Thursday, July 26, 2007

Do Smart Guys Tell Better Jokes?

In the wake of the recent blog brouhaha over IQ and the Wealth of Nations I have been thinking about the general connection between intelligence and income.

My interpretation is that many people find it natural to conclude that IQ causes macroeconomic growth because IQ appears to cause microeconomic success. High IQ people are richer people, on average.

While I am sure that many smart people are quick to assert that their intelligence is what got them where they are, are we so sure? Height is correlated with individual success. I willing to bet height is also correlated with economic growth. And, we know that there is a height “Flynn effect.” That is, people have been getting taller over time. Do we think height causes growth?

The height correlation is usually settled by noting that height is a general sign of health and fitness, thus the correlation with macroeconomic growth, and therefore tall people are more likely to be chosen as spouses of successful people. Rich men and women have a greater choice in spouse and they tend to choose taller ones. Therefore, height and the genetic or cultural traits that produce wealth are commingled.

Could the same thing be true with IQ? That is, are smarter people more likely to be chosen as spouses to the rich and powerful? Now one possibility is that intelligence is just out and out attractive. Some people may agree with that conjecture.

Another, however, is that intelligent people are more likely to land a successful spouse because they are more clever at the dating game. My pet theory is that the human brain evolved through sexual selection. It’s just too big and mostly useless to have come about any other way. Looking at the monstrous and dangerous thing sitting a top most people’s shoulders one cannot help but be reminded of the Irish Elk.

It wasn’t so much that we impressed each other with our big brains, but that those brains busied themselves with devious plots to ensnare the objects of our affections. Most of us are aware of the modal thought among men and I would reason a guess that the modal thought among women is the dissection of the thoughts and intentions of men.

It seems possible then that IQ may simply be commingled with the attributes that produce success. My guess is that those attributes have more to do with perspiration than inspiration.

Why Trade?

So the common objection I have gotten to my draft both on and off line is, why trade? Doesn’t this apply to any policy, not simply trade? Or, we already know that people are afraid of trade?

I am sensitive to this but I think the trade argument is important because of the special status free trade has within economics.

Perhaps, my perception is way off but I think that most economists feel comfortable asserting that the gains to the winners from trade liberalization will outweigh the losses to the losers except in the following cases:

1) There are externalities.

2) There are unexhausted returns to scale.

I am offering a third and I believe more general critique. The very fact that there are winners and losers is inherently costly. Unless you know for certain exactly who those winners and losers are, you are imposing uncertainty on the world.

It is possible that the cost from this uncertainty outweighs the gains from trade liberalization.

In fact, it is possible that freer trade is unambiguously a social ill. That is, the increase in uncertainty could make every single person in the world worse off because of freer trade. In this case there is no social welfare function that would rate this as a good idea.

Since this is a theoretical possibility, the notion that the gains to the winners outweigh the losses to the losers becomes an empirical question that is almost impossible to rule out a priori.

Now, I think that distributional uncertainty is an issue that goes beyond trade. Indeed, I think it affects any policy we might consider. However, I do think that trade is unique in the level of confidence economists display about policy prescriptions.

In a survey reported by Robert Whaples 90.1% of economists disagreed with the suggestion that US should restrict outsourcing.My guess is that the 10% who agreed did so primarily on the grounds of equity and that most of those who disagreed felt that in the absence of externalities or a returns to scale argument trade unambiguously promoted the general welfare.

I am challenging that assumption.

Wednesday, July 25, 2007

Oldies but Goodies

So to finish working on Losses from Trade I am reading

The Foundations of Welfare Economics


Welfare Propositions of Economics

They are both fun reads, especially the first. It is wonderful just how careful these guys were.

Friday, July 13, 2007

Losses From Trade

A draft of the idea in the last post.

Tear it apart :)

Thursday, July 12, 2007

Kaldor Hicks Preview

Gabriel says that I should post my ideas no matter how nascent because lets get real, whose gonna want my ideas.

So here is one that I have been kicking around promising myself that I would finish the write up on but haven’t gotten around to it.

Kaldor-Hicks tends to overestimate the net benefits of a policy whose distribution is uncertain.

That is, when we think about whether a policy is a good idea we do a cost-benefit analysis. We add up all the costs to whomever they occur and all of the benefits to whomever they accrue. If the benefits are greater than the costs we declare the policy to be efficient.

Perhaps, the policy is not equitable but it is efficient. The winners could compensate the losers and be better off.

Now the problem is that the winners don’t compensate the losers. And, that’s not just a problem for the reason you think it is. We all admit that the distribution of the gains may be such that the winners don’t personally value their gains as much as the losers personally value their losses. However, without the ability to do interpersonal comparisons we are stuck.

Yet, there is another problem. If the distribution of the gains is not certain then the individual agents will value them at less than their face value. Likewise if the distribution of the losses is not certain than the individual agents will value them at more than there face value.

This means that even if the total benefits outweigh the total losses with certainty, uncertain distribution can lead to individual agents perfering not to make the trade.

To drive the point home I create the following example:

There is a policy were the gains to the winners outweigh the losses to the losers with certainty but NO AGENT wants to see the policy enacted. That is, there is a policy which passes cost-benefit analysis but is uniformly rejected by each person affected by it.

The simplest example is easy. Suppose that the benevolent government is offered the following deal. One million of your residents will be selected and given $100,000. Another one million of your residents will be selected and charged $99,999.

