used to smooth consumption or take advantage of temporary opportunities for high-return investment: borrow when consumption would otherwise be low, pay back when relatively wealthy.

After the impatient country has run up its debt to the maximum level the creditors are willing to tolerate, the impatience motive to borrow disappears, because the lenders do not allow more consumption to be transferred from the future to the present. Only the insurance motive to borrow remains. The punishment for default is the inability to insure via debt, because in a low-consumption or valuable-investment state of affairs, no more can be borrowed. Bulow and Rogoff assume that the country can still save or buy insurance by paying in advance, so “one-sided” risk-sharing (pay back when relatively wealthy, or when investment opportunities are unavailable) is possible. This seemingly one-sided risk-sharing becomes standard two-sided risk-sharing upon default, because the country can essentially “borrow” from itself the amount that it would have spent repaying debt. This amount can be used to consume or invest in the state of the world where these activities are attractive, or to buy insurance if consumption and investment are currently unattractive. Thus full risk-sharing is achieved.

More generally, if the country can avoid the punishment that creditors impose upon default (evade trade sanctions by smuggling, use alternate lenders if current creditors exclude it), then the country has no incentive to repay, in which case lenders have no incentive to lend.

The creditors know that once the country has run up debt to the maximum level they allow, it will default. Thus rational lenders set the maximum debt to zero. In other words, borrowing is impossible.

A way around the no-borrowing theorem of Bulow and Rogoff is to change one or more assumptions. In an infinite horizon game, Hellwig and Lorenzoni allow the country to run a Ponzi scheme on the creditors, thus effectively “borrow from time period infinity”, which permits a positive level of debt. Sometimes even an infinite level of debt.

Another assumption that could realistically be removed is that the country can buy insurance after defaulting. Restricting insurance need not be due to an explicit legal ban. The insurers are paid in advance, thus do not exclude the country out of fear of default. Instead, the country’s debt contract could allow creditors to seize the country’s financial assets abroad, specifically in creditor countries, and these assets could be defined to include insurance premiums already paid, or the payments from insurers to the country. The creditors have no effective recourse against the sovereign debtor, but they may be able to enforce claims against insurance firms outside the defaulting country.

Seizing premiums to or payments from insurers would result in negative profits to insurers or restrict the defaulter to one-sided risk-sharing, without the abovementioned possibility of making it two-sided. Seizing premiums makes insurers unwilling to insure, and seizing payments from insurers removes the country’s incentive to purchase insurance. Either way, the country’s benefit from risk-sharing after default is eliminated. This punishment would motivate loan repayment, in turn motivating lending.

Volunteer parking wardens may benefit the environment

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Reducing the utility from car use and ownership motivates substitution towards other forms of transportation, which benefits both the environment and public health. One way to cut the convenience of driving is enforcing parking regulations, because drivers have to park further from their destination when the option of illegal parking becomes less attractive. Parking at a greater distance also makes people walk more – a minor health benefit.

Enforcing speed limits and other traffic rules that slow cars down increases the time cost of driving. This may reduce wear and tear on vehicles and roads, which benefits the environment.

An implication of is that people who want to reduce global warming or improve public health should become volunteer parking wardens and traffic police by reporting parking violations, speeding and dangerous driving (preferably with photo or video evidence from phones or dashboard cameras).

A possible countervailing effect of the enforcement of parking rules occurs if the illegally parked cars obstruct the movement of other cars enough to motivate some people to switch away from driving. Then stopping the parking violations may open the road up enough to encourage more use of cars, with an overall negative environmental and health effect. Similarly, if reckless drivers make the roads unsafe enough to reduce others’ car use, then making traffic civil again may attract risk-averse people back to driving. However, in most developed countries, illegal parking and the ignoring of rules of the road is not severe enough to deter driving significantly, so better enforcement is likely to reduce car use.

Slowing traffic down may increase congestion and emissions per kilometre travelled if there is little substitution away from driving. Again, in developed countries public transit and cycling are usually feasible options. Of course, some people always find excuses not to use these, and in remote rural areas public transit may indeed be economically unreasonable and distances may really be too great for bikes. Electric bikes are then an option. These increase the range of travel with less pollution and congestion than cars.

Equilibrium response to reduced material use for plastic bags

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Probably to save material on the manufacture of the free plastic shopping bags in the US, these bags are small and thin compared to the ones in Estonia (which used to be free, but are now priced at significantly above production cost due to EU regulations on disposable plastic products). The equilibrium response of cashiers and customers to thin flimsy bags is to double-bag groceries, a practice unheard of in Estonia. After all, if one bag is sturdy enough, almost nobody will use two inside each other. I have successfully carried 10 kg in an Estonian plastic bag.

