Tag: Economics

Discounting the relativistic future

Tyler Cowen’s new book, “Stubborn Attachments,” contains a quote about why we should use low discount rates. He’s right about the conclusion of wanting low discount rates, but I think the example doesn’t quite make the point. (H/t for pointing out the quote goes to Robert Wiblin.)

…it seems odd, to say the least, to discount the well-being of people as their velocity increases. If, for instance, we sent off a spacecraft at near the velocity of light, the astronauts would return to earth, hardly aged, many millions of years hence. Should we pay less attention to the safety of our spaceship… the faster those vehicles go?

As I responded on Twitter, I’m fairly sure this is conceptually wrong because economists are used to thinking about time in Newtonian terms. If we use a proper spacetime metric, the problem, I argue, goes away — and so do some other things.

Let’s work through Tyler’s example. An astronaut leaves earth and immediately accelerates to 0.99c, crushing him into a pulp in a way that is mathematically conveniently for us. As economically rational agents, assuming his spaceship conveniently resurrects him ,should we care about his safety? [Note: The assumption of economically rational agents is obviously ridiculous, but it’s only slightly more of an exaggeration than the other parts of our story.]

So let’s look forward in time. When it’s a year later on earth, how much do we care about the astronaut? Using a typical discount rate, of say, 5%, we care about him 95% as much.

He, however, has had only about 0.02 years of time pass, and cares a bit more. But when he lets a year pass in his reference frame, he cares 95% as much about future him, but us earthbound people need to wait 50 years for that to happen, and we care about him 50 years from now about 8.7% as much as we did when he launched.

But where is he? About 10¹² kilometers away. Americans can’t be bothered to think about poor people in Africa, so why should they care about this guy who is about 100,000,000 times as far away? But Tyler Cowen agrees with Peter Singer in his moral objections to distance based discounting, so after we’ve spend the next 50 years avoiding existential risks and solving poverty in some economically efficient way, we need to decide how much value we should have initially placed on our astronaut.

Even if we don’t want to discount distance in space, unless using a discount rate of 0%, these post-Einstein sophisticates need to discount distance in space-time. Our astronaut travelling at 0.99c is about already a light year away, and using a handy-dandy space-time distance calculator, that means he’s just about 51 years away, and we think he’s worth about 8% of what he was when we launched him.

Let’s say he turns around, once again suddenly changing velocity, getting crushed to a pulp, and being resurrected by his ship. On the centennial of his launch, he comes back, 2 years older. Unless we’re doing something really complicated with our intergenerational discounting, we should initially have discounted this future by that same 5% yearly, and our future returnee is worth 0.76% of a person. That has nothing to do with space travel, it just means people don’t care about the future. [Note: Yes, high discount rates might be bad if you’re hoping to live to 100, because it means decision-makers now should trash the future for present gain. As if they aren’t already. But we’ll get back to that.]

Our prospective astronaut, however, has a higher self-valuation, and thinks this future is worth about 90% as much as the present. That makes sense — he’s only lived 2 years. [Note: If you’ve got a fast enough spaceship, you’re gonna be able to find a hell of an IRR for your investments. Just make sure you figure out that whole not getting crushed to death thing.] But different people always have different discount rates — we’re just saying that high-speed relativistic astronauts should hope that society cares about the long term future.

So we conclude that the people on earth care about events happening in a century very little, but people who travel really fast care quite a bit more. And we conclude that people who are really far away are absolutely worth less than people nearby, if only because they can’t get back here until the far future. But if we want to put someone on a spaceship, they better realize that they care about their safety a lot more than we do.

The conclusion is inescapable; we need to launch political decision makers away from earth as fast as we can possible make them go. We don’t even need to make sure the spaceship is safe , because in our reference frame, it’ll be a long time until it gets back. This way, they might start to care a little bit more about the far future. [Note: Or at least they’ll care a bit more about engineering standards.] The problem goes away, and so do the politicians.

Dynamic Evolution of Chaos in Politics

There is a tension I have noticed between stability, instability, growth, and political movements. Basically, there is a cycle where stability leads to desire for less control, less control leads to growth, justifying further reduction in control, which eventually leads to instability.

It’s certainly not original, but I wanted to write it down so I could get ideas about who explained it already — or who explained where it does or does not apply, and why.

Finance

A basic and well discussed example is modern financial markets. Regulation strangles growth, so in good times there is a constant push to reduce regulation. Reduced regulation allows new approaches which are exciting and profitable. The reduction in regulation also allows developments that reduce stability, eventually leading to a moderate or large collapse — which leads to a push for more regulation — as we saw in 2008 and onward.

