Tuesday, April 23, 2013

Moral Hazards and Capitalism

A common critique of the TARP bank bailout by conservatives was that the bailouts created a moral hazard - the situation where people take excessive risks because others will shoulder some of the burden if they fail. The American Conservative magazine even went so far as to entitle an article "Moral Hazard, Everywhere", which is rather ironic because they only place they seemed to find moral hazard was in places where the government was involved. These self-same conservatives then go on to blame the economic collapse of 2008 on the moral hazard created by potential bailouts of banks during a crash, which allowed banks to take undue risks prior to the collapse. In essence, they are arguing that a hypothetical second-order chance of a bailout in an extreme situation was enough to cause the global economy to wilt like a daisy in the desert sun as soon as punch-bowl was removed. They are also implicitely arguing that only the government can cause moral hazard, as they are completely blind to moral hazard that exists in its absence.

This is far from the case. In fact, there are very large moral hazards at the very heart of every corporation - limited corporate liability, the principal-agent problem between management and ownership, and externalities such as pollution, for example. Any form of insurance, public or private, creates moral hazard. Any situation where one purchases from someone with more knowledge than oneself (a doctor, an auto mechanic, a home contractor, etc) also creates moral hazard. Even things like the rampant mis-labelling of fish arises from information asymmetry-driven moral hazard. In fact, it is pretty hard to think of a market that ISN'T riddled with moral hazard.

There are non-market moral hazards as well. Personal bankrupcty laws create moral hazard, as does any potential "bailouts" by family and friends. Very fundamentally, there is also a zero-lower-bound moral hazard as well - no matter how badly you screw up, the most you can potentially pay back is the sum of your future earnings less whatever it takes you to survive.

For a corporate executive, there are at least SEVEN layers of moral hazard affecting his or her decision: corporate limited liability limits the corporate risk, corporate malfeasance laws that shift consequences of bad corporate behavior to shareholders, principal-agent problems regarding corporate pay, opportunities to externalize costs, and in the case that the executive is actually held liable for something personally, personal bankrupcty, bailouts by friends and family, and the zero bound.

In other words, the corporate structure is literally riddled with moral hazards that have nothing to do with government beyond the very existence of the corporation itself, which of course cannot exist without government, as you can't create limited liability with a private contract. Non-corporate portions of markets have only slightly fewer moral hazards, lacking the limited liability issue and some of the principal-agent problems, but markets with few moral hazards are rare beasts indeed.

If the moral hazard created by potential bank bailouts was enough to collapse the economy, then the very idea of capitalism is a failure, as it is hopelessly wrought with moral hazards built into its very heart.

Sunday, April 21, 2013

Coal Mining Moratorium

There are stupid policies. Then there are really stupid policies. Then there are ignorant policies. I doubt there is any policy in our nation that is as collosally ignorant than selling publically owned coal resources.

For example, the Bureau of Land Managment recently leased 400 acres of land in Colorado to Peabody Energy for a price of $800,000. The land is expected to produce 3.2 million tons of coal, so we are selling it for a whopping $0.25 a ton. The market price for coal from that area is around $35/ton, so right off the bad, it looks like we are getting a bad deal, only capturing a fraction of a percent of the final sales price.

However, the real issue is that both coal mining and coal burning wreak havoc on public health and the environment. Each of those tons of coal will result in about 2460 kilowatt hours of electricity, and the most comprehensive estimates of the fully externalized costs of coal (including mining, power plant emissions, etc) are nearly $0.18 per kwh! That implies that each ton of coal causes almost $440 of damage to the public for each ton burned, in terms of destroyed land, fouled water, toxic chemicals and fine particles released into the air, and climate change. We are literally selling something for pennies that will have hundreds of dollars of costs blow back into our faces. The $800,000 we received for leasing those 400 acres is trivial relative to the over $1.4 billion in damages that mining and burning that coal will cause.

I have seen governments implement a lot of bad policies over the years, but I doubt I have seen any that fails cost-benefit by three orders of magnitude. Not only should we place an immediately place a moratorium on coal-related leases on public lands, we should take back any we have already issued and compensate the lease-holders justly. It would be much better for us to hand Peabody $5 million and renege on the lease than let them mine the coal, which would cost us hundreds of times more.


Post-analysis: What about jobs?