The equilibrium response to small bags is to distribute the groceries among many bags, especially the heavy or bulky items, for example to put each milk canister or large salad sack into a separate bag. Both double-bagging and the one-item-per-bag distribution lead to more bags being used in response to manufacturing each bag out of less material. It is an empirical question whether thinner, smaller bags result in less or more plastic waste overall. To incentivise reducing the one-time use of plastic bags and to encourage reuse, customers should have to pay for these, like in the EU.

One form of plastic bag reuse is as garbage bags (although it is only a one-time reuse, it is better than nothing). However, the flimsy free bags in the US come in bulk packs with the bottoms of the bags stuck together, so separating one from the stack often results in holes in its bottom an inch wide or more. The holes discourage many forms of reuse, including as trash bags, because small items (dust, crumbs, scraps) fall out. Partly the holes are due to the flimsiness of the material, partly to the way the bags are glued together to make a bulk pack.

Delivered food and restaurants are unhealthy due to moral hazard

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Consumers observe the taste and cost of food directly, but checking the ingredients for healthiness takes extra effort and time. Rational inattention then implies that eaters are unlikely to verify the health claims. Thus food suppliers are subject to moral hazard: consumers buy based on the healthiness they expect, not the actual ingredients the seller chooses, so the seller has an incentive to improve taste, reduce the production cost and cut price even when this makes the food less healthy.

The standard solutions to moral hazard from economic theory are verification, repeated interaction and vertical integration (selling the firm). In the context of food, safety standards and truth-in-advertising laws restrict the substances manufacturers may add and claims they can make. Regulators verify claims made and punish for illegal additives or false advertising. Also, if a food supplier is found to use unhealthy ingredients (or amounts of sugar, salt and fat), then some consumers may switch to alternate providers, which is a repeated game punishment for the original seller.

The weakness of both verification and repeated interaction is imperfect monitoring: small increases in unhealthy substances are difficult to detect, because tests are noisy and food composition varies naturally. The variation sometimes makes the amount of an ingredient exceed the healthy limit, so honest suppliers would also be punished with positive probability. Incentives are created by the difference in payoffs, so reducing the payoff of the honest decreases their motive to stay honest. The imperfect monitoring allows unscrupulous sellers to outcompete the providers of healthy food on taste and price, for example by using various tricks to circumvent the legal requirements on labelling (https://sanderheinsalu.com/ajaveeb/?p=728).

The remaining solution to the moral hazard problem is vertical integration of the buyer and the supplier, i.e. home cooking. Of course, the ingredients bought to be cooked at home are subject to similar moral hazard – unhealthy substances can be added at any stage of the production process. The risk could in principle be even larger than for processed foods and restaurant meals, but in practice, it seems that simple and unprocessed ingredients are more difficult to manipulate than prepared meals, which are a mixture of many components. Adding sugar, salt, fat or monosodium glutamate to flour, rice or dry beans without mentioning it on the nutrition label is easier to detect than the same (amounts of) additives in shrimp fried rice, bread or a burrito. Raw meats and fish do have extra salt and food colouring added, but usually less than for ready-to-eat meals.

Relative prices are another reason why there may be less manipulation of ingredients than processed foods. There is a per-unit cost of adding unhealthy substances, as well as a fixed cost due to the risk of lawsuits and fines, especially if the additives are not declared on the label. Unprocessed ingredients are less differentiated, so the price competition is more intense. The increase in the price that customers are willing to pay if an ingredient tastes better than the competitors’ may be small if price is the main dimension of competition. The slightly higher price may not justify the per-unit cost of the additives. In contrast, for processed foods the margin may respond greatly to taste, motivating manipulation of the ingredients.

The taste of the final dish is likely to respond less to manipulating one ingredient than to altering the composition of the entire food, both because the ingredient may be only a small part of the final dish and because the taste of a dish is largely determined by the seasoning and the cooking method. In this case, additives to ingredients do not improve taste that much, reducing the profitability of manipulating these.

Intense price competition motivates cost-cutting, including by substituting cheaper ingredients or using additives (e.g. preservatives) that reduce the manufacturing cost. However, if the additives cost more than they save on production cost (such as preservatives for dry goods that already keep indefinitely), then they are unprofitable to include.

Demand for cooking ingredients may also respond less to price and taste than for restaurant meals or delivered food (raw ingredients may even be an inferior good, but eating out is more like a luxury good). In this case, there is a range of fixed costs of unhealthy substances for which adding these to ingredients is unprofitable, but to processed foods profitable.