But let’s start with a slightly less obvious example of this; the 1970s London real estate bubble. From that case study, we have a simple timeline.


External shocks led a slightly under-regulated bubble to collapse. They were lucky the external shocks came when they did to pop the bubble — without them, bubbles inflate until they burst under their own pressure. And that’s what happened in 2007–8; the US housing market started to climb above trend around 2000, when the dot-com bubble popped, and people sought a “less risky” place to put their money. This continued until it spurred a housing-backed derivatives industry that accelerated the process until the financial bubble was large enough that upon popping, the housing price collapse was almost unimportant.

Government

This is worse for governments as a whole. There is a tension between chaos and stability, and between growth and collapse — and it’s possible to reach any point in that space, with sufficient cleverness and/or mismanagement.


Looking at Russia, we saw a relatively rapid (20-year) shift from the top right in the 1980s, to the bottom left now. China’s cultural revolution managed to move from the bottom right to the top left. The transition from top to bottom is usually more sudden; the Arab Spring has numerous examples. The United States has been moving steadily from the bottom left to the top middle over the past century, sacrificing growth for stability.

I think that’s the missing dimension; wealth creates a desire to push upward, towards more stability. Poverty creates the need to move rightward, towards higher growth. These are not directly in conflict — but the pursuit of stability is easiest at the cost of growth, and the pursuit of growth is easiest at the cost of reducing or eliminating structures that enforce stability. Fukuyama’s end of history is democratic liberal capitalism, which marries political stability with market chaos, and allows growth alongside stability. China’s alternative, capitalism with Chinese characteristics, is similar, without the ability for the populace to control the government.

The Chinese model and democracies have common failures; poverty undermines the stability, and if growth is insufficient, or insufficiently widespread, then the populace revolts — either via election, or via Tienanmen. Increasing authoritarianism is the short term “solution” in both cases, leading to a vicious cycle of decreased growth and increasing rigidity. If increased stability occurs alongside poverty, there is a push for revolution. If increased stability maintains widespread wealth, it is stable.

There are two ways which historically undermine widespread growth in stable systems; corruption, regulatory capture, and monopolistic wealth extraction, or economic instability and collapse.

I have more to write on this, but I should probably find out where I’m wrong or covering well-covered ground first.

A New Way to Pay for Stadiums?

There is a well known problem with building stadiums. Simply put, it’s a losing proposition for cities, and a way for team owners to bilk the public out of tax funds that could be better spent elsewhere. On the other hand, is it really fair to tell cities and fans that they can’t try to lure team to come — or stay — by building new stadiums?

Thankfully, Alex Tabarrok has a proposal that I think fits the bill, with some adaptation, called “Dominant Assurance Contracts.” Think of it as a kickstarter for public goods, with an extra safety net. Basically, someone puts up a starter fund for a project that enough people want, and pledges that money, irrevocably. Everyone else then decides if they also want the project to happen. If they do, they make a kickstarter-like pledge of a fixed amount, with a special bonus; if the project doesn’t succeed, the people who put money in get paid extra, from the starter fund — a fixed amount of that fund is distributed to everyone who pledged, if the project doesn’t get funded. It’s a sort of a compensation for the losers, who are now actually winners.

This has a clever component, which involves some fairly light game theory. Basically, it’s about solving the free rider problem; people don’t contribute, but they still benefit if the project happens, so they “free ride.” If this happens too much, people feel like suckers for paying, more start to cheat, the system runs out of money.

Here, there’s an incentive not to let that happen; if the project fails and you didn’t contribute, you don’t get paid. So if you’re unsure the project will happen, you can bet on it, and win either way. People who want the project to happen can free ride, but if the system has too many free riders, it’s now (somewhat) self-correcting. And taking a page from Kickstarter, I think the dynamic can be further improved.

How would this work for stadiums? There are a couple options, and I’ll outline one of them. But first, it’s worth noting that now, stadiums are usually financed by public bonds, which allows the city or state to pay for the stadium upfront, and use tax revenue for the next 20, 30, or 50 years to pay off the bond. Sports teams then pay only 10% of the overall cost for a stadium from revenue, as a way to circumvent the requirement that no more than 10% of the cost can be paid for by revenue from the project.

Stadium Assurance Contracts, Part 1

One possible use for a Dominant Assurance Contract, is to let the team pledge a couple percent of the cost. The city, or the sports team, can then decide how many people it thinks will pledge to build the stadium — and people who pledge can be given something, such as season tickets, if they pledge.