First, the coal industry does not employ many people, 134,000 at all levels across the US. With over a billion tons produced per year, that's about 8000 tons per worker per year, implying about 400 man/years to mine the 3.2 million tons noted above. That would imply a cost of well over $3 million per man/year even assuming this 400 figure was true. However, it is not, at least if you believe in free market economics, which would not leave the capital and workers idle but rather shift them to the next best resources, which would likely employ about the same number of people. "Counting jobs" has always been an exercise which I find to be totally pointless and no more accurate than counting pinhead-dancing angels. If anything, it is pretty clear that coal employs fewer people per kwh than other forms of energy, which is one of the main reasons it is "cheap".

Tuesday, April 16, 2013

Guns, Booze, and Automobiles

A comment I often hear from gun advocates is a variant of "Why don't we restrict access to cars and alcohol, as they get a lot of innocent people killed as well?".

This is actually a good argument, qualititatively. Where it breaks down is quantitatively. In other words, the numbers just don't add up. I have posted the wonky details here, but what I have calculated or discovered is that:

Americans make 233 automobile trips per year, killing approximately 21500 third parties, or 10.7 million trips per third party fatality.

Americans drink approximately 28 billion times per year, killing approximately 7400 third parties, or 3.7 million drinking events per third party fatality.

Americans use long guns (rifles, shotguns, etc) approximately 840 million times per year, resulting in 950 third party fatalities, or one fatality per 1.15 million uses.

Americans use handguns approximately 500 million times per year, resulting in over 7600 third party fatalities, or about one fatality per 67,000 uses.

It is very clear what item stands out here: handguns. Long guns seem to be only marginally more dangerous than drinking or driving, and probably safer than drinking AND driving. However, handguns are in a league of their own, with well over a hundred times the third party fatalities per use as automobiles and around fifty times the fatalities per use as alcohol. This is why they are not remotely compariable, and why is it perfectly reasonable to call for the abolition of handguns, but not necessarily long guns.

Guns, Booze, and Automobiles - Wonk Version

This is the wonky details of my post found here for those who like to quibble.

Note that throughout this exercise, I have focused on "externalized" fatalities: deaths to parties other than the drinker, the driver, and the gun owner. Matters such as suicide, single-car auto accidents, etc are excluded or explicitly accounted for. While obviously these are still a matter of public policy, they are on a different level than harm inflicted upon innocent third parties.

For automobiles, there are approximately 233 billion trips made per year in the US, and bit over 32000 traffic fatalities. However, roughly a third are self-inflicted and only involve the driver. This can be inferred from the facts that about half of all fatalities occur to a driver and that about a third of fatal accidents are single car, thus implying that roughly two thirds of the half of fatalities that occurs among drivers happens to the at-fault driver, while the other third of a half occurs to an innocent driver in a two car accident. Thus, there are approximately 21500 externalited traffic fatalities each year. This leads to the conclusion that with respect to driving there are approximately 10.7 million trips per externalized fatality.

For drinking, the average American drinks 9.4 liters of alcohol per year. If you assume that the average drinking session involves three ounces of alcohol (about three drinks), that implies the average American drinks 88 times per year, or 28 billion drinking events per year among all Americans. There were 10228 drunk-driving related fatalities in 2010, but approximately 45% of them are likely self-inflicted, resulting in 5625 externalized drunk driving fatalities. Additionally, approximately 28% of violent crime is alcohol related. There were 12664 homocides in 2011, and assigning 50% of the responsibility of "alcohol related" homocides to the alcohol results in 1773 externalized deaths. Combined with the traffic fatalities, this gives alcohol a total of 7398 externalized fatalities, or approximately one externalized fatality per 3.7 million drinking events.

The data for guns is a little more sparse and I have to make some assumptions. One is to look at ammunition use. The domestic ammunition market is $1.9 billion dollars per year according to a recent industry report. At $0.20 per bullet wholesale, that is 9.5 billion bullets. Of those, the military uses 1.8 billion, and other federal agencies 400 million. I could not find data for state and local police use, but considering there are more than five times as many state and local law enforcement officers as federal ones, my assumption that their bullet consumption is the same at 400 million is probably conservative. Thus, there are approximately 6.9 billion bullets available for civilian use annually. For a rough estimate, the assumption that people shoot six bullets on average when using a gun would lead to 1.15 billion uses per year. Of course, "using" a gun could range from no shots fired (an unsuccessful hunt, brandishing it in order to scare off an intruder) to a few boxes full at the gun range. The figure of six per use is literally made up but probably reasonable. Note that since there are about 64 million gun owners in the US, this would imply the average gun owner uses a gun 18 times per year and expends and annual total of 110 bullets. That seems very reasonable to me based on my experience.

