Showing posts sorted by relevance for query local maximum. Sort by date Show all posts
Showing posts sorted by relevance for query local maximum. Sort by date Show all posts

Wednesday, April 14, 2021

The Local Maximum Problem

Ever since being introduced to this concept, I’ve been intrigued by it and see examples of it more and more throughout life, business, and public policy. This is the problem that occurs when people get stuck in a situation that is the best near-term or near-possible outcome but is not the best possible yet reasonable long-term outcome. 

The analogy is to imagine four people playing a game that has them blindfolded and linked arm-in-arm in a square configuration. Each member of this team is responsible for one of the cardinal directions (north, south, east, and west). Their goal is to locate the highest point possible. They experiment by taking steps to see if a step in that direction is up or down. If the step is down, they don’t take it. If the step is up, they take it. They keep walking until none of the four can make a step that is in the upward direction. This point is the conclusion of their game by reaching the local maximum. However it is most likely not the highest point on the surface where they’re walking. They just can’t reach (or detect) a higher point by virtue of their own rules. 

I believe governments are particularly susceptible to this problem. The rewards for experimentation that drive one out of a local maximum are very dispersed or completely irrelevant to those bearing the costs of experimentation. This is more than just people not wanting their cheese moved or having their apple cart disrupted. This is the very legitimate concern that an ambitious idea is going to have significant negative outcomes or the potential rewards will not accrue to those bearing the risk. It is an acute combination of asymmetric risk-reward and principal-agent problems.

The many, many public and private failures in the COVID pandemic are vivid examples. Perhaps the most costly in the United States were the CDC and FDA's insistence on using their own developed testing (staying with the controllable and familiar) and as important if not more so the refusal to allow challenge trials to speed the vaccine development process. Sadly this list goes on and on from "pausing" the Johnson & Johnson vaccine to not approving AstraZeneca's. 

The position those in power have taken are understandable but completely inexcusable. And we have ourselves to blame as these mistakes are just the latest examples of how the FDA works against medical advancement and is a deep net cost to society. 

To be sure individuals, firms, and other organizations are also susceptible to the LMP. Notice, though, the degree to which these entities are somewhat or greatly better structured and incentivized to resist and correct it.  

As a general rule, the more insulated and protected an entity is from competition, the more vulnerable they are to a local maximum. Hence, traditional banks are more vulnerable than are start-up fintech firms. 

To whom a firm or organization is held responsive has strong implications for its fragility to local maximums. As a firm is more responsive to those who reap rewards proportional to risk taken, it will better prevent the LMP. Hence, non-profits (highly responsive to donors rather than customers) are more at risk than are profit-seeking firms (highly responsive to owners and customers). 

Within a firm the dominant force becomes existing and entrenched stakeholders who are in comfortable, conventional positions. Hence, no one in marketing will ever suggest the firm experiment by not running ads

The degree to which a person faces public scrutiny or cannot capitalize on public adoration, the more they will rest once finding the local maximum. Hence, a public figure with a lot to lose/little to gain will tend to play it safe. 

Risk bearing requires compensation in the form of return, and this risk-return should be commensurate, symmetrical, and willfully accepted. Those are tough hurdles to achieve. All the more so when we are relying on force rather than persuasion. 

P.S. I believe Arnold Kling deserves credit for introducing me to this concept.

Saturday, May 8, 2021

The Seductive Allure of Socialism

The more local something is the more essentially socialistic it becomes. I think the best way to describe this is that size/complexity has a positive relationship with the net benefits of the market (free market principles and market incentives, etc.) while size/complexity has a inverse relationship with the net benefits of socialism (yes, there are benefits). Simply put: the bigger or more complex something is, the more you want/need markets and not central planning to do the heavy lifting.

Intelligent people recognize that they know things and understand how to solve problems much better than most other people. They see this in action locally where it works or seems to at least. Thus, their belief is reinforced. This leads them down a bad path to an unreasonable conclusion that they can guide the world.

Keep in mind that what distinguishes a person as being "intelligent" can be local knowledge rather than pure IQ. Therefore, a local shop keeper may be orders of magnitude more intelligent about running her shop than would be a team of McKinsey consultants. 