Let’s consider a brand new, top of the line 75,000 seat football stadium, which costs about $1 billion. The city agrees on the minimum for the team to put up, say $15m, and the public gets a chance to pay for it — on a voluntary basis. The difference here is that teams can run a kickstarter; work out the prices so that if the team can get 15,000 fans to commit to pay for NFL season tickets for the next 30 years, at an average of $2,000/year, the stadium is paid for. (Don’t worry, season tickets for the really good seats already cost $3,000–$4,000, and those are likely the ones that people will want to reserve.)

That’s effectively a bond that pays out football tickets instead of coupon payments, paid for by the team out of their revenue, which pre-sells the seats to pay off the cost. Buyers can always sell their multi-season tickets, potentially at a profit — it’s like a bond. And if the team wants to move before then, it can refund the pledgers the remainder of their commitment — and pay for the remainder of the stadium itself.

In this setup, the team won’t risk their funds if they aren’t sure the fans will pay for them to stay. If the fans and investors don’t see the stadium built, they’ll get an average of about $1,000 each in payout — quite an incentive for simply pledging to buy tickets if the stadium is built. More, if the team can’t find enough fans to pay for a stadium, the team is out quite a bit of money — so they’ll need to rally their fans to support the stadium.

Of course, we’ll need a way to convince the cities that this is a better idea than continuing to give in to teams that want public funds — an uphill battle. But if we got cities to try it, it might keep fans, politicians, and economists all happy — and help . And best of all, neither the Giants fans nor the Jets fans will need to help pay taxes for the other team’s stadium.

PS. Thanks to Kevin Chlebik and Jim Stone for their thoughts on the idea — and if anyone else has suggestions, I’d love to hear them here, or on Twitter.

Chasing Superior Good Syndrome vs. Baumol’s (or Scott’s) Cost Disease

Slatestarcodex had an excellent (as always) piece on “Considerations on Cost Disease.” It goes over a number of reasons, aside from Baumol’s cost disease, for why everything in certain sectors, namely healthcare and have gotten much more expensive. I think it misses an important dynamic, though, that I’d like to lay out.

First, though, he has a list of eight potential answers, each of which he partly dismisses. Cost increases are really happening, and markets mostly work, so it’s not simply a market failure. Government inefficiency and overregulation doesn’t really explain large parts of the problem, nor do fear of lawsuits. Risk tolerance has decreased, but that seems not to have been the sole issue. Cost shirking by some people might increase costs a bit, but that isn’t the whole picture. Finally, not on that list but implicitly explored when Scott refers to “politics,” is Moloch.

I think it’s a bit strange to end a piece with a long list of partial answers, which plausibly explain the vast majority of the issue with “ What’s happening? I don’t know and I find it really scary.” But I think there is another dynamic that’s being ignored — and I would be surprised if an economist ignored it, but I’ll blame Scott’s eclectic ad-hoc education for why he doesn’t discuss the elephant in the room — Superior goods.

Superior Goods

For those who don’t remember their Economics classes, imagine a guy who makes $40,000/year and eats chicken for dinner 3 nights a week. He gets a huge 50% raise, to $60,000/year, and suddenly has extra money to spend — his disposable income probably tripled or quadrupled. Before the hedonic treadmill kicks in, and he decides to waste all the money on higher rent and nicer cars, he changes his diet. But he won’t start eating chicken 10 times a week — he’ll start eating steak. When people get more money, they replace cheap “inferior” goods with expensive “superior” goods. And steak is a superior good.

But how many times a week will people eat steak? Two? Five? Americans as a whole got really rich in the 1940s and 1950s, and needed someplace to start spending their newfound wealth. What do people spend extra money on? Entertainment is now pretty cheap, and there are only so many nights a week you see a movie, and only so many $20/month MMORPGs you’re going to pay for. You aren’t going to pay 5 times as much for a slightly better video game or movie — and although you might pay double for 3D-Imax, there’s not much room for growth in that 5%.

The Atlantic had a piece on this several years ago, with the following chart;


Food, including rising steak consumption, decreased to a negligible part of people’s budgets, as housing started rising.In this chart, the reason healthcare hasn’t really shot up to the extent Scott discussed, as the article notes, is because most of the cost is via pre-tax employer spending. The other big change the article discusses is that after 1950 or so, everyone got cars, and commuted from their more expensive suburban houses — which is effectively an implicit increase in housing cost.

And at some point, bigger houses and nicer cars begin to saturate; a Tesla is nicer than my Hyundai, and I’d love one, but not enough to upgrade for 3x the cost. I know how much better a Tesla is — I’ve seen them.

