Alex Soojung-Kim Pang, Ph.D.

I study people, technology, and the worlds they make

Tag: economics (page 1 of 2)

Robert Merton on self-fulfilling prophesies

From Merton's "The Self-Fulfilling Prophecy," The Antioch Review 8:2 (Summer 1948), 193-210:

The self-fulfilling prophecy is, in the beginning, a false definition of the situation evoking a new behavior which makes the originally false conception come true. The specious validity of the self-fulfilling prophecy perpetuates a reign of error. For the prophet will cite the actual course of events as proof that he was right from the very beginning…. (195)

[P]ublic definitions of a situation (prophecies or predictions) become an integral part of the situation and thus affect subsequent developments. This is peculiar to human affairs. It is not found in the world of nature…. (195)

The self-fulfilling prophecy, whereby fears are translated into reality, operates only in the absence of deliberate institutional controls. And it is only with the rejection of social fatalism implied in the notion of unchangeable human nature that the tragic circle of fear, social disaster, reinforced fear can be broken. (210)

Another interesting element in this article: Merton presents a scenario of a bank failure as self-fulfilling prophecy that reveals his assumptions about who bankers were back in the day. "It is the year 1932. The Last National Bank is a flourishing institution…. Cartwright Millingville has ample reason to be proud of the banking institution over which he preside."

File under “self-fulfilling prophecies”? The Hindenburg Omen looms

We'll know in September. From the Wall Street Journal:

Forget about Friday the 13th. Many on Wall Street took to whispering about an even scarier phenomenon—the "Hindenburg Omen."

The Omen, named after the famous German airship in 1937 that crashed in Lakehurst, N.J., is a technical indicator that foreshadows not just a bear market but a stock-market crash. Its creator, a blind mathematician named Jim Miekka, said his indicator is now predicting a market meltdown in September.

Wall Street has been abuzz about whether the Hindenburg Omen will come to bear, with some traders cautioning clients about the indicator and blogs pondering all the doom and gloom.

There's a technical but still accessible explanation of it on Zero Hedge. I confess I haven't heard of it, but apparently the fact that it's "easily the most feared technical pattern in all of chartism," combined with the fact that warnings about it came out on Friday the 13th, provides something for everyone to worry about.

On the use of economic forecasts

Tyler Cowan asks, "Why does anyone support private macroeconomic forecasts?"

I've long found the market for such forecasts to be a puzzling practice…. Even if some forecasts are quite useful, what's the value of supporting a marginal or additional forecast? Is the next forecast to come along so much better? Forecasts would seem to be the classic example of a public good.

Given my interest in turning scanning from a private resource into a public good, Tyler's question caught my eye. He suggests that it's not about getting better knowledge at all, but about something more like social status: perhaps

outsiders pay for the forecast to join a more exclusive club of clients with other privileges. It's a bit like how art galleries won't sell their best pictures to complete outsiders but instead ask that you "pay your dues" by being a loyal customer for years. In other words, it's an arbitrary fee to enforce price discrimination, backed by some plausible pretext.

Under a related model, the firm pays for the forecast as a means of generating publicity, signaling its size, seriousness, and audience, and in general marketing itself to outside clients. It is unclear who bears the final incidence of these expenditures, the firm or the clients, but still "forecasting isn't about knowledge," as Robin Hanson would have said to the oracle at Delphi.

In other words, the "utility" of macroeconomic forecasts doesn't come from the actual information you get by buying them, but from the signal buying the forecasts sends to competitors about your seriousness. I've heard similar kinds of arguments about futures and scenario work– that Hermann Kahn's work on nuclear scenarios in the 1960s was intended not just to improve the Joint Chiefs' or SAC's thinking, but to make the Soviets worry about what we going to do in the future– and I think there are almost always local reasons for engaging futurists that don't have much to do with the official reasons you hire futurists. (Indeed, the really good consultants are able to figure out these reasons, and to adjust their engagements accordingly.)

Bruce Bartlett proposes another answer:

Why Tyler may not realize is that forecasting companies do far more than generate aggregate data; they also produce a vast amount of industry specific data that is enormously useful for investors, managers and others that need to know how a particular industry is expected to perform given the forecast for GDP, inflation etc.

In some cases, the industry data may even contribute to price collusion.

I should note that there's an excellent study of futures orientation, forecasts and uncertainty in forestry— a profession that sees itself as managing processes that play out over centuries– but we could use many more studies of how our work is really used.

