A Moral Hazard Before It Even Happened

The Times has this new blog called "Economix." It's supposed to be about "the science of everyday life," which is already annoying to me, as if economics were the basic tool for explaining why people do what they do.

As I've discussed on C and C here before, economists cheerfully admit they have no idea why people do ordinary fun things like pay a lot for concert tickets, or why they feel compelled by fairness to pay for things even when it's not required, or why people vote.

Also the economic theory of rationality predicts that we all act in our own self-interest, which is just obviously false.

So while it's fine with me if they want to study money, the idea that economists are going to explain everyday life is just really, really irritating to me.

Anyway, over at one of their "guest posts" today, an economist named Bob McTeer explains that contrary to appearances, the bailout represents no risk of "moral hazard."

Moral hazard is when someone is rewarded for behaving badly or doing something dumb, and so is more likely to do it again next time rather than less.

The crux of McTeer's argument seems to be that since the individuals who made bad decisions actually will suffer consequences, there's no moral hazard. I'm not sure I've got all the details, but the idea seems to be that since the CEO's of AIG etc., are going to lose their jobs and money, the CEO's of the future won't be tempted into the bad behavior that got us into this mess.

CEO's, McTeer says, look at what happens to other CEO's, not to what happens to customers.

I don't know how this applies to the proposed bailout -- McTeer objects to the term "bailout" in any case -- but the basic idea seems to be that as long as you save the company but not its owners and managers, you don't risk moral hazard.

I'm no economist, but come on, really? Even before all this happened, lots of people were wondering at the planning skills of the people in charge. Lots of people were wondering, why on earth are these companies taking such enormous and dumb risks? It's not like no one knew something like this could happen.

One reason it must have seemed safe to take huge risks was because everyone else was taking huge risks. So you figure, well, we can't all go down in flames; the economy won't survive that. So there's safety in numbers.

Turns out that was right. Because we're going to bail these guys out. So the bailout created moral hazard before it even happened, just because we knew it was overwhelming likely that something like it would happen.

I'm not buying McTeer's argument that losing a job is the ultimate in motivating a CEO or bank manager to act one way rather than another. Anyway, anyone who *was* motivated by that sort of fear into behaving in ways that weren't taking big economic risks probably would have been fired before the crisis, for not bringing in enough money.

So the no moral hazard argument, I am not buying it.

Money and Happiness In The News

Last Wednesday in the Business section, the Times ran a story about data challenging the old hypothesis that "relative wealth" was more closely tied to happiness than "absolute wealth." The hypothesis was formed in the 1970's on the basis of research showing that while being wealthy did not make people happy, being wealthier than other people did.

This hypothesis is called the "Easterlin paradox" after its formulator, and says that happiness is tied to how wealthy you are relative to others, rather than in absolute terms. But what's paradoxical about it? It's highly intuitive to me. Feeling like one of the richest, the smartest, the coolest, is way more important to my happiness than being, in an absolute sense, rich smart and cool if everyone else is richer, smarter, cooler.

The new data are supposed to challenge the hypothesis, on grounds that people in richer countries are, well, happier.

OK, so I'm not trying to be a pain in the ass about this, but really, I don't see how this follows. I mean, if you're the one of the richest people in Haiti, you're still way poorer than people in other countries. So even if you're rich relative to Haitians, you're still poor relative to the world.

So your unhappiness is just as well explained by the "relative" wealth hypothesis as it is by the absolute wealth hypothesis.

Some cool looking Haitian money.

At least, it is if you're willing to accept the premise that people in poor countries are comparing themselves not only with their fellow-countrymen but also with people in other countries.

The premise seems reasonable. With globalization and the internet, I'm sure people all over the world are fairly informed about people all over the world, and how well they live. At least roughly speaking.

So, uh, I don't get it. Am I missing something?

Noko (n+1), I Feel Your Pain. But Why?