To make matters simple only residents who have at least $99,999 will participate in this program. However, whether the resident is a winner or loser is chosen at random.

This program seems like an economic free lunch. The gains are guaranteed to outweigh the losses by $1 million. The selection process is completely random, so there are no economic distortions. In fact, there is no a priori reason to expect that the winners will have lower marginal utilities of income than the losers.

Yet, we could expect that every single agent will reject this program. Why? They reject it because the program exposes them to risk. The cost of that risk outweighs the expected benefit of program.

Perhaps, the agents could insure against the risk. Since the expected gains are positive they should be able to write a contract that splits the expected gains with an insurer so that everyone winds with more than what they started with.

However, what if I said that I am not going to announce the winners and the losers? I am simply going to subtract the losses from the losers net worth and add the gains to the winners net worth with no record of the transaction. How could one insure that?

If this seems a little far fetched and unrelated to real world issues, allow me to change the offer again. Rather than simply adding $100,000 or subtracting $99,999 I am going to do this.

The winners will receive an increase in the demand for their services and a pay raise. The losers will see their jobs outsourced to Asia. The winners won’t know for sure why they lost they received a raise. The losers won’t know for sure why they lost their job.

To add another layer of realism lets change the terms a little. I won’t change any of the expected values but this time instead of selecting 1 million winners and giving them each raises worth $100,000, I will select 100 million winners and give them each raises worth $1000.

The expected gains from this deal are still $1 million. Does anyone want to go for it?

There are two insights that I draw from this thought experiment.

1) That distributional risk is a real concern in policy. If the winners don’t know they will be winners and the losers don’t know if they will be losers the policy will seem better than it really is.

This was the idea that I started with. Workers I talked to disliked outsourcing not just because some people did loose there jobs but because they felt like any of them could loose their jobs. The difference is subtle but important. The first is just about direct costs; the second includes a notion of risk.

2) The second insight I take away is that just as Von Neumann / Morgenstern risk comparisons allow us to define cardinal rather than simply ordinal utility. Who-will-gain risk comparisons allow us to define a sort of interpersonal utility comparison. If you had an equal shot of being on any end of this policy would you still support it? Its not exactly interpersonal comparisons but it carries much of the intuition we want to gain from it.

Comments? Suggestions?

Tuesday, July 10, 2007

Prior Trap Preview

Arnold Kling has an interesting post on Inequality, that references Brink Lindsey's piece in the Wall Street Journal.

My October talk at GMU is going to be on the same issue that Lindsey refers to as the Culture Gap.

The type of facts that go to the heart of my concern and apperantly his is this:

Among students who received high scores in eighth grade mathematics (and thus showed academic promise), 74% of kids from the highest quartile of socioeconomic status . . . earned a college . . . 29% for those in the bottom quartile [did as well].

That is socio-economic status seems to have an effect independent of ability.

Lindsey argues that it is a cultural phenomenon. On one level I do not disagree.

However, I believe that "culture" is the rational extrapolation of unknown parameters from the behavior of people in your reference group.

Whew! In other words:

Look life is full of choices. The consequences of those choices depend upon the complex interaction of factors that you don't have the time or in many cases even the resources to understand. So what do you do? You copy the behavior people who seem to be doing well given similar circumstances. If you think Joe is doing good for himself and Joe has constraints similar to your own then you copy Joe. If Fred is screwing up royally and Fred was faced with the same choices that you had, you avoid Fred's behavior.

This is in part why people feel moved by an example "they can relate to." This is simply a way of saying the constraints in this problem as sufficiently similar to my own that I can use it as a data point.

When your circle is an unbiased sample of population consequences this works remarkably well. It is possible for people to make fully optimal choices in the face of no data, apart the actions and consequences of those around them.

In other words, to be successful you don't have any clue about how the world actually works, you only have to learn from the experience of the people around. This is nice because in academia some of the smartest people, with the most powerful computers and the largest data sets spend all day trying to understand how the world actually works and they still have no clue.

When your sample is biased, however, you can be steered off track. If everyone you see is a high school drop out and most of them are just as smart as you, then what makes you think that you can or should finish high school, let along go to college.

Remember that investing in education requires giving up work and leisure today for the possibility of gains tomorrow. Working at McDonald's or spending time with you friends pays off with probability one. College? Well in a world where the only person you know that has graduated from college is your teacher, what are likely to conclude about the expected return from that investment.

The corollary to my theory is that good teachers are not ones who have high instructional ability but high motivational ability. Good teachers encourage already successful students to push themselves even harder. Good teachers can relate to at risk students and convince them that the pay off from education is indeed positive.

Rick Hanushek shows that working with great teachers four years in a row can eliminate the performance gap between low income and high income students However, what makes a great teacher has little to do with education or experience. He says that the missing factor is unknown but probably innate.

I suggest that the missing factor is the ability to gain a student's trust. The ability of a teacher to convince a student to disregard that giant data set called her community and instead believe the message the teacher is painting. This often requires disregarding parents as well. After all, poor parents are disproportionately likely to be people who estimated a low expected return to education themselves.

Tuesday, July 3, 2007

Whats Going On

A commenter asks just how slow this summer is going to be.

Pretty slow I am afraid. In fact, I think I am quasi-retired for the time being.

The incentives in Academia being what they are I have to concentrate on writing for other economists before I can get back to writing for the blog.

My feeling is that it is better to wait and come back full-time rather than popping the occasional post every week or so.

If people feel differently then I can start posting on a when-I-have-a-moment basis.