We can attempt to look at this from the bottom up as well. There are 13.7 million active hunters in the US. Assuming 30 hunts per year, that is approximately 400 million hunts. As for shooting ranges, their annual industry revenue is about $560 million, so at $30 per trip, there are about 19 million visits to gun ranges. However, these would disproportionally add up to a lot of bullets fired, as most people shoot a fair number each time they are there. Even the wildest estimate of defensive gun uses is 2.5 million per year. Assuming the average gun owner uses their guns about ten times a year in addition to the aforementioned uses puts us right back at about 1.1 billion uses. To be generous, I will overweight the (likely exaggerated) defensive use estimate 100-fold, just for good measure, resulting in 1.35 billion gun uses per year.

Hand guns make up a bit under one third of all guns in the US. I will assume they make up no portion of the hunting uses, 80% of the 100-fold overweighted defensive uses, and a proporitionate 1/3 of the remaining miscellaneous uses, resulting in 510 million uses per year, with the remaining 840 million uses being long guns (rifles, shotguns, etc). According to the FBI, there were 8583 firearm deaths in 2011, with 6220 from handguns, 776 from long guns, and 1587 from "unstated". Assigning the "unstated" deaths to handguns and long guns proportionately, this results in 7631 hand-gun deaths and and 952 long-gun deaths in 2011. Thus, 1.15 million uses per externalized fatality for long guns, and 67200 hand gun uses for externalized fatality.

Tuesday, April 9, 2013

The Texas Miracle Myth

The NYT had a article this week discussing a book that defended the "Texas Miracle", the idea that Texas has had solid economic growth in recent years and therefore its policies should be mimicked elsewhere. Paul Krugman had already dissected this idea last year, noting that Texas's growth is mostly explained by increasing population (both migrants northward out of Mexico and Central America, as well as the long-term gradual drift of Americans to the south and west), combined with the recent commodity boom. Texas's fortunes have always waxed and waned with oil booms and busts.

However, Krugman's key critique lies here.

"What Texas shows is that a state offering cheap labor and, less important, weak regulation can attract jobs from other states. I believe that the appropriate response to this insight is “Well, duh.” The point is that arguing from this experience that depressing wages and dismantling regulation in America as a whole would create more jobs — which is, whatever Mr. Perry may say, what Perrynomics amounts to in practice — involves a fallacy of composition: every state can’t lure jobs away from every other state."

This, folks, is a classic prisoner's dilemma. Sure, it is a "win" for Texas if it can kill a $30/hour labor job and Michigan by turning it into an at-will $12/hour in Texas. Texas's economy will grow a bit, Michigan's will shrink by more, and the nation loses as a whole on a number of levels. Should then Michigan retaliate and undercut Texas, thus "winning" the job back at $11/hour and causing "growth"? It is clear here what is going on is that Texas is defecting in a prisoner's dilemma, which does in fact work in the short term to maximize one's gains. However, as I mentioned before, if your answer to a political issue is to defect in a prisoner's dilemma, you are almost certainly wrong. In the long term, it is a losing strategy for everyone.

Writ large or small, this same pattern keeps occuring. Almost all nations are engaging in a tit-for-tat game of poaching jobs from one another by subsidizing, bribing, gutting regulations, or stomping on labor. Likewise, it is sicking to watch blue states Oregon and New York bend over backwards to offer the biggest wet-kiss subsidies in order to capture "Project Azalea", a multi-billion dollar next-gen semiconductor factory. This stuff doesn't "create" jobs. That factory is going to be built regardless. It is only a question of who poaches the jobs from whom, and for how much the taxpayers will be on the hook.

This kind of job poaching can be framed as a "race to the bottom", which can never be won, and only fools enter. Sadly, playing this game is a core element of the Republican party's economic platform.

Sunday, April 7, 2013

Retirement Account Caps

One policy that I have been advocating over the last year has been a lifetime cap on government-sponsored retirement accounts such as 401k's or IRAs. I first developed this idea in response to reports that Mitt Romney has at least $20 million and as much as $100 million or more stuffed away in his tax-free accounts, despite contribution limits of around $20,000 per year. There are a number of speculations as to how he pulled this off, but a simple cap on lifetime holdings in your tax-free accounts would cut off any of the loopholes which Romney and other rich people are abusing.

It appears the gods are listening, as the president has included this idea in his soon-to-be-released new budget, using almost the exact same lifetime cap (around $3 million with inflation adjustment) that I had been advocating.

