Able Archer

A gaping hole in philantropy (2)

2012-01-22T14:08:00.000-08:00

A great TED talk given by winners of the 2011 Google Science Fair shows that high school students can perform useful research if given the chance. These students were persistent and lucky enough to find a researcher who could give them access to a lab. Though it is difficult to know the exact number, a multitude of students must have given up before getting access to research facilities.

It is clearly not cost effective for individual researchers to give access to their lab to research savvy high school students on weekends, but society loses a great deal by not sponsoring these students.

Specialized schools in the fields of sports, ballet, music and theater exist already. Why aren't there any high schools which let teenagers do self-directed research in lieu of classes for half the school day?

Many parents already teach their profession to their children, but giving access to equipment and materials in the workplace is usually not possible. Now that the price of equipment has fallen enough for hobbyists to open labs such as Genspace, why can't specialized schools offer such equipment too?

Beyond Vouchers

2012-01-12T05:20:00.000-08:00

Charter schools and voucher systems are a good first step towards improving the teaching of a state mandated curriculum. However, many market failures remain in such a system. While competition between a few schools offers students choice, the overhead of changing schools or selecting a school which is farther a field makes the market work poorly. Most importantly, student utility (eg. pain and effort to achieve a grade) has very little weight in the selection of teaching methods.

In reality, the operation of schools has little to do with the success of its students: after all managing a building and administrating personnel is a commodity. What matters is the teachers. So why not have charter teachers, all in the same building, rather than charter schools? If there is some overcapacity of teachers, then the worst ones as chosen by the students would end up out of business. This would give students much more choice in the compromise between attaining the highest grades vs. the effort they have to put in.

Knowing how good a teacher is before taking his class is quite difficult for a student, and repeat business is not really possible given that teachers specialize in one subject and grade level. So charter based teachers suffer from some of the same problems as charter schools: by the time students have enough information to choose a teacher, it's too late -- they are already committed.

A solution to this information problem is to force each student to cancel exactly one class per semester at any time prior to the final exam. The worst teacher as judged by the students will be financially penalized for each student that abandons his class. The very worst teachers would abandon teaching altogether.

Whatever system is chosen to improve education, the student's preference for effort vs. grades should be fully internalized.

Making leisure pay

2011-07-27T15:26:00.000-07:00

The Bixi system in Montreal allows users to rent bicycles at stations all around town. It's popular but expensive: maintaining a Bixi bicycle cost around 3000$ per year, which is heavily subsidized by the city. Some opposition politicians suggest that just buying everyone a regular bicycle would be a cheaper alternative to Bixi, and accomplish the same congestion reduction and environmental goals.

There are often one or two broken bicycles at each Bixi station waiting for repair. Such repairs require paid staff to service the bicycles. The alternate solution would have owners of bicycles repair them on their own time. This is an example of how one method makes use of "work hours" to accomplish a task, whereas the other method makes use of "leisure hours".

While increasing the number of officially worked hours is not popular, making small changes could result in heightened productivity by moving tasks from work hours to leisure hours.

For example, the vast majority of state services provided for individuals could be offered outside of regular work hours. Very often, employees must take time off work to go to a clinic, to renew a passport, etc. Only offering these services on week nights and during weekends would increase productivity of those working in non-government service jobs.

Drugs and Drug Policy

2011-07-20T14:27:00.000-07:00

I'm currently reading Drugs and Drug Policy. I'm very impressed after two chapters: it's clear, accessible and well balanced. The lesson seems to be that decriminalization of consumption (not production) has little impact on prevalence, whereas retail prices have a huge impact.

I was disappointed to read that the authors do not believe in the legalization of the supply chain while maintaining elevated prices levels. Once the decriminalization of consumption becomes politically feasible, the supply chain of drugs that have a high markup could easily be nationalized.

In Quebec, decent quality alcoholic beverages are distributed exclusively by the government through the SAQ. The SAQ turns a decent profit with markups of two to one, and there is no large scale contraband of wine in Quebec. It should be trivial to run a similar organization for illegal drugs whose markup is significantly greater than two to one.

As an example, cocaine production costs around 1$ per gram; bulk cocaine smuggled across the border costs 20$ per gram, and retail cocaine is sold at 100$ per gram. I'm assuming that given current law enforcement spending, prices are close to as low as they can be to sustain contraband. Nationalized drug prices could be adjusted to prevent the bulk of contraband: in all likelihood that price would in the same order of magnitude as today's retail prices.

Nationalization does not seem to be a compromise at any level.

Unconventionnal tools

2011-07-19T18:30:00.000-07:00

Economists agree that increasing consumer spending is the most effective way to stimulate an economy out of recession or stagnation. Conventional tools (such as infrastructure spending) are both slow and inefficient. Letting politicians choose how to apply stimulus in recession years is like giving your child a credit card and sending him to Toys R Us. There must be a better way.

Why not give the Fed the responsibility to coordinate direct stimulus in addition to affecting the markets by buying and selling financial instruments? Specifically, the Fed could be given a stimulus fund worth 1% of GDP per year (from general taxation) to be sent to all citizens in the form of monthly cheques when the economy needs to get back on track. Or it could just be trusted to spend the right amount, and possibly need to be recapitalized using general taxation as is the case currently.

Learning to read

2011-07-10T11:41:00.000-07:00

Children watch DVDs over and over again (eg. Cars, The Little Mermaid). These DVDs come with subtitles. A computer program could be used to detect when each word in the subtitle is being spoken to either highlight the subtitle (like a karaoke machine) or place the word in a single frame (like subliminal advertisement).

I did some literature research but could not find anyone who conducted this experiment. It would be interesting to perform such a study with children and perhaps market the program afterward.

A gaping hole in philantropy

2011-06-16T10:03:00.000-07:00

It seems that improving K-12 education is a major philanthropic priority. However, much if not all of the effort is directed towards underachieving students. While addressing this issue is a noble objective, increasing the productivity of overachieving students is equally important in the long term, as improving research provides a boon to everyone 20 years down the road. Most important discoveries are made by people under thirty. Should that be restated as in the first fives years of research? If not, this opportunity should be exploited.

Setting the medical bar

2010-03-31T10:33:00.000-07:00

The soaring cost of health care as a percentage of GDP has forced public servants (and some private insurers) to make well researched decisions on what services should be covered based on health outcomes and costs. This research currently applies to procedures and medication.

Why aren't the same rules used to set the target cost of medical labor? Without resorting to government control of wages in the medical field, health regulators could increase the supply of labor by reducing medical schooling requirements, both in terms of difficulty and length. Doctors are likely overqualified today, in the sense that health outcomes would be sensibly unchanged if the medical education bar was set much lower.

Why isn't this issue at the forefront of all health reforms?

Weighing down on gold

2009-11-24T13:56:00.000-08:00

The marginal value of gold is held up by people who wear it as a status symbol. If the world population were to decrease or if the supply of gold were to increase, the market price would plunge due to the physical burden of carrying the gold on one's body.

As of 2008, 160000 metric tonnes of gold had been extracted. That's 50g per woman. I'd guess that at around 1 kilo per woman, the demand for gold would be very low. Who would want to walk around with paper weight dangling from their neck?

Quantified Smoking in Canada

2009-08-09T10:42:00.000-07:00

I have never smoked, I don't like to be exposed to second hand smoke, and find it unfortunate that a non-negligible fraction of women in my age group have taken up the habit. I'm also glad that smoking in most public places is not allowed.

Government intervention to prevent smoking in vulnerable groups (such as adolescents) also make much sense.

As per John Stuart Mill's "Harm principle", I think people should be allowed to do as they please, as long as they are not harming others too much; for example if they smoke at home or in a well ventilated area.

Smokers in Canada are getting a raw deal from the government. The least the government could do is give tobacco tax money back to them, possibly through prevention schemes. Here are the numbers:

A 1997 study conducted in the Netherlands showed that smoking reduces lifetime health care cost by 14%. In Canada, this means: $5170 * 80 years * 14% = 57904$.

A 2003 study conducted in the UK showed that smoking reduces life expectancy by 10 years. This saves 10 years worth of Old Age Security Benefits: 500$ * 12 * 10 = 60000$.

Finally, lifetime taxes on tobacco represent in Canada: 4.5B$ / (30M * 19%) * 50 = 40000$.

Under the current system, smokers cost the state 160000$ less than non-smokers during their lifetime.

$5170 = health care cost per person, per year (2008)
19% = ratio of population who smoked in 2007 in Canada.
80 years = life expectancy
80 years = life expectancy
30M = population of Canada (1999)
4.5B$ = tobacco tax revenue (1999)

World Government and Climate Utility

2009-08-09T08:03:00.000-07:00

Futuristic shows always depict Earth as being ruled by a single world government with sweeping powers. It's fair to say that we are not there yet, not even close. Currently, socialist countries hypocritically embrace wealth redistribution through taxation for the well-being of the poor in their country, yet feelings of sympathy for fellow humans across our national borders are insufficient to mandate sending them our tax dollars in any significant amount.