Art Carden gives a model, salient version of this. For example, consider the family, the firm, and especially small and midsize towns. The local banking relationship in these places illustrates this nicely. 

The key skill of a banker today is not financial acumen. It was once upon a time at least to the degree of assessing credit risk. But large firms, algorithmic models, and risk spreading have largely supplanted that need. It is still important--vitally important for the bank itself--but it is not primarily dependent on the skill of individual banker. I believe financial risk assessment is a quality of secondary importance.

Rather the key skill of a banker today is relationship building. That is what makes a great banker. Hence, bankers are deeply involved in their communities. Again, this is not new, but it is now the primary attribute rather than a secondary one as it was in decades past.

It is strange then that a bank and its bankers, the stereotypical image of a capitalist (think of the board game Monopoly) are in fact the leading proponents of a road to local socialism. 

Here is how it unintentionally works. First, bankers are deeply interested in current customers' wellbeing and credit soundness. They have made loans, and they want them paid back. Second, they want to make future loans. These same customers would be the easy way to accomplish that goal. This gives them an all-too human impulse to favor the known and familiar as opposed to the new and (perceived) extra risky. 

Certainly bankers are interested in growth and new development. It is just that the unseen has a built-in bias against it. 

How is this a slippery road to socialism? I am not proposing that it formally leads to socialism, but it is central planning friendly. Most directly it runs the same risks of all central planning whether at the household, firm, or governmental level: decisions are made that suffer from the knowledge problem and are subject to the local maximum problem

Bankers are deeply imbedded within their communities for good reason: they want the business relationships and they want to stay close to the credit--all the better to monitor the risk. Yet this presents a sort of capture risk similar to formal regulatory capture. The bankers can easily be persuaded to support their customers' desires at the expense of their customers' competition. 

P.S. When I was in college I had a righteous disdain for kids wearing Che Guevara t-shirts, etc. They were "old enough" to know better. As the great P.J. O'Rourke explains, that is no longer true of kids these days, who are now the same ages as those who I rebuked back in the day.

P.P.S. Iain Murray's The Socialist Temptation explores this topic in depth. For a good discussion on it I recommend this recent episode of Jonah Goldberg's The Remnant

See this for more on the source for the above image and related story.

Sunday, May 2, 2021

Zoning Laws Suffer From The Fixed Window Fallacy

The Fixed Window Fallacy is an error in reasoning whereby people believe they know or can know what is nice/preferred/optimal. This line of thought is based on unimaginative, linear-thinking and further held back by the Local Maximum Problem

It can be summarized as a thought process that goes: "We know what is best. We/they can afford what is desired (after all, it is usually for our/their own good). Therefore, we should make ourselves/them provide it." 

Both premises are false, and the conclusion is fallacious (non sequitur) as it ignores the critical questions: do we have a right to do this, and can we successfully do this? 
The only constant is change, and it comes in two types. 
  1. Depreciation, which is the natural condition, difficult to counter, and mostly objective.
  2. Appreciation, which is the abnormal condition, difficult to achieve, and highly subjective. 
Attempts to stop depreciation such as zoning laws are never done in a vacuum. They are not single events where good replaces bad, and we move on to the next decision. They are part of economic evolution where decisions made affect trend trajectories with uncertain net outcomes and unpredictable magnitudes. 

Similarly collective action attempts to realize appreciation such as subsidizes for development and master plans are fraught with captured interest risk bringing asymmetric outcomes adverse to the presumed collective goal. In other words the rent-seeking developers and their friends in power do what is good for them and costly for society. For those cases where everyone has the best of intentions, we still have the knowledge problem. When artificial outcomes are engineered by those who do not bear the full risk, bad ideas do not get properly punished and good ideas do not get properly rewarded. 

Back to zoning, trying to stop people from doing things they want to do is prohibition. People and markets work to thwart prohibitions in proportion to how much they desire that which is prohibited. The less morally sound the prohibition, the less compliant are those working against it and those third parties who have no dog in the fight. Fortunately the long-term trend is for less and less prohibition. Unfortunately working against a prohibition is costly as is the administration of a prohibition. 

