Monday, May 28, 2007

David Warsh: Knowledge and the Wealth of Nations

David Warsh describes the develpment of economists' models of growth and progress in his book Knowledge and the Wealth of Nations . The story revolves around the origins and consequences of a particular paper ("Endogenous Technological Change" by Paul Romer, 1990) in order to give us a view into the way economists think and the way economic theory evolves.

The book spent more time on personalities and personality clashes that I would have preferred, but Warsh apparently wanted this book to say more about how economists work than about the ideas they've developed. As a result, you have to work a little harder to keep track of how economists' models of progress evolve from Adam Smith to the present.

It shouldn't be a surprise that models of the real world (in any field) usually start simple, and accumulate details as people discover areas where the models' predictions aren't sufficiently clear to answer questions that arise. The thing that's interesting and hard to track when looking backward is remembering where the gaps were, and the order in which the problems were addressed. Warsh traces the earliest descriptions of how business works, and how progress is made to Adam Smith and his description of the division of labor in his Pin Factory example.

But the earliest economists described everything in prose. When the models were formalized, they started out simple. Until quite recently, all formal models of production in an economy were static: they assumed the means of production didn't change over time. Often the eonomists who presented these models explicitly recognized that that was an important factor that was missing from their models, but they still had to start simple in order to have models they could manage.

The path of evolution of the models next added the idea of growth, but assumed that progress was constant and outside the influence of the manufacturers in the model. This allowed the economists to model and describe more sophisticated situations, but didn't match what people could see about how developing countries advanced over time. Romer's contribution to the field was to build a model that made entrepreneurial investments change the cost of doing business and the alternatives available to actors within the model.

Romer's model assumes that the technological advances produced as a side effect of investment are general knowledge (they are non-rival goods), but that some of the benefits can be monopolized by the developer for a time (they are partially excludable). One of the major consequences of this is that the model predicts that trade barriers prevent underdeveloped countries from advancing, and that borders that are open to trade all lesser developed nations to gradually catch up with their trading partners, since they can take advantage of the greater stock of knowledge in the market.

I've read several books over the last few years that point out that the idea of progress is failry recent in human history. Romer's contribution wasn't in noticing it, it was deciding it was important, and figuring out a way of bringing it into the models that economists use. Now that invention, discovery, and the sharing and hoarding of knowledge are explicit in the models, economists' recommendations to policy makers more often point in the direction of investment in education and new technology.

Along the way, Warsh presents an interesting history, and describes other ideas Romer and his colleagues were struggling with and how they led to the particular paths chosen. If you're interested in the history of this particular idea, or how economists (or scientists in general) work, it's an engaging book.

Tuesday, May 15, 2007

Judith Rich Harris: No Two Alike

Judith Rich Harris's book No Two Alike is a followup to her previous work, The Nurture Assumption. In her first book, Harris explained that most of the non-genetic affects on the personalities of adults are a result of their interactions with peers rather than with their parents. She pointed out that many people want to believe (and prove) that parents are the major source of their children's personalities. According to The Nurture Assumption, the field of sociology has been confused for several decades and has been trying to distinguish nature and nurture, when they needed to be either distinguishing the effects of heredity from environment, or disentangling the environmental influences which include both parents and peers.

The best tool, according to Harris, for distinguishing the effects of heredity and environment consists of studies of twins. Comparing twins raised together and twins raised apart controls for genetic affects and allows us to see the effect of gross differences in environment. Comparing fraternal twins raised together with identical twins raised together holds the gross environment constant and makes it easier to see what differences are purely genetic.

In the new book, Harris focuses on why twins are so different, in order to isolate the causes of differences that aren't explained by other results. The existing literature says that some proportion of personality differences are due to genetics, and some proportion by each of various environmental causes: parents, wealth, neighborhood, etc. But a significant amount of variation remains that isn't apparently caused by any of these. Her focal example is that even siamese twins have different personalities, and they share all of their genes, and all of the environmental influences that anyone could hope to treat as responsible.

Harris' conclusion (skipping over most of her argument for the moment) is that there must be something driving each of us to be unique, and that means we have to find a distinction to enhance. The bottom line is that a significant part of personality (who we are) isn't determined by factors that we can examine or control. Each individual starts out with an endowment of heredity, and occupies an environment that isn't fully under their control, but the developing personality is still a negotiation between that individual and their context. If the strongest part of their innate tendencies is best suited for a niche that is already filled, they will look for a second best. When two identical individuals struggle to fill the same niche, some factor (random or not) will eventually determine a winner in each particular event, and at some point the effects of competition, if nothing else, will drive them to exploit different strengths. The different choices and different results in competition will magnify any differences, and over a reasonable lifetime, they will become recognizably different people.