In fairness, some aid is given to poor countries, especially those who have suffered a natural disaster and were fortunate enough to get media coverage -- thank God the 2004 tsunami didn't occur on August 28th 1996. But this is merely "lets feel good about ourselves" aid, for it is nothing but pocket change in the budget of developed countries.

It's obvious that taxation for the purpose of wealth redistribution should be done worldwide, not at the national level, if fairness is a principal concern. The democratic world chooses not to be fair in this respect, for better or for worse. The discussion about why this is, and about the optimality of the current state of affairs is quite complex -- I will spare you. One thing is clear: national sovereignty and self-interest is how humanity has always worked, is our basis in law and here to stay.

This brings us to CO2 emissions and concentration within the atmosphere. It's debatable how much greenhouse gas in the atmosphere is the optimal amount. Some countries may benefit from a warmer clime, while others will lose out. Even if geoengineering the Earth's climate to reach this optimal weather pattern becomes possible, properly accounting and trading climate utility between nations is an intractable problem. If climate utility trading is not an option, we could simply choose the fair amount, which is the concentration before the industrial revolution (280 ppmv -- in effect the status quo).

In reality, we will end-up with a political amount and some arbitrary settling of climate utility, which will be based on guesswork and pandering. That's life. But the fairness problem does not end there.

It's overwhelmingly likely that the chosen political amount of greenhouse gas in the atmosphere will be higher than today's levels. This concentration will be reached rather quickly, at which point the Earth will have to become carbon neutral. Then on, all countries will have to become carbon neutral, meaning that they remove as much carbon from the atmosphere as they emit (through trading or otherwise). Even with very clean electricity generation, we will always emit a good deal of CO2, so reducing emissions to zero is unrealistic. Unless esoteric geoengineering techniques become available (such as ejecting CO2 into space), the only way to reach neutrality is by increasing biomass or depositing calcium carbonate in the oceans.

How should countries trade this natural resource? Changes in land biomass can be directly charged or credited to the land owners. As always with natural resources, countries with more landmass reap the greatest benefits. Who should own the remaining atmospheric storage capacity? A case could be made in allocating the storage capacity per surface area, as we currently do with airspace.

The biggest CO2 absorption and storage prize comes from the ownership of the oceans, as these have the most CO2 absorption capacity (deposits of calcium carbonate) and atmospheric storage capacity (due to the huge airspace above them). Unfortunately, no one owns the oceans, and this has led to tragedies in the past: blue fin tuna, codfish and corals can attest to this. So how do we divide up the oceans' natural resources (fish, CO2 capacity, oil, etc)? Here are a few options.

1. A war, winner takes all.
2. Increase the territorial water range (from 200 nautical miles), until all water has been allocated.
3. Give international waters to a newly created "World Government".
4. Split the oceans into small blocks, and divide ownership of each block between countries based on population.
5. Split the oceans into small blocks, and divide ownership of each block between countries based on land area.

Option 1 has no basis in law but has occurred very often in history.

Options 3 and 4 split the wealth evenly between persons across the world. This has no basis in law and has never occurred. It goes directly against the national sovereignty and self-interest that the developed world is structured around.

Options 2 and 5 have the most basis in law; they have occurred frequently in history. When natural resources have been discovered (think of oil as an example), all nations have complied with sovereignty rights based on previously accepted geography. India didn't claim a right on Russia's gas resources, despite the asymmetry of population and land area.

Natural resources have never been distributed fairly. Those who argue for splitting CO2 assets based on population should also be arguing for worldwide wealth redistribution through taxation and splitting of all natural resources per capita. That's a big step, and deserves some thought. However, piecemeal implementation of such a world makes no sense on its own.

Note: this debate is framed around CO2 emissions because this is how it is portrayed in the media. The actual issue is climate utility, which we can control through geoengineering. A country which grows white vegetation can reflect a good deal of sunlight into space, thus reducing temperatures in the same way as a country which increases it's biomass and removes CO2 from the atmosphere.

RRQ Annuities are Unfare to the Poor

2009-07-29T11:17:00.000-07:00

Life insurance companies are now offering "Lifestyle Annuities", for which the life expectancy of the annuitant is adjusted based on lifestyle choices (smoking, obesity and known health issues). For smokers in particular, this represents a significant decrease in premiums.

Unfortunately in Quebec, the government manages the pension scheme during both the contribution and retirement phase. Their meager return on investment is a burden shared by everyone, so at least it is fair; however, subgroups of the population (especially poor citizens) have a lower life expectancy due to correlated lifestyle choices. Because annuities only reflect the age of the contributor (not lifestyle choices), poor citizens are getting a particularly raw deal from the RRQ program. They should have the right to buy a private annuity with the funds they accumulated in their RRQ account over their lifetime. This would give them substantially higher monthly income.

Caloric Restriction in Rhesus Monkeys

2009-07-25T11:08:00.000-07:00

This image shows salient anecdotal evidence of the effects of caloric restriction in rhesus monkeys after 20 years of elapsed time.

This paper contains convincing scientific evidence.

Throwing money at the problem

2009-07-18T12:43:00.001-07:00

Eating well is difficult. Enough said.

Abstinence under temptation, cooking a single meal for multiple persons or choosing well in advance what one will eat all bear significant utility cost.

Similarly, properly measuring and accounting for all food intake is tedious and time consuming.

The solution to all theses problems? Open a healthy food only restaurant in the vicinity of your house. This solves the in your face temptation problem, although you may lose a few friends along the way. Using terminals as menus automates accounting and allows patrons to make informed decisions on RDAs and energy intake. Delegating tedious measurements to others in the kitchen makes the overhead bearable. Having many patrons allows stocking fresh/perishable foods in an economical and socially acceptable manner (low stock turnover results in waste). It even allows custom products to be developed, such as low alcohol beer or wine.

Costly regulations

2009-07-16T12:19:00.000-07:00

Getting my blood tested for IgG avidity: 31$.
Getting the test authorized by a doctor (this is mandatory in Quebec): 225$ + two hours of my time.

My love for regulators just keeps on growing. On days like theses, I feel irrevocably libertarian, and start to wonder how inefficient the world is becoming.

Problems with Paygo

2009-07-07T06:31:00.000-07:00

It seems difficult to prevent a politician with a surplus to do anything but spend it. As a result of such spending, California is about to default on its debt. The few politicians who choose to cut taxes or repay government debt -- and thus create little new spending -- end-up being rather unpopular.

It would seem that capping government spending increases to long term GDP growth makes much more sense than just forcing the government to balance the budget each year.

Baffled by tobacco

2009-06-13T13:57:00.000-07:00

A thought struck me today as I was walking down St-Denis street, seeing all those smokers huddled on terrasses. How did governments across the world manage (politically) to revoke such an in-your-face right from a very high percentage of the population? Normally such a move is political suicide.

Perhaps many decades of negative publicity got the best out of smokers.

I also find it odd that smokers have not successfully contested taxation of tobacco, since smoking has a positive externality on the bulk of society (people dying quickly after retirement consume less state sponsored resources). Even adopting a paternalistic point-of-view, all taxation of tobacco should be given back to smokers in one form or another, not redistributed equally to everyone.

It's time for a single, all-long market

2009-03-20T15:25:00.000-07:00

The time for regulation and nationalization of many activities is upon us. An overlooked market that deserves nationalization is that of all-long trades, where no credit risk is born by the exchange. Private exchanges for trades of shares have become affordable, though they remain oligopolistic (ie. they are still charging too much). Other forms of trades remain very expensive: currency and bond trades are a good example of this.

The logistics behind an all-long trading platform have become trivial and cheap because of the advent of computing. I would suggest that two all-long trading platforms be created and maintained: one by the US and one by the EU. The platforms would be all electronic and would be offered to everyone. Obviously only very liquid securities with large capitalization would be traded on these platforms. Trade costs could be kept very low (0.01$) and fractional ownership of securities should be allowed.

Banks would no longer be able to charge disproportional fees for currency transactions. Low transaction fees and fractional ownership would render many ETFs obsolete, saving carrying costs.

Fair Accounting of Capital Losses

2009-02-18T19:09:00.000-08:00

As previously posted, fiscal laws are messy. Not only that, but some are unfair in the sense that they penalize low-income taxpayers. Capital losses are a very good example of this. Using the settlement method (which is the standard method used to calculate capital gains and losses on shares in Canada), the value of securities is only taken into account when an individual executes transactions. Though this method has the advantage of being very simple, minimizing tax liability with it requires a crystallization of losses through actual transactions. When dealing with shares, such transactions cost about 20$ per security (plus management fees).