Whether it is in icky markets (e.g., sex work, recreational drugs deemed illicit, kidney transplants, etc.) or in we-know-better markets (e.g., zoning), an underlying force supporting the prohibition is not in my backyard thinking. In fact I believe NIMBY is the last vestige of prohibition rationalization.

Saturday, April 11, 2020

Who You Gonna Call? An Economist

If you had questions about the conditions of the local restaurant market, you wouldn't ask a chef or a restaurant manager.
If you had questions about the OPEC oil cartel or how it's actions affect the U.S. fracking industry, you wouldn't ask a petroleum engineer.
If you had questions about the affect charter schools have on education outcomes, you wouldn't ask a teacher.
If you had questions about the pricing and payment of medical services, you wouldn't ask a doctor.
If you had questions about fractional reserve banking, you wouldn't ask a banker.

Well, you might ask these people, and they might have brilliant, insightful answers. But if they did, it would be because they were using the tools and skills of economics. You might be better off just asking an economist--especially one with expertise in the specific area of interest.

Drs. Fauci and Birx are very important experts in immunology. Their understanding of infectious disease and their roles in the current crisis are keys to us conquering SARS-COV-2. But asking them when we should open society back up and revive the economy from the self-induced coma is likely asking them to speak outside their depth. I am not saying they are incapable of performing the necessary trade-off analysis, but if they are, it is because they will be employing economics not epidemiology.

Just as we did not prepare properly for a pandemic, just as we did not heed the warning signs as this one approached, just as we did not do the relevant cost-benefit analysis as decisions were hastily made and virally accelerated, I fear we are not willing to reasonably and scientifically consider, plan, and execute the return to normal life.

Reversing the lockdowns and shelter-in-place commandments should require us to consider the following at a deep level:

Benefit of reduced infection going forward minus Cost of change in way of life

What would we like to know includes:
  1. R0 - the rate of infection now and going forward (both the average and the distribution of typical people and super-spreaders); Robin Hanson's analysis shows the need for an even deeper level of thought. 
  2. How did R0 changed over time both as a result of human action and public policy as well as naturally?
  3. How many people were infected and when?
  4. How did the various policies impact viral transmission, viral impact (did putting asymptomatic infected people, mostly kids, in intense contact with at-risk people, mostly elderly, cause dangerously strong infections--dose makes the poison?), other health results, etc.?
  5. How did the various policies impact our way of life? Just how damaging were the policies and how damaging was the virus?
  6. What would we do different? How many lives on net did the actions taken save? How much was overall well being benefited by the actions taken? 
  7. How would we do it differently in the future?
At this point we don't really know enough to depict the overall tradeoffs and how the equation above would plot in the graph below.

The x-axis runs from maximum virus eradication (all resources thrown at fighting the virus, which is well beyond even the extreme measures we have taken so far) to not changing our lives one bit other than perhaps dealing with infections as they arise including hospitalizations and death. The y-axis is overall societal well being. In the middle is the point of well being that is equal to a world where there was no SARS-COV-2.

Is the trade-off function like one of the solid-line parabolas? Don't get too hung up on the lines I've drawn other than to notice that one is at times above the other. And of course choices we make could allow us to jump from one trade-off frontier to another. But notice the other two stylized functions. Perhaps the virus is so dominant that any effort short of total effort to counter it was a net loser for societal well being (as depicted in the red-dashed line). This is possible but highly unlikely. Yet this in the extreme is the position implied by many in the populace as well as some in power. Alternatively, the virus could be an unfortunate circumstance but not one that at any level deserves us changing our way of life (as depicted in the green-dashed line). This is also possible but highly unlikely. Yet this in the extreme is the position implied by those who might be labeled virus deniers.

We would expect, however, that some type of parabolic function if not one with multiple peaks would properly depict the real world tradeoffs. The devil is in the details, and which function and how we might transform the function to improve our lot is the many-trillion-dollar question. I would like to see it asked more strongly and widely, and I would especially like to see it asked of economists.