“The crisis of middle-class America”

A really excellent piece in the Financial Times on “the crisis of middle-class America,” which alternates between high-level discussion of the squeeze on the middle class, and a focus on two families, the Freemans and the Millers:

Mention middle-class America and most foreigners envision something timeless and manicured, from The Brady Bunch, say, or Desperate Housewives in which teenagers drive to school in sports cars and the girls are always cheerleading. This might approximate how some in the top 10 per cent live.  The rest live like the Freemans. Or worse….

The slow economic strangulation of the Freemans and millions of other middle-class Americans started long before the Great Recession, which merely exacerbated the “personal recession” that ordinary Americans had been suffering for years. Dubbed “median wage stagnation” by economists, the annual incomes of the bottom 90 per cent of US families have been essentially flat since 1973 – having risen by only 10 per cent in real terms over the past 37 years. That means most Americans have been treading water for more than a generation. Over the same period the incomes of the top 1 per cent have tripled. In 1973, chief executives were on average paid 26 times the median income. Now the ­multiple is above 300.

The trend has only been getting stronger. Most economists see the Great Stagnation as a structural problem – meaning it is immune to the business cycle. In the last expansion, which started in January 2002 and ended in December 2007, the median US household income dropped by $2,000 – the first ever instance where most Americans were worse off at the end of a cycle than at the start. Worse is that the long era of stagnating incomes has been accompanied by something profoundly un-American: declining income mobility.

Combine those two deep-seated trends with a third – steeply rising inequality – and you get the slow-burning crisis of American capitalism. It is one thing to suffer grinding income stagnation. It is another to realise that you have a diminishing likelihood of escaping it – particularly when the fortunate few living across the proverbial tracks seem more pampered each time you catch a glimpse.

The very long shadow of the history of technology

A confession: when it comes to thinking about the future, I hold two views. On one hand, I find the black swans work of Nassim Taleb– the argument that the speed and complexity of the modern world has left it vulnerable to more, and more unpredictable, crises– pretty convincing. (Call this the New View.)

On the other, I also believe that much of what we claim is novel about this modern age is not so new. Many facets of globalization– the importance of migration, global trade, etc.– are actually as old as civilization. I also believe that other things, like a belief in greater vulnerability to epidemics and financial panics (or just as worrying, the belief that we are now immune from such things), are a product of a relatively short-term view of history. You could better understand our current world, and think more clearly about the future, if you stretch your view of the past from the last 50 years to the last 500 or 5,000. (Call this the Long View.)

Obviously, the New View and the Long View are contradictory. I get around that by not thinking about both of them at the same time. But I'm trying to construct a framework that fits them together.

This morning I ran across another data-point in the Long View: a new piece by Diego Comin, Erick Gong, and William Easterly looking at very long-term trends in technology and economic development. As Easterly explains,

We collected crude but informative data on the state of technology in various parts of the world in 1000 BC, 0 AD, and 1500 AD.

1500 AD technology is a particularly powerful predictor of per capita income today. 78 percent of the difference in income today between sub-Saharan Africa and Western Europe is explained by technology differences that already existed in 1500 AD – even BEFORE the slave trade and colonialism.

From the abstract (pdf):

The emphasis of economic development practitioners and researchers is on modern determinants of per capita income such as quality of institutions to support markets, economic policies chosen by governments, human capital components such as education and health, or political factors such as violence and instability.

Could this discussion be missing an important, much more long-run dimension to economic development?… Is it possible that history as old as 1500 AD or older also matters significantly for today’s national economic development? A small body of previous growth literature also considers very long run factors in economic development…. This paper explores these questions both empirically and theoretically. To this end, we assemble a new dataset on the history of technology over 2,500 years of history prior to the era of colonization and extensive European contacts…. We detect signs of technological differences between the predecessors to today’s modern nations as long ago as 1000 BC, and we find that these differences persisted and/or widened to 0 AD and to 1500 AD (which will be the three data points in our dataset, with 1500 AD estimated from a different collection of sources than 1000 BC and 0 AD). The persistence of technological differences from one of these three “ancient history” data points to the next is high, as well as robust to controlling for continent dummies and other geographic factors.

Our principal finding is that the 1500 AD measure is a statistically significant predictor of the pattern of per capita incomes and technology adoption across nations that we observe today.