Along the way, Harris spends a good deal of effort (successfully) demolishing other possible explanations (differences in environment, combination of nature and nurture, gene-environment interactions, environmental differences within the family, gene-environment correlations, and transferability of learning between situations). At the end she argues that she has demolished all the other possibilities and provided an argument for the one remaining theory (an innate drive for status), and so it must be true. But her argument for the specific mechanism is a little too weak, and it seems plausible that some variation or related description will fit the data a little better. I'm reasonably convinced that something drives us to differentiate, but it may not be purely a status drive. Two possible variations on her theory include drives for attention or to master something.

I found the style of Harris' presentation sometimes compelling, and sometimes distracting. She fit the presentation into the framework of a detective story. The presentation is salted liberally with examples from popular detective stories to show how attentive the detective has to be to details that have distracted other investigators. This worked for me when I was familiar with the detective in question (Sherlock Holmes, Kinsey Milhone), and didn't work when I hadn't read the stories (Alan Grant). I suspect that Holmes is the only one of these that is widely enough known that other readers would feel that they should get the references even when they don't.

On the whole, I think the book was successful in explaining that fundamental differences in personality are effectively the result of an innate drive that causes us to differentiate. The drive makes use of arbitrary differences in the material it has to work with (genes and environment). Parents do make a difference in the lives their children lead, but the ultimate person each child becomes isn't determined by parenting style at any gross level.

Thursday, May 10, 2007

Safe Harbor for Prediction Markets

A group of distinguished economists wrote a public letter advocating a legal safe harbor for some small-scale academic prediction markets. I can see why they limited their goals as they did, and I agree that everything they advocated should be legal, but I think they may have limited their objectives just enough to prevent any big wins.

One thing that Prediction Market maven Chris Masse constantly argues is that Prediction Markets on dry subjects need to be accompanied by entertaining questions in order to to keep the audience's attention. The economists had good reasons for shying away from recommending that sports betting should be included, but there are many other topics that diverse markets could include that give traders a reason to check back in. The range from the obvious entertainment questions (movie earnings and oscar winners) to legislative outcomes (bills passing and control of particular legislative bodies) and introduction and market success of new technologies. While these kinds of questions might be out of place on some single-topic markets modelled after the University of Iowa's markets on elections, the internal corporate markets that they also mentioned often use them to help maintain interest. The letter's recommendations that the CFTC "allow contracts that price an economically meaningful risk or uncertainty" unnecessarily limits the kinds of contracts that would be allowed.

Back on the side of supporting the letter's authors again, I'd have to admit that if the CFTC or Congress acts to implement anything resembling the recommendation it would very likely increase Prediction Market activity greatly, and eventually lead to a broader acceptance. If the initial definition is too narrow, however, questions that don't have clear economic implications (in the view of Congress and the regulators) might be stuck offshore for a long time to come.

Friday, May 04, 2007

Helping People find Me

Every once in a while, someone contacts me and says they had been trying to reach me for a while, but had an old email address. Then I find out that the address they have is one I haven't used for a decade or more. Brian Warner suggested that people who have several old, defunct addresses should publish them on the web someplace where Google might find and index them, so people who still have the old address will be able to get back in touch. I set up such a redirector about a month ago, and my old addresses page now comes up as the first result for most of my old addresses. It hasn't yet succeeded in helping someone reach me who couldn't any other way, but it might soon, since some of the easiest places to find my name don't provide working addresses any more.

Wednesday, May 02, 2007

Cato on Employment Verification

Jim Harper of the Cato Institute testified at the House's Hearing on Proposals to Improve the Electronic Employment Verification System last week, and made some very important points about privacy and government intrusiveness. Here are some quotes. There is much more valuable material in the complete text.

[I]mprovements that prevent eligible citizens from working should not be adopted. It is more important that American citizens and eligible people should be able to work than it is to exclude illegal aliens from working. There is probably no way to change the current system so that it prevents more ineligible people from working without also preventing more citizens and eligible people from working. [...]

The policy that will dissipate the need for electronic verification by fostering legality is aligning immigration law with the economic interests of the American people. [...]

Because the I-9 process and employer sanctions seek to defeat their economic interests, the system has two principle opponents: employers and workers. It relies on them for implementation, though, which is why success has been so elusive and will continue to be. [...]

Let there be no illusion that people seeking redress for a "tentative nonconfirmation" from the Social Security Administration or the Department of Homeland Security will enjoy a pleasant, speedy process. [...] People will wait in line for hours to access bureaucrats that are not terribly interested in getting them approved for employment. [...]

Electronic verification would have far greater privacy consequences than the current system — and these consequences would fall on American citizens, not on illegal immigrants. [...]

Ironically, all of this government spending and expanded bureaucracy would go toward preventing productive exchanges between employers and workers. Taxes and spending would rise to help stifle U.S. economic growth. Astounding.