Individuals with valuable portfolios can crystallize losses on a daily or monthly basis, maximizing their capital losses at all times, whereas their poorer compatriots can't afford 20$ per crystallization (this number may seem low, but someone who owns many different securities will see the 20$ multiplied by the number of securities that he holds).

Since market data can easily be collected for actively traded securities, I would recommend amending the capital taxation laws so that losses are automatically crystallized without needing to sell and buy back the securities for any holding of less that 0.1% of the outstanding number of that security. An even better method would be to bring transaction costs down to 0$, but that's more complicated.

Keeping USDs on Income Account

2009-02-18T18:25:00.000-08:00

Fiscal laws are always a mess. In Canada, superficial loss and stop loss rules make them even more so.

Upon selling a property, the taxpayer always has a taxable gain or loss. This allows the taxpayer to choose which instruments he wants to sell in order to defer taxable gains for as long as possible. For very liquid instruments, transaction costs involved in selling and then immediately buying back instruments are low. This allows taxpayers to crystallize losses when instruments are trading at a low value.

The Canadian government tried to somewhat patch this loophole by enacting the superficial loss and stop loss rules. In short if you buy back the same instrument within 30 days of selling it, the loss is denied, but can be claimed when the instrument is sold later on. Gains are always taxable immediately.

It was easy to get around this rule by having an affiliated party do the buying: your spouse, your RRSP, your trust or your company could be the other party. These loopholes were patched as well: any affiliated party that buys securities sold within +/- 30 days also triggers the superficial or stop loss rules.

When the selling party is a physical person, the denied loss is transferred to the affiliated person. When the affiliated person sells the instrument, he can claim the loss. When the selling party is a moral person (RRSP, trust or corporation), the loss stays with the seller. It can be claimed by the seller only when the buyer disposes of the security.

This rule is particularly unfair when a person sells an instrument at a loss and buys this same instrument within his RRSP. The loss is transferred to the RRSP, but since the RRSP does not pay any taxes, the loss cannot be claimed against any gains. Worse yet, it's not possible to transfer the loss out of an RRSP, since the RRSP is not a physical person.

Though it's a logistic burden, it's very easy to hold different instruments in RRSP and non-RRSP accounts. The one instrument which is very likely to be held in both accounts is the USD. You can't get around holding cash when trading stocks! So any foreign exchange losses resulting from USD trades have a tendency of being transferred to an RRSP and die there!

Well, there is good news on this front. One can elect to place a given instrument in the income account forever. That's right, once you've elected to hold USD in the income account, you can never bring them back into the capital account. Superficial loss and stop loss rules don't apply to property held in the income account, for some obscure reason. The downside is that gains are taxed as income rather than as capital (at full rate rather than half rate). The upside, is that losses can be applied against other income including salary at the full rate (rather than not at all). Since foreign exchange fluctuations have an a priori expected value of zero (as compared to shares or bonds which nominally increase in value over time), holding USD in the income account results in a better hedge than holding them in the capital account! When factoring in utility, there is absolutely no reason to hold USDs in the capital account. Thank God!

The Externalities of Speed Limits

2008-10-26T11:17:00.000-07:00

Speed limits on highways are setup to reflect externalities linked to damage caused by accidents (affecting other drivers' cars and bodies). Clearly a balance must be struck between the frequency and severity of accidents, and efficiency of transits. Given that not all transits bear the same costs in lost time, properly matching the cost of going slowly with the harm caused by accidents requires some form of adaptive pricing of speed.

If cars were equipped with some form of time, position and speed tracking device (a GPS), the cost of causing accidents could be adjusted based on actual risks measured in recent years. With basic statistical methods, we easily could account for weather, time of day, moose activity, traffic conditions, etc. With enough data, prices could even be adjusted based on the type of vehicle (4x4, car, truck) and the driver's history.

When you are really in a hurry, you won't mind paying the extra 0.20$ per kilmeter to drive at 130 km/h. To make the scheme revenue neutral, slow/safe drivers should actually be paid to compensate them for the risk they are taking sharing the road with their speedy neighbors.

US unemployment will be 6.6% by June 2009

2008-09-17T06:04:00.000-07:00

I recently fell upon a blog that was arguing for the link between new housing starts and unemployment. He showed a graph that looked a lot like this one:

I tend to be very skeptical when people find correlation between two sets of data, but it turns out that housing starts are the real deal. Not only do housing starts correlate well with the unemployment rate, but they are that rarest of animals: a reliable leading indicator. The number of new housing starts can predict 40% of the variation of the unemployment rate 10 months ahead. More specifically, you can predict the unemployment rate 10 months ahead using the following equation:

UE = (2520 / HS) + 3.71

The following graph shows the predicted unemployment rate and the realized rate:

Given the data just released of the number of new housing starts at 854 for August, this predicts an unemployment rate of 6.6% for June 2009. The pain isn't over yet.

Side note: I would have assumed that the absolute number of housing starts would have trended up over time as the population increased, but this hasn't really been the case. I'm guessing this is for demographic distribution reasons: the number of young families buying houses has stayed more constant than the total population.

How low should it go?

2008-09-16T04:56:00.000-07:00

Following the collapse of Lehman Brothers and the quasi-collapse of Merril Lynch yesterday, the S&P500 went down 5% and closed at 1192, its lowest level in almost 3 years (it was 1178 in October of 2005). How close are we to the bottom?

Recent history offers us one comparable benchmark: following the tech bubble, 9/11 and Enron and WorldCom accounting scandals, the S&P500 finally bottomed out at 776 in October of 2002. If we assume for the sake of simplicity that all recessions/financial crises are of equal severity (obviously false, but it's the best I can do given no other way to quantify them), then one easy target would be for the S&P500 to eventually hit 776, another drop of 1.54 times.

But the index is a nominal value, which should at the very least be adjusted for inflation. The CPI in October 2002 was 180.7 and is now at 220, so we should at least adjust the index to 945.

The S&P500 divisor has also gone down in the last 6 years, as companies have bought back shares with their considerable earnings. The divisor has fallen from 9.221B$ to 8.72B$, a decrease of 1.057 times. So the adjusted S&P500 value is now 999.

Lastly, the GDP has increased. Folding together the GDP increase and CPI, we see that nominal GDP has increased from 9.25T$ to 12.64T$, an increase of 1.366 times. 776 * 1.366 * 1.057 = 1120. This would match the lowest market cap / GDP ratio since 1996.

Bottom line: if you truly believe that this crisis/recession will be as bad or worse as 2002, we're not at the bottom yet. Don't jump in before 1120.

Subsidized Education Arbitrage

2008-08-24T14:45:00.000-07:00

Many university degrees lead to either a career in academia or in the catering business (philosophy and physics come to mind). In Canada, education is heavily subsidized, which leads to an unusually large pool of highly educated unskilled labor.

Many degrees require grueling effort for many years in fields that have no commercial application whatsoever. Diplomas in these fields are void of "know-how" value for employers, but they should bear the same "sorting effect" value as their counterpart in applied fields (like engineering). So by comparing the wages of physics majors and engineers in the industry, it should be possible to split the value of the "sorting effect" from that of scholarly knowledge.

Then again, the labor market is not very liquid (ask any HR person to describe the "sorting effect" and you'll see what I'm talking about), so an arbitrage opportunity may exist for those employer smart enough to exploit this inefficiency.

Liquidity in the meat market

2008-08-10T16:12:00.000-07:00

I was having breakfast this morning at a restaurant where two servings of meat were offered with eggs and toast (the norm is one serving). The choices were bacon, ham and sausage. Out of the three, I personally prefer bacon, so I ordered two servings of bacon. Yet in the small survey of other patrons that were in the restaurant at the time, everyone ordered two types of meat. Apparently my stomach and taste buds form a much more liquid market (for bacon) than that of others. Or perhaps some other effect is going on here.

Education Hedge

2008-07-21T10:31:00.000-07:00

Reducing the number of drop-outs is a very common objective of education reform. Yet, no matter which novel program is chosen, dropping out below a certain age is impossible. Rather than trying to reduce the drop-out rate, shouldn't we focus on making those who drop-out employable?

Most jobs require only good reading and writing skills, and very little math, science, economy and history. So why don't we teach only reading, writing and simple arithmetic until a decent, employable level is reached? Such a target should easily be achievable by age 13, when dropping-out becomes an option.

Perhaps by then the really boring subjects (reading and writing) will have been learned, and the basket of subjects remaining will be sufficiently interesting to prevent most drop-outs from occurring.

Demographics and Groceries

2008-06-29T14:15:00.000-07:00

Yesterday my family threw a party for my 30th birthday. At age 80, my grandmother was present both in mind a body, which I find impressive. During dinner, we discussed how trips to the grocery store became more frequent over the years. Apparently one visit a week was the norm in the 50s and 60s (Thursdays evenings), whereas today I keep less than a day of inventory in my cupboard. How could this be?