Limitless Demand, Invisible Supply

There are only a few things that we have a limitless demand for, but very limited ability to judge the impact of our spending. What are they?

I think this is one big missing piece of the puzzle; in both healthcare and education, we want improvements, and they are worth a ton, but we can’t figure out how much the marginal spending improves things. So we pour money into these sectors.

Scott thinks this means that teachers’ and doctors’ wages should rise, but they don’t. I think it’s obvious why; they supply isn’t very limited. And the marginal impact of two teachers versus one, or a team of doctors versus one, isn’t huge. (Class size matters, but we have tons of teachers — with no shortage in sight, there is no price pressure.)

What sucks up the increased money? Dollars, both public and private, chasing hard to find benefits.

I’d spend money to improve my health, both mental and physical, but how? Extra medical diagnostics to catch problems, pricier but marginally more effective drugs, chiropractors, probably useless supplements — all are exploding in popularity. How much do they improve health? I don’t really know — not much, but I’d probably try something if it might be useful.

I’m spending a ton of money on preschool for my kids. Why? Because it helps, according to the studies. How much better is the $15,000/year daycare versus the $8,000 a year program a friend of mine runs in her house? Unclear, but I’m certainly not the only one spending big bucks. Why spend less, if education is the most superior good around?

How much better is Harvard than a subsidized in-state school, or four years of that school versus 2 years of cheap community college before transferring in? The studies seem to suggest that most of the benefit is really because the kids who get into the better schools. And Scott knows that this is happening.

We pour money into schools and medicine in order to improve things, but where does the money go? Into efforts to improve things, of course. But I’ve argued at length before that bureaucracy is bad at incentivizing things, especially when goals are unclear. So the money goes to sinkholes like more bureaucrats and clever manipulation of the metrics that are used to allocate the money.

As long as we’re incentivized to improve things that we’re unsure how to improve, the incentives to pour money into them unwisely will continue, and costs will rise. That’s not the entire answer, but it’s a central dynamic that leads to many of the things Scott is talking about — so hopefully that reduces Scott’s fears a bit.

Expanding definitions and Obsoleting Industries

I’ve already explained why we can’t figure out if bitcoin is “really” a currency. But I think there is a lot more to say — because those 3 characteristics of money (Unit of Account, Store of Value, and Medium of Exchange) are not the only things that make money useful.

What else is needed?

Principally, gold stopped being used as currency directly because it was too hard to carry around as a currency — especially safely! But the gold standard was abandoned because the supply was too inflexible. Country’s economies started to expand much faster than their metal-backed currency, so that the value that existed was in excess of the medium of exchange for that value, and their needs for credit couldn’t be easily supplied with gold. This clarifies that these three tasks are not all a currency can do, nor is it the only thing we might care about. In fact, much before digital currencies, there were lots of things that we need that traditional forms of money don’t provide. Instead, systems were created to fill in the gaps, and these systems sprouted entire industries that software is getting ready to eat.

For example, we frequently need a system for measuring, processing, and communicating transactions. This is traditionally done by bookkeepers (not even necessarily accountants). I’ll refer to it as a “ledger of transactions” (4). Bookkeeping employs a couple hundred thousand people and costs around $50bn in the US alone. Under modern accounting principles, using third party verifiers, this system also allows an owner to provide a “proof of worth” (5) for a company or an individual. That’s accounting, (audit, not tax) and it employs another couple hundred thousand people and costs $100b. Both of these are bonuses that blockchain ledger currencies like bitcoin can provide, for example, using merkel hash tree signed proofs. Because of this, traditional businesses and currencies must rely on those large, expensive systems instead.

Next, we have more ancillary, non-currency systems that provide “tokens of ownership” (6) for non-currency goods, like real estate deeds or stock certificates. In order for these to be liquid and saleable, a “verifiable exchange market” (7) is needed, such as a county clerk for real estate, so that people can reliably sell their property without worrying that someone else will appear with a different deed to the property. If you’ve ever bought a house, you know the “title search” fee of $250+ you pay, instead of a 1 line query of a distributed blockchain database. And then you probably still need title insurance, in case the search missed anything.

The verifiable exchange can also provide a “transaction price log” (8) like the stock market’s ticker, where everyone can see the value of the goods currently being traded, and therefore be able to make decisions about whether to buy and sell. And all three of these can be accomplished using on-chain blockchain tokens, which track ownership, and the blockchain can show the prices paid for them.