This is great news, and a great policy. Tax-free accounts for the middle class are a good way to assist people in saving for retirements. However, these accounts should not be tax dodges for the wealthy, and there is no reason we should be subsidizing tens or even hundreds of millions of dollars worth of savings. Hopefully this policy makes it through the budget talks, as it is more than needed and more than fair.

Saturday, April 6, 2013

I am now published in Science

Somehow, a random midnight rant of mine wound up as a published blurb in Science magazine, one of the world's leading scientific publications. At least I was coherent in what I wrote. I had completely forgotten about it when the editors contacted me asking for a mug shot.

For the record, I agree with what I said that night. The entire value of all the major academic publishers' libraries is no more than a couple billion or so, and the journal structure could be maintained for something on the order of a few hundred million a year. The government (or a group thereof) banding together, buying out the publishers, and making all this information open access would be a incredible use of public money.

Wednesday, April 3, 2013

HSR: California x 1.3 = Spain

From a discussion I took part in on the California HSR blog, "Jo" pointed out an addendum to my comparison of my France to the midwest cooridor, which showed that France had a similar population, area, and economy to that of New York, Pennsylvania, Ohio, Indiana, and Illinois. "Jo" calculated


Population: 47,265,000
Area: 195,364 sq mile
Density: 231 sq mile
GDP: $1,497 Trillion


Population: 38,041,000
Area: 163,696 sq mile
Density: 242 sq mile
GDP: $1,9365 Trillion

Or, in other words, Spain, which is building out HSR like crazy, is essentially 1.3 Californias, with a notably smaller economy. If Spain can do it, there certainly is no reason California can't. Thankfully, it looks like the last pieces are falling in place in California and construction is scheduled to begin this year.

Monday, April 1, 2013

The Prisoner's Dilemma

If there were one idea I could drill into the head of everyone on earth, it would be the prisoner's dilemma. I am complete serious in saying that if you don't know what I mean, that you should read the rest of this post, and then spend the next couple hours further studying the topic. The prisoner's dilemma, or more broadly game theory, is an absolute necessary component of understanding politics, economics, biology, and human relations.

So what is a prisoner's dilemma? Essentially, it is any scenario where two people or groups interact in such a way that


If they cooperate, both do well

If one cooperates but the other double-crosses the cooperator, the cooperator is screwed and the betrayer makes out very well

If both double-cross the other, both do poorly


The problem with a prisoner's dilemma is thus: no matter what the other party does, you are better off if you betray them. If they cooperate, you do very well, rather than merely well, if you cheat. If they betray you, you are screwed if you cooperate but make out merely poorly if you cheat as well. So if you are the self-interested person of the economics textbook, you cheat. Unfortunately, the other party faces the exact same incentives you do, so if they are self-interested, they cheat as well. Hence, everyone winds up doing poorly, rather than everyone doing well, as would happen if they cooperated. Game theory is simply the extension of this to more complex systems, with repeated encounters, memory, multi-party, etc. The key thing to note here is that depending on the payouts, self-interest does not lead to optimal outcomes.

So is the prisoner's dilemma relevant to the real world? Absolutely. An oft-cited example is the observation that male peacocks have huge tails that both attract females and make them vunerable to predators. Why don't they all cut (or evolve) their tails in half, maintaining their pecking order but making all of them safer? Because it's a prisoner's dilemma. Why can't the US and China agree to cut carbon emissions? It is a prisoner's dilemma. Why do states keep offering corporations "incentives" in order to poach jobs from one another? It is a prisoner's dilemma. Why do athletes dope? It is a prisoner's dilemma.

Note that a key element of most prisoner's dilemmas is ranking. Prisoner's dilemmas often arise when what matters is not ones absolute performance, but relative performance. Any improvement in your performance lowers everyone elses' relative performance, forcing them to do more just to get back to where they were. But once they do, everyone is putting in more effort but in the same place they were before. Variants on this theme riddle every aspect of human (and biological) endeavor, and to understand and identify them as prisoners' dilemmas brings some level of clarity to the issue.

Unfortunately, prisoners' dilemmas are hard to resolve, requiring repeated rounds of trust-building, acts of faith, and a few well-timed (but clearly explained) sticks being used to push the laggards from behind. However, if you find yourself in a prisoner's dilemma and are arguing for defection, you really need to reflect on what the end game is. Sure, defecting might work in the short term and you might even be able to drag forth evidence supporting such. In the long run, however, defection only leads to ruin for all. It is always a good idea to examine your political beliefs, identify any lurking prisoner's dilemmas, and ask yourself if you are arguing to defect. If you are, you are probably wrong.