I first thought that perhaps the cost of going to the store was higher (maybe gas was more expensive). But what caused the changed in habit is family size: I live alone, whereas my grandmother had a husband and three children. Assuming that the utility of a given meal type varies randomly in time (today I want chicken, but I can't predict what I will crave tomorrow), the advantages of preselecting a meal becomes diluted as the number of mouths who will be fed increases. In fact, when one is alone and choses his meal a few minutes in advance by going to the grocery store right before dinner, the cost of imperfect selection is always zero: you choose what you want. Whereas when a couple goes to the grocery store right before dinner, one person get to eat what he wants, and the other will have to tag along for a sub-optimal meal. Thus, given a large family size and a single meal, it becomes impossible to tame the cost of imperfect menu selection. Buying the food just-in-time only helps out one person.

By analyzing the distribution over time of meal preference, it is possible to build a pleasure cost model for couples. To lower the cost, you need to have overlapping preferences, and the distribution should be as flat as possible over time. Otherwise you may have to cook two meals at once.

More debt?

2008-06-24T07:11:00.000-07:00

I recently came across a 2007 editorial by investment adviser Kenneth Fisher whose main thesis is that people are far too worried about the US federal government’s debt.

http://www.financial-planning.com/asset/article/528151/learning-love-debt.html

He put forward many arguments on why this is so, most of which I disagree with, but I shall concentrate on the one that stuck out at me the most. I will quote the full paragraph to ensure I am not misrepresenting what he said:
“Is the U.S. over- or under-indebted? Since we have total assets of about $120 trillion (according to the Federal Reserve Flow of Funds Account) and a GDP of $13 trillion, our return on assets is 11% after taxes--that's very high. A current fair estimate of borrowing cost is about 6%, or 4% after taxes--much less than our return on assets. We're not over-indebted. Instead, we're falling far short of profit maximization--immorally so!”

This is blatantly wrong, though it is not obvious at first blush why. There are at least 3 major reasons why this argument is incorrect even though the numbers may be good:

1) ROI can’t include the share of labour. $13 trillion of GDP is being created with assets of $120 trillion AND the labour of roughly 150 million people. The aggregate wages of all employees in the United states were tagges at $7.4 trillion in 2006 (when the GDP was roughly $13 trillion). “Net operating surplus”, all the returns due to capital, was $3.2 trillion. So roughly 70% of GDP is due to labour and 30% is due to capital. So the return on assets isn’t really 11%; it’s more like 3.5%, which suddenly makes it a lot less interesting that it used to be.

2) The interest rate shouldn’t equal the total Return on Assets; it should equal the marginal return on assets. Obviously I don’t know what this is, but I do know that it is significantly lower than the total return, since the marginal return always goes down with each extra dollar invested (or somebody made very bad investment decisions initially).

3) This assumes that US government debt is used to finance capital which will be used to grow GDP and to increase effective standard of living. But this simply isn’t the case: most of the government’s expenses go to military expenditure, entitlement programs such as Social Security or Medicare, or debt interest payments. None of these is truly capital investment.

The optimal level of debt of a country depends in large part on what the debt is being used to finance. Debt used to finance infrastructure such as roads, power stations or research (yes, research produces capital!) can be defended up to a point, but debt used to finance consumption is silly, mortgaging future generations’ standard of living in favor of those spending today. If that’s what you’re pushing, fine, but call it what it is.

The Politically Incorrect Triumph of Western Civilization (part 5 of 5): Conclusion

2008-05-29T11:54:00.001-07:00

The next time you read about a primitive culture that sacrifices virgins to appease their gods, you may reflect that we were once no different, or you may crack a smug smile, thinking how much smarter and more evolved we are. Both these reflexes would be correct, but not for the most obvious reasons. Our society has evolved to better values, but not because we are inherently better. We are simply lucky to live in a place and time where human morality and institutions have advanced.

This leads us to the politically incorrect conclusion that today’s Western society is a superior society to live in, both better than itself several hundred years ago and better than other societies on Earth today. Refusing to acknowledge this is tantamount to saying that the lives of people in other countries are inherently less valuable or important than those of western citizens, and so it doesn’t matter if their rights are violated. If you truly love human freedom and liberty, it is your duty to uphold them everywhere.

The Politically Incorrect Triumph of Western Civilization (part 4 of 5): Modern Times

2008-05-29T11:53:00.000-07:00

Western Civilization has also adapted itself as times have changed. Initially focused on laissez-faire capitalism, the Great Depression brought about a change in the “default” mode of operation of a Western Government, introducing the concept of the welfare state, as Franklin Roosevelt added “freedom from want” and “freedom from fear” to the basic freedoms to be enjoyed by humans everywhere.

The genius of liberal democracy has been to combine the two kinds of freedoms important to human well-being and happiness: political freedom and economic freedom. True political freedom is a relatively recent innovation, since most societies throughout history had some form of monarchy or autocracy and severe restrictions on freedom of speech, but it is essential to advancing the marketplace for ideas. Political freedom includes social freedoms such as the right to privacy, freedom from arbitrary search and seizure, and the right to assembly. Economic freedom gives people an incentive to hard work and has proven to be the best way of raising the human standard of living: China has become immensely richer over the last 30 years by embracing the market, as has every successful nation before it. By helping out the worse-off, social democracy also helps to equalize opportunity for all, an essential ingredient of true economic freedom.

Ironically, those most willing to tout the superiority of Western Civilization, modern conservatives, are those least likely to insist on the things that make it unique. They are more likely to push the value of the Judeo-Christian faith, rather than the religious tolerance and appeal to reason that has made the West so special and successful. They have constantly pushed back on rights for minorities, women and gays, even though the respect and expansion of individual rights has been the major difference between the West and the rest. And they are involved in embarrassing denials of science such as teaching creationism in schools and refusing the reality of global warming, which fly in the face of our most up-to-date knowledge.

On the flip side, modern liberals are guilty of two sins. The first is to choose idealism over pragmatism, seeing the state as the solution to all woes even though history speaks strongly to the contrary. The history of the 20th century shows quite well that strong states, be they socialist or nationalistic, quickly descend into totalitarianism. This is not just due to a couple of bad apples: it is the nature of the beast, what Hayek called “The Road to Serfdom”. The other is to refuse to pass judgment due to moral relativism. Female genital mutilation cannot be excused as “just a primitive tradition”, and dictatorial Asian governments are not simply upholding Confucian values. The sins of the West, from the Holocaust to Hiroshima to Guantanamo Bay, are no retort: even though our society does not always live up to our values is no reason not to uphold our values.

There is nothing inherently special about western culture that allows it to support these ideals: it is foolish to think that Chinese or Arabs are incapable of liberal democracy. If Christianity is the key, why did it take 1800 years for a true democracy to emerge in the West? How has India managed a vibrant democracy for the last 60 years, despite widespread poverty and a melting pot of cultures and religions? How did Japan beat the west at its own capitalist game? The West just got there first, probably by accident of history. But the values are universal, and can be promoted as such.

Societies cannot undergo these changes overnight. Today, there is a strong tendency to push for elections in foreign countries, assuming that this will lead to democracy taking root. This is like planting a seed in a concrete floor and expecting it to grow. Liberal democracy requires many ingredients, including an educated population, strong institutions, and sources of information independent of the government. It took the west centuries to get here: there have been dictatorships in the last 60 years in Germany, Spain and Greece, and even today terrorism and security are used as excuses to curtail civil liberties. Worse yet, western countries have been hypocrites in foreign lands, toppling governments and installing pro-western dictatorships because it suited their economic needs or they wanted to combat communism. But the change can take place, and it is worth undergoing. Economic freedom can lead to political freedom, as the recent transitions of South Korea and Taiwan demonstrate, and as China will demonstrate sometime in the next 100 years. The natural state of people is liberty.

The Politically Incorrect Triumph of Western Civilization (part 3 of 5): Religion

2008-05-29T11:52:00.000-07:00

Many have credited the advance of Western civilization to its Judeo-Christian heritage, and there is no question that the history of the two is inextricably intertwined. But most of the progress of Western Civilization over its impressive 300 years has occurred when it has distanced itself from the church: truly representative government could not emerge until the separation of church and state. One of the great philosophical advances of the Enlightenment was that morality could be arrived at through human reason, not only by divine decree, which has allowed values to progress beyond those of the Torah and the Bible. Religion has stood in the way of almost every major discovery that has advanced our knowledge of the world, including Copernicus’ heliocentric model, Galileo’s astronomical observations, and most memorably the theory of evolution that has explained the origin of mankind. Even today, religious conservatives still fight to keep evolution out of classrooms, on the basis that it contradicts religious doctrine.