We also want a “system of credit” (9) that allows for transactions that are contingent, risky, or require a future payment. This last is closely related to, and requires, a unit of account — but credit cards and most other typical forms of credit use outside systems for their unit of account. This is a feature that blockchain based currencies don’t do well, yet. Some smart contract platforms seem poised to allow, for example, collateralized loans, but the key difficult with extending credit via blockchain is that unsecured credit requires known identities, which blockchains don’t do. (If I lend money to you, then you stop paying me back and just start using a new wallet for your money, it’s not clear what recourse I have.)

Further, built on top of these systems, we have complex systems for many other features of the modern economy that are enabled by these various services and characteristics of money and related market systems. For example, fractional reserve banking relies on a “system of credit” for loans so that banks can have assets in excess of their reserves. For this to be trustworthy, we need (but don’t fully have) a robust “proof of worth” for these banks.

We have a repurchase agreement (“repo”) market that allows “tokens of ownership” (6) to assist the “system of credit” (9) which helps ensure liquidity on the basis of owned assets.

The Future

This large set of needs, combined with a healthy dose of historical path dependence, leads to the current complicated set of systems that are all intertwined. But as one 2016 Nobel laureate said, “The times, they are a changin’.”

Cryptocurrencies and Smart contracts have the ability to do all of these things. Definitions don’t dictate reality, they reflect it. Cryptocurrencies can do things currencies cannot, and focusing on the definitions is a red herring.

Problems Defining Money

There seems to be confusion about the functions of currency, and the definition of what money is. I’d like to explain why the confusion exists — and it starts with the fact that “Money” and “Currency” aren’t defined simply or clearly.

For something to be considered money by economists, it must have certain uses, or characteristics. Economists have identified three. It should be a;

  1. Unit of Account, which is used to measure value.

2) Store of Value, which is used to hold in order to ensure it can be used in the future.

3) Medium of Exchange, which is used to allow transactions without direct barter.

That last one is the one even critics agree bitcoin displays most obviously. But bitcoin definitely displays all three of these characteristics, to a greater or lesser extent. On the other hand, almost everything else can display these characteristics to some extent as well. The things historically used as money have been whatever does these function best.

Gold has served as a store of value for millennia at least, since it is a fairly compact and valuable item, and has intrinsic worth for its beauty. It was also of limited supply ensuring that it remained valuable, and it worked well as a store of value . Even before coinage, it was a useful medium of exchange, since relatively large amounts can be carried easily, and it is also divisible. Once coinage was created, this was still sometimes true, and Spanish pieces of eight were broken into pieces to allow this. Coinage also led to gold as a much more useful unit of account, no longer requiring careful measurement and sometimes difficult verification of its nature.

Other historical “money” was less well suited for some of these different tasks; Cattle was a great medium of exchange in ancient cultures, was easy to validate, and was a reasonable store of value over the short term. It was also a unit of account, but served this purpose less well. (They sometimes varied in value between different animals, and over time, and were not easily divisible — it tended to get messy when you split them in half.)

Now, many things fall into the grey area created by our linguistic imprecision in grouping these functions. This means that they are money, but aren’t perfectly suited for the purpose. Examples include the UN’s Special drawing rights, which are a unit of account (1) and a store of value (2), but not a medium of exchange(3). Similarly, banknotes (or fiat currencies!) and gold certificates are a great unit of account (1), and a very convenient medium of exchange (3), but their reliability as a store of value (2) is contingent on the trustworthiness of the issuer, which can vary.

Cryptocurrencies are great as a medium of exchange, since the transaction system is designed explicitly for transacting, and they are divisible into fairly small amounts. Their usefulness as a unit of account and store of value, however, is less clear. As exchange rates fluctuate, the reliability of these uses can be tricky. As Bitcoin has stabilized, this has become a less critical issue, but digital currencies lack intrinsic worth, so any stability is limited by trust. As noted, fiat as a store of value also depends on trust, albeit different; it’s trust in a central bank instead of a algorithm and a social agreement.

In terms of just these three characteristics, we seem to have nothing that works quite as well as gold once did, leading some to wonder why we don’t go back to gold. But this is a bad idea, because those three characteristics aren’t a full list of what we need from a currency — notably, gold has a fixed supply, not just a limited one, which has real downsides. (Not just nominal ones. But that’s a different discussion.)

In any case, I think that it’s obvious that nothing fits the platonic ideal of a currency. And arguing about definitions is a silly thing to do. (That doesn’t mean you can use words however you want!) Given the lack of a platonic exemplar, the question of whether to call something money is really just asking what the best trade-off is between different choices — and that’s subjective and contentious. Which, I think, explains the confusion I started with.

Added: But this confusion misses the point; Instead of arguing definitions, we need to look at expanding definitions and obsoleting industries.