I wrote recently about the strange relationship a person might have with his future selves. What if Noko (n) eats salad for dinner today to try to lose five pounds, and Noko (n+1) sabotages her efforts by ordering the creme brulee tomorrow? What if Noko (n+12) doesn't appreciate our efforts?

But, of course, we worry about our future selves, too. Constantly. Will they have enough money to retire on? Will they be healthy? Will they be suffering at next Tuesday's dentist appointment?

So. Why do we worry about our future selves? And how much should we worry?

In last Sunday's Times, Jim Holt reflects on the analogy between worrying about future selves and worrying about actual other people. He says the reason we worry about our future selves is that our evolutionary ancestors worried about their future selves.

OK, sure. As philosophers say, that's an explanatory reason, of a sort. It explains why, in the course of things, we are a certain way. But it's not an justificatory reason. It's not even a satisfying explanatory reason, in a way. It leaves open the question: Are we right to care about our future selves? And if we are, what makes this make sense? An evolutionary answer isn't going to solve that problem.

The question is important, because without an explanation of why we ought to care about our future selves, how are we going to answer the question of how much we ought to care about our future selves?

I'm inclined to say that in a way the question of "why" has no satisfactory answer. You care about your future self because it's you: it's more like caring about your present self than caring about someone else. In that case, the question of "how much" has no satisfactory answer either.

Holt imagines a person who doesn't care about his future self as someone who is really improvident: never saving for the future, never preparing for what's going to happen.

But even a person who doesn't want to sacrifice for his future self might care about his future self; he just isn't motivated to give up what he has now. He might still dread the bad things that are going to happen. He just doesn't dread them enough.

So how much should you dread the bad things that may befall your future self? The background assumption seems to be something like this: you should dread them the same about you would dread similar suffering of your present self. Rationality, on this view, requires you to treat your future self and your present self the same.

This Freakonomics post by Daniel Hamermish uses the example of cheating on your spouse to illustrate the concept of "hyperbolic discounting": "people overemphasize current pleasure and pain in comparing actions at different points in time." This leads them to "irrational" behavior.

Hamermish allows that one might properly "discount" for something being in the future, but seems to suggest that cheating is discounting too much. Indeed, hyperbolically so.

So how much is the right amount?

When I was a kid, in like seventh grade, there was a poster on our classroom wall that had a quote from a poem -- something about how the author wanted to burn bright and short like a star rather than endure long and cold like a planet.

I remember I always thought it was the darndest thing to put up in a kids' classroom. After all, adults are always trying to get kids to do the exact opposite: Do your homework! Don't smoke! Care about your future selves, guys!

Inviting the classic teen response: Why should I?

Why indeed? Ya got me.

Disgust and Purity: Should We Care?

Disgust, repugnance, and fears of impurity have made three appearances in The New York Times over the last few weeks. OK, it's not Britney, but still. For an abstract concept, three is a lot.

First, as I wrote about before, we have Stephen Pinker's essay, The Moral Instinct. There, Pinker says early on that, psychologically speaking, there are (roughly) five distinct sources of moral sense: not harming others, being fair, being loyal to a community or group, respecting authority, and purity.

Later in the piece, Pinker says that the excessive pursuit of purity can be a source of moral illusions: those who are against cloning because it gives them "a moral shudder," he says, just aren't being thoughtful or reasonable enough. It's a kind of prejudice.

I was struck at the time: how can disgust be a source of moral judgment and also be a distorting factor on moral judgment?

Then there was this recent short item in the Arts section: "Economists Dissect the 'Yuck' Factor." Here, Patricia Cohen points out that disgust is a complex issue for conservatives: on the one hand, economic conservatives favor fewer limits on markets, so the fact that you feel grossed out by, say, kidney purchasing or baby buying is simply not relevant to whether these things are good or bad. On the other hand, social conservatives (as Pinker points out) frequently invoke the moral shudder in explanations of wrongness.