Religion has been more helpful on the front of values: the first people who lobbied for the abolition of slavery were driven in large part by their faith, believing that no such treatment of human beings could be morally justified, and charity towards the less fortunate has almost always been spearheaded by faith. On the flip side, the Catholic Church in particular has often been an obstacle to the equal rights of women, despite Christians’ constant claims that “Jesus hung out with women”.

One of the biggest contributions of religion to western values has been accidental: the wars of religion in 17th century Europe, and the fact that the American colonies were largely populated by people fleeing religious persecution, taught those people the importance of the separation of church and state and religious tolerance. This has been a key ingredient in creating a society that has been a magnet for the best and brightest from all over the world, which has helped it maintain its economic and technical edge.

The Politically Incorrect Triumph of Western Civilization (part 2 of 5): Origins

2008-05-29T11:50:00.000-07:00

The ideals that have led to modern Western Civilization have their root in the Enlightenment. Many great thinkers such as John Locke, John Stuart Mill, Thomas Paine and Voltaire established the bases of what is now known as classical liberalism, stressing the importance of individual freedom and natural rights. These thinkers were the inspiration behind both the American and French revolutions, and the framers of the US constitution which began with the most important phrase in the modern world: “We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty and the pursuit of Happiness.” As history shows, the practice didn’t follow the theory: both blacks and women didn’t achieve truly equal rights until the 20th century, but the cat of freedom had been let out of the bag, never to return.

At around the same time, another parallel revolution was taking place: the industrial revolution, which brought about a huge increase in economic growth and reorganized the economy around a capitalist market. Only a few years earlier, Adam Smith had just written “The Wealth of Nations”, and his ideas were about to be put into practice. A functioning market economy is yet another innovation of the Western world.

These two institutions – liberal democracy and the capitalist market – have been the twin engines of western domination over the last 300 years. They give legitimacy to the government in its people’s eyes and give people ownership of the fruits of their labor. They entrench the fundamental rights of human beings in the institutions of society.

The Politically Incorrect Triumph of Western Civilization (part 1 of 5): Introduction

2008-05-29T11:48:00.001-07:00

Of all the views that modern leftists have been accused of holding, few are as problematic as that of moral relativism. Moral relativism is the position that ethics do not reflect objective truths, and therefore that there is no true right or wrong. There are many problems with this position, one of the major ones being that nobody really believes it. While there is a solid case for cultural relativism (seeing other cultures, religions or traditions as being as valid as one’s own), no one would look at a society where murder, assault and theft were rampant and assume that it’s “just another way of doing things”. There are certain values that are objectively better than others. Freedom, caring and equality are better than slavery and destruction. A society that works to the benefit of all its members and provides security is better than one in which the few may exploit the many and people fear for their lives. There is no way around it.

Of all the societies and civilizations that have emerged throughout history, the Western Civilization of the last 300 years is the one that has embodied the most evolved and progressive values. This has not been, by any stretch, an unblemished record: dozens of wars, the Holocaust, and slavery have all been products of the Western world, to its shame. But it is the first society to have organized itself successfully based on the universal guiding principal of human behavior, the Golden Rule. Among the concepts we owe to Western Civilization are the freedom and dignity of the individual, freedom of religion, equality of all people, gender equality, property rights, free markets, judicial independence, liberal democracy, the power of human reason, and the separation of church and state. Not a bad list.

Buy Local, Quantively

2008-03-11T11:19:00.000-07:00

This is a follow-up to a previous post. Buying local products has always been popular: we should encourage thy neighbor and help save the environment by reducing transportation. Encouraging thy neighbor does not make much economic sense though, since doing so generally increases living expenses. However, due to the taxation of income, helping thy taxation neighbor really does help us financially through the coffers of the state.

When you buy a product, a seemingly useless label tells you where the item was made. Why not state the tax that was received by each level of government in making the product? I'm not taking about sales taxes (which are uniform across all products), but rather in the complex set of dividend, capital and employment income tax collected in the manufacturing and delivery of the product.

For example, a Volkswagen car made is Brazil barely contains any Canadian capital & labor (say 10%). But a Toyota built at the Cambridge (Ontario) plant contains much more Canadian capital/labor (say 50%). So an Ontario resident gets 25% (tax rate) of 50% (car value generated in Ontario) back in taxation when he buys a Toyota, whereas he would only get 25% or 10% were he to buy a Volkswagen. Saying that the Toyota is 10% cheaper than the Volkswagen because of taxation is only partly correct, because if we were to not buy the local product, the Canadian capital used in making it would be re-allocated (with some loss) to another sector.

By using the capital reallocation loss instead of the percentages above, it would be possible to show the tax contribution behind the purchase of a local product over that of a foreign product. Rational consumers should consider this percentage like a "mail-in rebate" that they are getting statistically when buying the local product. Like many situations, the system only works well if everyone abides by the buy local rule; if everyone but one person buys local, then that black sheep is getting a cheaper product and almost all the tax benefits of buying locally.

To fully account for this externality, it makes sense to impose subsidies/tariffs on products that reflect the local capital reallocation costs to achieve maximum economic efficiency.

Am I actually saying this? Alternately, having either no local capital, local capital that can be reallocated with no loss, or no taxation proportional to the value of local capital (ie. a head tax) eliminate this messy problem.

The Legacy of Paper

2008-03-11T09:14:00.000-07:00

A major misconception in the workings of monetary systems is that non-interest bearing paper money must exist. As a substitute for fixed denomination paper money, we could trade using only variable interest-rate perpetual bearer bonds bound to the fed funds rate.

A key advantage of such a system is the possibility of imposing negative interest rates, preventing the "money under mattress" harmful effect of deflation. Thus a target of extreme price stability becomes possible (near zero percent inflation) without the risk of triggering a deflationary spiral (as occurred in Japan in the 1990s). It is unclear what the inflation target would be for optimal economic growth in this system; I would assume somewhere between 0% and 2%.

The switch from cash to variable interest-rate bonds is very easy to do: on January 1st 2009, all US paper currency in circulation could be automatically converted into interest bearing bonds. Thereafter, cash can only be held in electronic form in bank accounts managed by the Fed. The interest on all electronic deposit accounts would be very close to the fed funds rate, otherwise one would prefer holding variable interest rate paper bonds. Financial institutions outside the US electronic banking system could only hold paper bonds; they could no longer hold paper cash, since all US cash must be electronic and interest bearing.

Each variable interest rate bond, regardless of the emission date, would simply bear the January 1st 2009 cash equivalent denomination. The price of goods quoted in this bond's denomination (rather than the current cash denomination) would generally deflate over time, as interest rates are usually positive. The price of goods quoted in electronic cash denomination would follow the current trend, slowly inflating over time.

Since prices would be primarily denominated in electronic cash (as is done today), transactions executed using paper bonds would need to be adjusted using cumulative fed funds rates. In such a system, electronic cash accounts would be preferable, avoiding the tedious currency conversion. Persons who require anonymity in money transfers could still trade bearer bonds anonymously, but would need to be good at multiplying by a fraction. You could then tell your kids: "Timmy, if you want to be a mobster like M. Soprano, you'll need to get better math grades!"

In your face socialism

2008-03-10T09:46:00.000-07:00

Billing people for government services without actually charging them anything much allows them to adjust their behavior in order to minimize the cost they impose on others. Right now it is very difficult to asses how much my choices (going to the doctor, going to school, etc) cost the government and my fellow tax payers.

Unenforced moral behavior tends to be quite popular in North America: recycling is a good example. Were the government to pay for 99.9% of all services you use, and thus bill you on monthly basis to collect the 0.1% not covered (which would amount to a few dollars a year), individuals would finally have the feedback necessary to adjust their consumption behavior of free services offered by the government.

Some selfish individuals do not react to purely moral incentives, so the system is not fool proof, but I think it would be a very good step forward. Making this information public for all individuals would greatly increase peer pressure on this immoral group, but would also be an unacceptable violation of privacy in my opinion.

Dealing with Dutch Disease

2008-03-08T07:10:00.000-08:00

When I was young, I remember my parents talking to me about countries such as Saudi Arabia and Kuwait that were immeasurably rich, much more so than my native Canada, because they had oil. It turns out my parents’ hyperbole was unfounded: in practice, these countries have tended to do rather poorly over the long term, despite periods of wealth during commodity booms, because of something known as Dutch Disease which affects countries for whom natural resources are a significant source of export revenue.

Dutch Disease refers to the tendency of a country’s exchange rate to rise when it exports more natural resources because the price of resources can fluctuate much more quickly than labor productivity, the main determinant of an exchange rate. If my country discovers oil, we will export some (or import less): consequently, our exchange rate will rise, making other exports less competitive. As a whole, the economy of the country does better, but non-resource industries suffer.