Of course, one can get into how this is a different set of forces than most futurists are interested in– but to the degree that it serves as a corrective to the tacit view held some futurists that history doesn't matter at all– a kind of social science version of transhumanism, in which thanks to technology (or migration or whatever) we're able to ignore the past and its gravitational pull– it's worth reading and pondering.

Justin Fox on economists versus historians

Harvard Business Review blogger Justin Fox talks about why economists have become more prominent public intellectuals than historians: He argues that

economists had managed a remarkable balancing act between making the guts of their work totally incomprehensible — and thus forbiddingly impressive — to the outside world while continuing to offer reasonably straightforward conclusions. The basic form of an academic economics paper is a couple of comprehensible paragraphs at the beginning and a couple of comprehensible paragraphs at the end, with a bunch of really-hard-to-follow math or statistical analysis in the middle. An academic history paper, on the other hand, is often an uninterrupted cascade of semi-comprehensible jargon that neither impresses a lay reader nor offers any clear conclusions.

The one economist in the audience had another suggestion. Most economic work was aimed at prediction, and the world is always hungry for predictions. He added that most macroeconomic predictions are worthless (he was a microeconomist), but that doesn't seem to have damped the demand for them.

Once again, it's clear that Philip Tetlock's work explains everything.

But seriously, it seems to me that one of the key features of any form of prediction or forecast– or even something less formal, like scenarios– should be transparency: if you're asking people to base their actions in the expectations that certain futures are more important to prepare for than others, it's imperative that you be able to explain to yourself and others how you came to think that those futures were worth taking more seriously. It's never possible to clearly describe every step in your thinking: all knowledge work involves a measure of intuition and tacit knowledge that's acquired over years of practice.

There should be no shame in acknowledging that, and I think we have a lot more to gain than to lose from greater transparency. Obviously it opens your work up to criticism, but also to improvement– and potentially, rapid improvement. It's essential for making users smarter. The most thoughtful clients I've worked with were the ones who best understood what I do. (Knowing how someone else works doesn't make them obsolete: I love to read about tailoring, but that doesn't make me a cutter.) And it's important for any work that people aren't just going to apply, but are expected to adapt and extend– which is exactly what happens with scenarios and forecasts. Good tinkering and hacking depends on an ability to get under the hood, play with the parts, understand why things are put together this way rather than that, and thus see new possibilities and uses for products. Perhaps scenarios and forecasts should be designed not just to be read, but torn apart, recombined, and reused: they should be able to stand being assembled in new ways and used in contexts their authors never imagined.

[via Ezra Klein]

Want to reach your goals? Be oblique

John Kay may be my favorite business writer. For some time he’s been thinking about a concept he calls “obliquity,” which is the subject of a forthcoming book, Obliquity: Why Our Goals Are Best Achieved Indirectly. An essay from the Financial Times in 2004 explains the concept.

Obliquity is characteristic of systems that are complex, imperfectly understood, and change their nature as we engage with them…. [These are systems in which] the attempt to focus on simple, well defined objectives proved less successful than management with a broader, more comprehensive conception of objectives…. Obliquity is equally relevant to our businesses and our bodies, to the management of our lives and our national economies.

And yes, it is counterintuitive.

Isn’t it true that you must do better if you set out to maximise something – happiness, wealth, profit – than if you don’t? Surprisingly, the answer is no. Life is too complex and uncertain for us to be able to predict and follow the most direct perceived route to success. Our knowledge is always imperfect, and events are influenced by the unpredictability of other people and organisations. Instead, our objectives are best achieved by a more meandering approach that enables us to adapt our strategy to changing situations. And we learn about the nature of our objectives and the means of achieving them through a process of experiment and discovery.

Part of what’s brilliant about Kay’s argument is that it ranges very widely. He compares CEOs who think broadly versus those who focus more exclusively on profitability, and finds that the second are more likely to destroy value: as he puts it, “Obliquity gives rise to the profit-seeking paradox: the most profitable companies are not the most profit-oriented.” In forestry, it turns out that letting small fires burn helps protect forests from huge fires by clearing undergrowth. He talks about architecture and urban planning (“a house is not simply a machine for living in”), and the complexity and adaptability of biological systems (and how markets are like them). (Indeed, while he doesn’t trumpet this, Kay’s may be the best application of biological concepts to management and organizational theory around.)