As she tells the story, economists say that everything should be open to markets unless you can prove otherwise, while skeptics say that the burden of proof is on the other side -- that if you want to open up a market, you must make a case for the morality of the proposed transactions.

Interestingly, she cites Pinker's essay as one source of the idea that disgust is an "early warning system" -- a feeling that alerts us that something needs moral scrutiny.

On this view, the answer to my question is that disgust is a not a source of moral judgment, but is merely an indicator, and when trusted, acts as a distorting factor.

This answer is supported by the third appearance of disgust, in the pyschologist Paul Bloom's review of a new book by philosopher Kwame Anthony Appiah. There, Bloom summarizes some research as showing that disgust and other emotions cause us to make judgments we later find we cannot justify.

Interestingly, this approach almost seems to side with the economists, insofar as the suggestion is that if one cannot give a justification in terms of other factors -- such as harm -- then disgust is irrelevant.

I'm no fan of purity obsessions, believe me. But at the same time, I also think we humans are not always very good at figuring out what's good for us -- as I've said before, once we start doing cost-benefit analysis, we tend to start estimating wrong.

I'm left uncertain over whether, and when, and how, to care about disgust. If a poor man risks his life selling a kidney to a rich man and then gets sick and dies, I feel a kind of disgust. I'm inclined to take my reaction as morally significant whether or not I can back it up. But I know that some people feel a kind of moral disgust at sexual freedom, homosexuality, and so on, and there I feel, well, no, that's not morally significant.

I suppose ideally I would be able to articulate in other terms what is bad about free markets for organs donations. But in the meantime, what am I supposed to do? It's not like cost-benefit analysis has such a great track record, either.

What Is Up With Economists?

Like I mentioned before, I sometimes read the Freakonomics blog. As I also mentioned before, sometimes the arguments economists make about things, and the way they approach their theories and their lives, leaves me feeling seriously mystified.

Leading me to wonder, is thinking rationally bad for you?

Over at Freakonomics, Stephen Levitt tells the true story of an unnamed economist with a young daughter. Here's the story.

Father promises to take daughter to Hannah Montana concert. They have no tickets. They go to the venue. Increasing panic and anxiety as father realizes prices for scalped tickets are astronomical and time is running out. At the last minute, father scores cheap second-row seats, hooray!

Then a twist. Father thinks: I could sell these, make a huge profit, buy regular seats, and still see the show! Uh-oh! What will he do?

Thank god someone there was behaving like a normal person. Daughter starts crying. Father shifts course: OK, we'll use the tickets! They do, the show is awesome, daughter totally gets to talk to some back-up singer or something and is thrilled. Happy ending.

I suppose the idea behind selling is that using the tickets is like giving away the 1000 dollars you could get for them; you wouldn't pay 1000 dollars even for second-row tickets to start, so why would you now?

Man, if someone tried to pull that reasoning on me I'd start crying, too. Let's face it: giving up the opportunity to maybe make 1000 dollars when time is short and you might miss the concert is in no way comparable to paying 1000 dollars for tickets. It just isn't.

Then, too, how thrilling and fun to suddenly be in the second row. How awesome! It seems so cold not to treat it that way. Many of life's most excellent experiences are like that; how could a person fail to appreciate that so dramatically?

You could say, in this case it's better to act non-rationally. But you don't have to. As some Freakonomics commenters point out, by factoring in the awesomeness, you can defend the choice to use the tickets on purely rational grounds: it was, in this case, worth the money. Cost-benefit-wise.

On this interpretation, what went wrong with the father's reasoning wasn't that he over applied rational thinking, but rather that he underestimated the disappointment of selling and underestimated the pleasure and fun of being in the second-row.

So then we ask, well, why did he misestimate? Clearly he misestimated because when you start doing cost-benefit analysis, you develop a clear bias toward easily estimated goods. Like money. And the fact that failing to make 1000 dollars should be the same as losing 1000 dollars, because it's clear, looms sort of large.