This would not be a problem except for two reasons: volatility and rent-seeking. The price of natural resources tends to fluctuate wildly, much more so than other industries whose prices are determined by labor productivity and capital investment. At some periods of time natural resources will be the only interesting investment; if the price crashes, there are no other sectors of the economy that have built-up capital to take up the slack.

In countries with weak institutions, the problem of rent-seeking is even greater: this refers to the effort expended to gain control of the natural resources. In other words, if control of a piece of land is worth $10 billion, then various factions are likely to expend close to $10 billion of lobbying, lawsuits and bribes to gain control of it. The country as a whole ends up with close to zero benefit.

There are two solutions to avoid these problems. The first is taxation: there is reason to tax natural resources more than other industries because of their pernicious effect on the rest of the economy. This also guarantees that the country as a whole benefits from its resources, no matter who owns the land. Because we are trying to rein in overproductive industries rather than the traditional goal of protecting unproductive ones, export tariffs work best.

The second avenue is nationalization. By nationalizing the exploitation of the resource, the government thus ensures that the money won’t go in the hands of a few lucky barons. Nationalization means giving up efficiency; this is an unavoidable consequence. However, by orienting all the profits of the state corporation into a fund that buys up foreign assets, the country can reap all the benefits of the world price of its resources without increasing the exchange rate. This is the solution that has been adopted by Norway regarding its North Sea oil.

A free-marketeer like myself always finds it painful to advocate limitations on the market, since the solutions usually just cause more problems. In this case, however, the track record of resource countries is unambiguous: either they minimize the impact of resources on the rest of their economy, as Norway and Abu Dhabi have done, or the discovery of natural resources will be a curse disguised as a blessing. Just ask the Dutch.

Do flowers have a Nash equilibrium?

2008-02-14T13:33:00.000-08:00

My wife recently bought me flowers for Valentine’s Day. When I thanked her for them, she cheekily asked me: “How do you know they’re from me?” Since I am not currently having an affair, the odds of them coming from anyone other than Marisa were low. However, suppose I was having an affair and I received flowers from an anonymous admirer. Should I thank my wife assuming it was her? Game theory may shed some light on the subject. The table of results is as follows:

Flowers from Thanks Result
Wife Yes Status Quo
Wife No You seem like an impolite bastard; no sex for a week
Mistress Yes Wife assumes you are cheating. Hell hath no fury like it.
Mistress No Status Quo

In more compact table form, this gives as values:
Yes No
Wife 0 -100
Mistress -9999 0

From this table, two things are clear: if you are having an affair, receiving flowers is a losing proposition, with little upside and significant downside. Secondly, if you are having an affair and receive flowers, shut up about them. You'll spend an evening on the couch instead of a year in divorce court.

Too many dimensions

2008-02-10T16:25:00.000-08:00

I started reading The Elegant Universe today, a book about string theory and its 10, 11 or 24 dimensions. I then read Marry Him!, an interesting article that discusses how to select a male life companion, which comments on a different set of dimensions. One particular line caught my attention: "Why should I settle for anyone less than my equal?"

If desirability is a universally objective measure (like normalized income or body mass index), applying this rule to both parties forces an exact desirability match to form a union. In reality desirability is highly subjective and quite different from one person to the other.

Say there are N different dimensions on which desirability is measured (in the range 0 to 1), and each individual assigns a different arbitrary weight to each, in such a way that all the sum of all the weights is 1. We have: Total desirability = Σ D[i] * W[i]. It is still easy to pair off individuals, as long as W[i] is chosen independently of the distribution if D[i] values.

Real life situations show that the weights are not independent from the distribution of desirability, as we generally assign a higher value to rare attributes. More importantly, we tend to highly value dimensions in which we excel, artificially boosting our own total score. This correlation creates huge matching problem, when applying the "equal score rule" stated above, since you actually need an exact match in each dimension for the match to be possible. Lets approximate this as my weights are proportional to my score in this dimension.

My desirability = Σ Dme[i] * (k*Dme[i])
Others' Desirability = Σ Dother[i] * (k*Dme[i])

From these equations it is obvious that a reciprocal match requires Dme[i] = Dother[i] for all dimensions. The fragmentation of the pair matching market can be measured as a function of the "number of events" in Dme[i].

Communism Promotes Protectionism

2008-02-10T12:19:00.000-08:00

The taxation of capital and investment income creates all kinds of distortions in the markets. For example, shares are only taxed upon their sale, so investors will hold on to shares that have gained value just to delay their tax bill by another year. The reverse also occurs, selling off stocks that have lost value in order to get an immediate tax credit. Taxation is thus a contributing factor to the instability of the stock market.

For this reason and many others, I propose to eliminate corporate taxes and taxes on all investment income. This could be done implicitly, by removing contribution limits on RRSPs, while keeping the tax system otherwise intact. Or it could be done explicitly, making RRSP accounts only useful to even out spending over one's life time. In the following example, I will calculate the an individual's worth and tax contribution over a 10 year investment period separating labor from spending. I will assume that taxation is flat at 50%. Government bonds' real yield is 2% a year and average individual investments' real yield is 4% a year.

With investment taxation explicitly removed, labor is taxed as soon as it is earned. This gives:
Individual after 10 years = (Labor * (1 - 0.5)) * 1.04^10
Government after 10 years = (Labor * 0.5) * 1.02^10

With investment taxation eliminated by removing the cap on RRSP, labor is taxed only when it is spent. This gives:
Individual after 10 years = (Labor * 1.04^10) * (1 - 0.5)
Government after 10 years = (Labor * 1.04^10) * 0.5

Both approaches give the same amount of money to the individual, but the second approach gives a bit more money to the government, at no cost to the individual.

Investments by individuals are unlikely to be truly global. They have more knowledge of the value of local capital (shares of local companies), like shares of Bombardier Transport. When the local government needs to buy new subway railcars, they should rationally prefer the local supplier, since the government owns about half of the capital of that company through the RRSP of its citizens. Only the explicit elimination of investment income tax solves this problem.

Unfortunately, the taxation of labor combined with the loss of man hours resulting from the reallocation of human capital (that is recycling the workers at Bombardier Transport into some other field of work) also lead to the state effectively owning local capital. Education is a form of capital from which the state collects investment income tax as a subset of the tax on labor. One's time is quite easy to re-allocate anywhere in the economy, but one's education may not be easily used in another industry. To decouple the state from all forms of local capital, we would have to find a way to not tax the education part of worked time and to only tax the "universally re-allocatable talent" of workers. I don't really know where to start to achieve this distinction.

In practice, highly educated workers in rich countries (those that own the most human capital) are not very vulnerable to foreign competition. Lowly educated workers are very vulnerable, but the cost of reallocating their labor is small. Finally, workers in the middle (ex: technicians) have the most human capital to lose from foreign competition. Minimizing the regulatory overhead in reallocating mid range educated workers is the way to go.

Another solution would be to impose a head tax, effectively detaching the interests of the state from all forms of local capital, including human capital. Not so popular, though.

From Quebec with Love

2008-02-03T16:42:00.000-08:00

I injured myself in an unfortunate event involving my right leg and volleyball net post last Thursday. A bear attack would have produced a similar result: three equally spaced grooves spanning about 20 cm. On the bright side, it looked much more painful than it felt.

By the time I got home that night all stores were closed, so I had to make a bandage with whatever was at hand: duct tape played a central role! The next day I used Google to find out how badly injured I was, and what I had to buy at the pharmacy to make a decent bandage. After two days of treating myself, the deepest grove did not seem to be healing as quickly as the rest, so I decided to have it looked at on Sunday morning, going to the closest state sponsored clinic (CLSC).

Upon arrival, I was pleased to see an empty waiting room. Perhaps the treatment delays encountered in our public health system were not as bad as portrayed by the media. The front desk looked much like that of a bank in an unsafe neighborhood, with two tellers sitting behind a thick glass, which spanned from the top of the counter all the way up to the ceiling. In the waiting area sat one elderly women and one security guard behind a makeshift desk.

A sign was posted on the protective glass, which said: "Today, February 3rd, no doctors are available for unscheduled patients. A nurse is available, however." I walked up to the first teller, and she asked: "Does your family doctor work in this clinic?". Since I seldom need to see a doctor (my last doctor visit was 13 years ago), I answered no. She said: "Unless your family doctor works here, we will not be able treat you at any point in time. We can put you on the waiting list to get a family doctor assigned to you if you want." This was clearly not the solution to my immediate problem.

I explained that I had a badly bruised by right leg, and I wanted to know how to treat it. Perhaps I needed stitches, I said. I had not mentioned when this had happened, yet the secretary said: "If it has been more than 24 hours, stitches can no longer be applied." Later I learned this was inaccurate.