Interesting stuff in theory, but what does it mean? Kay lays that out in a recent Management Today article:

  • Have objectives, but keep your approach flexible so that you can overcome unforeseen obstacles and take advantage of surprise opportunities.
  • Know that your knowledge is always imperfect and incomplete. Cast your net wide – always go fishing for more.
  • Don’t be afraid to change tack once you’ve started if you see a better course.
  • Meandering can lead to serendipitous discoveries and unexpected benefits.
  • Think laterally to solve problems: indirect solutions can often be the most effective answer.

Bringing market information to farmers

There are a growing number of systems that push market price information to farmers, fishermen and ranchers who traditionally have had to either make a guess about where they should sell their goods, or sell to intermediaries. I just came across another one in the State Department's eJournal:

The Armenian Agricultural Market Information System… distributes daily fruit and vegetable prices from the large city markets, using text messages sent over the country’s extensive cell phone network…. [F]armers pay a small fee for the service, allowing them to dial in a code to a market-specific phone number, which then triggers an automated text response from a central database of market information. This information puts [cucumber farmer Rafik] Smbatyan [and others] in a much better position to bargain with food wholesalers, improves his competitive position in the marketplace, and increases profits.

I always wonder what middlemen think of these systems, and how they've reacted to them. Have they provided actual value that these systems are in danger of undercutting, or they have merely arbitraged information?

And it's actually a pretty nice-looking Web site. Even here in California it loads quickly. Did you know that green apples are selling today in Armavir for an average of 425? (I don't know if that's 425 per apple or per bushel, or even what you need 425 of to buy however many apples you can buy in Armavir, but– I know that's how much, or many, you need. If you're there.)

Greater job insecurity = poorer health

In addition to the obvious problems created by job loss, The New York Times reports that “a growing body of research suggests that layoffs can have profound health consequences.”

One 2006 study by a group of epidemiologists at Yale found that layoffs more than doubled the risk of heart attack and stroke among older workers. Another paper, published last year by Kate W. Strully, a sociology professor at the State University of New York at Albany, found that a person who lost a job had an 83 percent greater chance of developing a stress-related health problem, like diabetes, arthritis or psychiatric issues.

In perhaps the most sobering finding, a study published last year found that layoffs can affect life expectancy. The paper, by Till von Wachter, a Columbia University economist, and Daniel G. Sullivan, director of research at the Federal Reserve Bank of Chicago, examined death records and earnings data in Pennsylvania during the recession of the early 1980s and concluded that death rates among high-seniority male workers jumped by 50 percent to 100 percent in the year after a job loss, depending on the worker’s age. Even 20 years later, deaths were 10 percent to 15 percent higher. That meant a worker who lost his job at age 40 had his life expectancy cut by a year to a year and half.

None of this is terribly surprising, but the degree of the impact is striking, as is another study showing that “‘persistent perceived job insecurity’ was itself a powerful predictor of poor health and might even be more damaging than actual job loss.”

That article [doi:10.1016/j.physletb.2003.10.071], incidentally, is pretty interesting.

Economic recessions, the industrial shift from manufacturing toward service industries, and rising global competition have contributed to uncertainty about job security, with potential consequences for workers’ health….. [P]ersistent perceived job insecurity is a significant and substantively important predictor of poorer self-rated health in the American’s Changing Lives (ACL) and Midlife in the United States (MIDUS) samples, and of depressive symptoms among ACL respondents. Job losses or unemployment episodes are associated with perceived job insecurity, but do not account for its association with health. Results are robust to controls for sociodemographic and job characteristics, negative reporting style, and earlier health and health behaviors.

This is in keeping with other research showing that anticipation of losses or punishment can be as bad as the punishment itself.

Okay, back to work….

[To the tune of Nina Simone, “I Shall Be Released,” from the album The Very Best of Nina Simone: Sugar in My Bowl (1967-1972) (a 5-star song, imo).]

The Queen’s economics lesson

From The Guardian:

A group of eminent economists has written to the Queen explaining why no one foresaw the timing, extent and severity of the recession.

The three-page missive… was sent after the Queen asked, during a visit to the London School of Economics, why no one had predicted the credit crunch.

What did they come up with? The explain that

the failure to foresee the timing, extent and severity of the crisis and to head it off, while it had many causes, was principally a failure of the collective imagination of many bright people, both in this country and internationally, to understand the risks to the system as a whole.

Sounds perfectly plausible. The question is, what would help improve that collective imagination?

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