In this sense, it seems to me that engaging in rational-decision-making can make you less rational. You just start guessing wrong.

I think this might help explain why economists also underestimate the vague goods associated with community and friends and so on and overestimate the good associated with money and material comforts (as I said was going on here). Material goods are just easier to add up.

When I went back to Freakonomics to get the link for this story, I saw a new post in which Levitt also said that he "started" but "didn't manage to finish" three of the five books related to high SAT scores (don't ask): 100 Years of Solitude, Crime and Punishment, and Atlas Shrugged.

I usually poo-poo alarmists about reading, but really? You couldn't finish 100 Years of Solitude? Crime and Punishment? I mean, I can see not liking them. And putting them down. And I can see never having picked them up. But it really sounds like the problem for Levitt was that they were too long. Hm! Surprising!

The People In Your Neighborhood

Because I was awfully busy last week, I missed reading The New York Times, and so I missed being enraged by the opinion piece, "What to Expect When You're Free Trading." Now that the archives are online, though, it was easy to get all enraged about it this afternoon. So, as the kids say, "No problem!"

In arguing against compensation for workers laid off in the wake of job-loss from global free trade, Steven Landsburg asks us to consider that in relevantly similar cases, compensation would not be morally required. In the irritating passage, he says,

Suppose, after years of buying shampoo at your local pharmacy, you discover you can order the same shampoo for less money on the Web. Do you have an obligation to compensate your pharmacist? If you move to a cheaper apartment, should you compensate your landlord? When you eat at McDonald’s, should you compensate the owners of the diner next door? Public policy should not be designed to advance moral instincts that we all reject every day of our lives.

Well, now that you mention it, um,. . . maybe? One letter writer to The Times made a good point (letters are here):

In fact, if I care about having a neighborhood with things like a local pharmacy (and I do, for what it’s worth), then I will continue to buy my shampoo there even if I have to pay a bit more.

And I would be getting a great bargain — not only shampoo, but also a community.

It was this letter that alerted me to having missed the original story. Obviously the author's point is logical: if you spend at Walmart, you'll be surrounded by Walmarts. If you spend at the mall instead of downtown, downtown will go away. I frequently spend extra money to buy at places I like; this is simple means-end rationality.

How well does the point extend to the analogy? Well, Mr. Landsburg might say that this is apples and oranges. By hypothesis he's considering cases in which one is indifferent to the differences and comparing on cost. Indeed, if a book is cheaper at Amazon and more expensive at bn.com, I'll buy from Amazon. I don't feel morally obliged to send money to bn.com.

But in a way I think it's actually apples and apples. Having the people in my town, my state, and my country happily employed is not unlike having a pharmacy around the corner: it's a nice way to live. This is well-captured by the final remark: you get a community. Goods like this are so vague they're hard to reason about, but they're also of the utmost importance.

Incidentally, the next letter on the page accuses free trade opponents of willfully overlooking the benefits of free trade: what if you had to grow your own food, fer Chrissake! Um, you don't have to be against trade to think that there should be limits to it. Just because free trade is good doesn't mean some other things, that don't fit easily with it, aren't good either. Why does everything have to be all or nothing? Sheesh!

This letter about community was much on my mind last Monday. Heading from Toronto to Ann Arbor, I had a three-hour layover in Detroit, and figured I'd spend some time walking around the city. It was MLK day so it wasn't a normal Monday in the city. But I got kind of emotional looking at how cool and interesting the city looked and how its poverty was just wearing everything down.

Here's some pictures.



A cool pretty building with art or graffitti in the windows. I really go for this sort of thing.


A giant Solstice ad! It's like they knew I was coming!


The view across the river from the Renaissance Center.

I tried to support the local economy by buying a guide book to Detroit in the Borders in the middle of the city. Alas, there are no guide books to Detroit. If you want to go to Vegas, though, you are in zee business.