She then gave me a list of twelve other public clinics in the area which may have spare capacity. Unfortunately only one of them was open on Sundays. I then asked if there was a private clinic anywhere in the area. She answered, "Hey, I work in the public system. We don't give out this kind information."

Considering all options, I opted to see the nurse, given the other public clinic was a good hours' walk away, and given that it was the only other open facility, I figured it must not have had any spare capacity.

After waiting fifteen minutes, I met with the nurse, who was very courteous and helpful (though the front desk was not a hard act to follow). I explained to her how I had been taking care of the wound, she looked at it, said I was doing the right thing, that I did not need stitches but I did need a tetanus shot. She vaccinated me and sent me home. It took ten minutes.

Price controls create shortage, requiring glass windows and security guards. I'm starting to think that the security lobby is the force behind universal health care. I knew health care was not universal in Quebec, especially in delivering specialized surgery for the ailing, but I was flabbergasted to learn first hand that it is not universal even for minor interventions directed at healthy citizens. So whatever you do, never injure yourself on a Saturday evening!

Who are you protecting?

2008-02-03T09:28:00.000-08:00

Anyone who has ever seen their brother, boyfriend or pals yelling at the television while the coach makes the worst decision possible can tell you that sports fans are mostly a male, testosterone-laden bunch. So it’s no surprise that any city that hosts a large sporting event such as the Olympic Games or World Cup sees a huge spike in the demand for sex. In anticipation of Vancouver’s hosting of the Olympic Games in 2010, a group of Vancouver prostitutes is proposing to open one or many legal brothels that would allow sex workers to operate in a safe environment free from the threat of violence. This has brought a chorus of condemnation from social workers, academics and social conservatives who object to “legitimizing” prostitution and see it as a form of slavery. So who’s right?

All economic activities (and paying for sex is a fundamental economic activity, which predates Adam Smith by some time) are influenced by the law of supply and demand. When an activity is made illegal, this affects the supply: providing the good or service becomes more costly, so the result is to lower the volume of trade while raising the price. This is one of the reasons why a 12-ounce beer is a dollar while cocaine is 100$ per gram. The other impact is to push the activity to the margins of society, which, combined with a high price, moves it into the realm of organized crime. When an activity is legal, organized crime usually leaves it alone. Nobody has smuggled vodka over the 49^th parallel in a very long time.

Canada is in an awkward middle ground: prostitution, defined as selling sex services, is legal, but soliciting is not, which is why urban magazines are full of ads advertising escort agencies at 200$ per hour. More importantly, operating a “bawdy house”, known to speakers of English as a brothel, is also illegal. This largely prevents prostitutes from operating under safe conditions, since they are forced to meet their customers in locations not of their choosing. This also means that street prostitutes are committing a criminal offense any time they contact a potential customer, and this shady underworld they live in makes them easier targets for pimps.

Many people oppose prostitution because it leads to human trafficking: indeed, human trafficking is a deplorable crime that preys on the weak and should be prosecuted to the fullest. But this is throwing out the baby with the bathwater: in the same way that society condemns drunk driving while allowing general alcohol consumption, so too prostitution can be allowed without condoning those who would enslave women into the sex trade. If anything, making prostitution legal would reduce the profitability of human trafficking, though it’s hard to say if this would have a big impact on the number of victims.

The single biggest improvement that could be made to this situation would be to legalize brothels: it would improve the life and conditions of prostitutes immensely while probably reducing the incidence of street prostitution that bothers so many people. Prices would come down, which would benefit customers (yes, affordable and safe sex is service that many people would value immensely), safety would improve, the odds of contracting a sexually transmitted disease would decrease, and the government could even collect taxes from an industry that could finally exit the underground economy.

Ultimately, the strongest argument that can be made in favor of a legal brothel in Vancouver is that it is the prostitutes themselves who are proposing it. They are the best judges of what is in their interest, and the ivory tower complaints of those who claim that we are “dehumanizing” them by tolerating prostitution ring hollow. That it will probably please thousands of sports fans as well is just a bonus.

Begging to kick the habit

2008-01-27T14:29:00.000-08:00

I'm not a smoker, so when a fashionably dressed young man asks me for a cigarette on the street, he has exactly zero chances of getting a free nicotine fix. A poorly dressed beggar asking for cash has much better odds of tapping my generosity. Presumably he wants to buy food and correctly assumes that I do not walk around with a stash of mixed nuts in my jacket. I can strongly relate to someone who is hungry: might my fortunes suddenly change, I could see myself on the street begging to stave off my hunger. But there is no way I would give anything to someone who is not hungry, so even had I been carrying a pack of cigarettes at the time, I would not have handed one to that nicotine craving chap out of charity.

Most beggars make a sufficient amount of money on the streets to eat very well; in fact, with a typical 25$/hour donation rate they can easily support such habits as smoking, drinking and using illegal drugs. So by giving money to beggars, we are helping out a small minority whose main purpose is to pay for their next meal (they need to beg only one hour a day to eat at McDonald's), and hurting the rest by paying for their substance abuse habits (75$/day can easily buy food, cigarettes, alcohol and—depending on market prices—various other illegal drugs). Unfortunately, it's very hard to estimate the charitable income that a given person on the street is getting. Might no one be giving them any money, their income could well be zero: they could be starving.

If the state gave each poor person enough cash to buy three meals a day, I would be disinclined to give money to buy better food, let alone to subsidize substance abuse. This would remove the possibility of getting any income above 25$ a day without getting a job. And it would ensure that everyone is eating well enough to get by. Some issues need to be addressed in order for this subsistence income program to work as intended.

1. How do you know who is eligible and who is not?
I would suggest making every resident of Canada eligible, so that there is little bureaucratic overhead. Well-off persons will just pay the equivalent amount of income tax to compensate for the subsistence income they are receiving. If their fortune changes overnight, the subsistence income would be immediately available, since they are getting it all the time. Persons with accumulated capital on which income tax has already been paid (such as retirees) would benefit unduly from this subsistence income, since the income tax hike could not be retroactive. All forms of changes in tax structure have this problem.

2. How do you make sure that people are not using fake identities to receive multiple subsistence income streams?
This is a tough one. Population records are fairly accurate, so massive fraud would be difficult (in terms of percentage of population). Births are quite easy to control, but it is likely that people would take a bit longer to die than usual.

3. How can we make sure that everyone on the street is covered, illegal immigrants and all?
This is another difficult one to answer. Perhaps the effects of immigrants would be minor.

4. How can you send money to and communicate with people who do not have a mailing address (ie. the homeless)?
Technology is a big help in this area. It's trivial to give someone a "withdraw-only" bank account using electronic payments such as Interac with very little infrastructure. It is also quite cheap to communicate with literate persons by email. When mobiles phones become the mainstream payment medium (this is clearly only a few years away), payments could be made to a mobile phone account, and everyone could be expected to have one (the same way that everyone needs a health insurance card). This would solve the communication issue for homeless people permanently. Obviously mobile phones need to be cheap for this to work (~30$), and enough public electric outlets to charge them would be needed, but I think these two requirements are already met. Obviously airtime and SMS to communicate with the government should be free.

5. How do you prevent people front-loading all their spending as soon as they get their subsistence income cheque, requiring hunger alleviating begging later on during the payment interval?
Electronic payments make this really easy. Just send 7$ at 6h00 for breakfast, 8$ at 12h00 for lunch, and 9$ at 18h00 for diner, et voila! Electronic micro-payments work much better than monthly paper cheques, and they are economical. Better yet, it is difficult to convert such small amounts into paper cash, preventing the sums from being spent on the black market. So buying illegal drugs would require one to accumulate a day's worth of payments before withdrawing the large 20$ lump sum, which is extremely difficult for normal humans to do—hyperbolic discounting at its best!

6. How do you prevent people front-loading all their spending by borrowing against future subsistence income?
Making the subsistence income legally unseizable makes formal lending impossible. Informal lending (like buying 100$ of drugs against the next four days of revenue) seems very difficult to enforce: the amounts are too small to warrant much violence, and the threat of violence would also fail since collection would require four days without spending anything. The account's maximum value would be around 9$ for most people!

7. How do you prevent people from buying cigarettes, alcohol and drugs rather than food, requiring hunger alleviating begging?
This is a tough one as well. We could rely on hunger being a stronger incentive than the drug addiction. Or we could rely on hyperbolic discounting again: as long as the minimum purchased quantity of alcohol, tobacco and drugs cost more than one meal's worth of cash (9$ in this case), it is unlikely that people would go hungry six hours without eating in order to accumulate enough cash for a fix.

8. Is the amount low enough to keep minimum wage jobs attractive?
Probably. 9125$ of yearly subsidy + 16000$ of minimum wage * 0.7 income tax = 20325$. You can more than double your earnings by working: not a bad deal.

In defense of destiny

2008-01-20T15:21:00.000-08:00

Here is a great quote from a scene in Quebec-Montreal, in which two friends are chatting about how to strike-up a conversation with an attractive opposite sex stranger.

Female: "This jerk was hitting on me last night at bar. A total moron, half-drunk. He was going to Cuba, and invited me there with him. What a dweeb! Jeez! I'd never go with some stranger."

Male: "It's not always easy to find the right words. It's as if talking to a woman you don't know isn't politically correct. Really, you always seem annoyed. It's like the only way to approach a woman is by chance; otherwise, it's impolite."

Female: "That's not true!"

Male: "That guy that was leaving for Cuba, had you met him there, after he tripped over your long chair on the beach, wouldn't his odds have been better?"

Female: "But that's the ideal situation."

Male: "Exactly, you are always waiting for the ideal situation, in which the guys is not so explicit about his intentions. It's the situation that wins you over, not the conversation."

Female: "Chance is a question of destiny, and that's what women like."

Single men will usually strike-up a conversation with a female stranger in the hope of eventually having sex, that part is clear. Often the attraction is reciprocal, yet sex remains a rare outcome if the feeling of destiny fails to materialize. Why is this? Two forms of adverse selection, in favor of the man, are to blame.

First, it would be wise to assume that the initiator of the conversion has a certain ease in chatting-up strangers. This implies that his ability of finding other mating partners is quite high: his market for mates is much more liquid than that of the average person. It could also mean that the initiator has some inside knowledge that his odds are good: perhaps he has tried this before and it worked for him. So the odds of this guy wanting a long term relationship with her are much lower than in the population at large.

Second, the initiator chooses whom he chats to, in such a way to maximize his pleasure by choosing the most attractive, wealthy and intelligent person that he has access to. Whereas the chosen person can't expect to get any better than average (or below average) for any of her criteria.

When a rare uncontrollable event occurs in the proximity of two people of opposite sex, the social barrier to start a conversion basically disappears for both of them. It could be that something supernatural wants them to hook-up (unlikely); or it could be that the guy finally has something to say that could not have been planned ahead of time, which he can only say to a few people who are physically close to him. The female realizes that the male's advantage in choice has been materially eliminated. He quickly assesses that his odds with this person are exceptionally good right now, so he says: "You don't see that every day. Hi, I'm Jim..."

I suspect that if roles were reversed (that is men waited around for women to buy them drinks and chat with them in bars) destiny would start playing a key role for males in the process of long-term mate selection, and would eventually be disregarded as a fitness indicator by females. Putting yourself in a situation where "coincidences" happen often improves your odds of having destiny on your side. If you are still not convinced, just watch the movie Serendipity.

Though not very romantic, it would be quite easy to emulate destiny using a random process and matching roughly compatible singles at a time interval which follows a Poission distribution with an average of about two months. Perhaps Loto-Quebec could make this work if it was presented in the form of a lottery, in which the winning pair wins a date at a fancy restaurant. Hum... not a bad idea!

Hyperbolic discounting and bubble gum

2008-01-05T16:39:00.000-08:00

An interesting experiment can be conducted involving children and chocolate: offer a child the choice between one piece of Caramilk consumable immediately, or the entire bar consumable after one minute (expressed in an understandable time unit). Which one does he choose? Preschoolers overwhelmingly choose immediate gratification, whereas ten-year-olds choose to wait for the greater reward. Though this is not the most thorough example of hyperbolic discounting, it illustrates that the time horizon we consider when making decisions gets longer as we mature.

While having suppressed the most counter productive forms of hyperbolic discounting, older humans will likely proceed to eat the entire stash of chocolate there and then, rather than eating a piece a day, which would definitely give them more total pleasure.

The spending pattern of many adults is strikingly similar to the aforementioned glutton's food stock dilemma. During the two week period between paychecks, most people front-load their spending. When spending is on capital goods (those used for many weeks at a time) this makes complete sense. But spending is also skewed on goods that give only immediate satisfaction (like expensive wine, eating at a fancy restaurant, going skiing), forcing one to consume sub-par beer and frozen meals at the tail end of the pay cycle. Choosing slightly cheaper wine would have made more sense in retrospect, yet the cycle repeats itself identically the next time around: it seems that adults can't learn to distribute income evenly over a two week period, regardless of experience and incentives.

So either humans innately can't break the two week hyperbolic discounting barrier, or they can't learn how to do so as adults. There are certain abilities which humans can only properly acquire at a young age (accent free speech and honed motor skills come to mind), so perhaps taming impulsive spending is one of those abilities. It's a theory worth testing.

The concept of discretionary spending provided by constant income is far fetched for anyone who has never had steady job. Such a job is only available in our late teens or early twenties. Predictable cyclic income is necessary to experience the woes of hyperbolic discounting, which in turn provide the only path to overcome it. Parallels with the medical world abound: shielding a child from all diseases results in severe health risks later on in life, like chickenpox. So why don't we vaccinate our children against poor economic behavior? Not literally of course. Although...

Since a child's irresponsible spending habits are inconsequential for a parent, why not give them a low fixed income (say 30$ a month) from the age of six? Start with a dollar a day for the first month, then 2$ every two days during the next month, and so on, gradually weaning them from impulsive spending. I'm sure they'll find something to do with the money: I sure did. In the odd chance that I found a quarter on the ground, I would immediately buy candy; bubble gum was my favorite—it lasted longer. Unfortunately, I was born too soon to benefit from my future insight.

Some parents already do something similar at a later age (calling it an allowance), but such schemes have several shortcomings. For one, it's possibly already too late. In practice, the income is rarely steady: both cutting it off on bad behavior or giving extra income on good behavior—especially when your child is broke— weakens predictability which makes budgeting impossible, thus defeating the entire purpose.

High-impact Education

2007-11-18T07:08:00.000-08:00

The Economist ran a very enticing article on counterproductive regulations: it's really worth reading. Taken individually, most of the examples given have a small overall negative impact on the economy. Regulations protect individuals who do not have the time, money or motivation to engage in full counterparty oversight. In the service sector, regulations are usually in the form of competency assurance through relevant recognized education. For example, you cannot practice medicine in Quebec without being certified by the Collège des médecins du Québec, which prevents the majority of doctors having acquired their MDs outside Canada/US from practicing, regardless of work experience. I ask my surgeon prior to an operation: "How many times have you performed this operation before?". The CMQ asks "What was your GPA, adjusted for college notoriety?". Perhaps those regulators should only be given access to doctors that have the least experience. This policy has a greater overall economic impact than horse floaters in Texas, but the total effect remains small.

The bulk of the economic impact of service regulations is paid by consumers who indirectly cover the costs of unnecessary education forced upon their service providers. It would seem that our education system missed-out on the most important force driving post-industrialization growth: the division of labor. The ministry of education and university faculties seem to highly value graduates who could run the entire economy on their own: literature, history, economics, physics, biology, chemistry and advanced math. Perhaps they simply can't forecast what ratio of each profession will be needed, thus feel compelled to maximally hedge their position. By the time these students start doing real work, only a small fraction of what they learned is relevant; worse, the relevant notions were probably not concentrated at the very end, leading to poor retention, thus transferring training costs on their first employer — in things as simple as writing!

The sheer length of university programs combined with the lag between market needs and matching curricula seriously discounts the useful skills acquirable through post-secondary education. As technology pushes the division of labor further (and at a faster rate), school programs should become shorter. Though there is more total information that can be learned, teaching anything useful requires reducing the turn time between a new expertise emerging, updating the curriculum and getting a person through it. This implies teaching less material to a single student.

Due to the poor performance of our education system, the value of experience grossly outweighs that of education in all fields of work, leading to an increase in salaries over time. Otherwise, a graduate would start at the highest salary level during his first work day, then see his salary decrease as his knowledge becomes obsolete (and eventually, retraining would be required keep his salary positive!). Non-human capital behaves exactly in this way.

There are several other casualties of long mandatory education, other than increased retail costs. Though education is heavily subsidized, it is more expensive to study than it is to work: you are not paid 30K$ a year to study! Thus very capable students from a poorer background cannot afford to forgo work during the 4 to 8 years required to complete post-secondary education. Might such education last only one year, just about anyone could get a private loan to get by. Thus long education sustains class differences despite subsidies — even in France where education is free. The patience required to acquire a diploma is independent of the qualities required to work in most fields. Thus people that like "action" and respond particularly well to short term incentives, but can't stand the boredom and futility of post-secondary education, will drop out rather than pursue four more years of zero productivity.

The work life of an average post-secondary graduate is 35 years (25-60). Shaving off 3 years of education increases this period by 8.5%. Those extra years just happen to be when persons have little responsibility outside of work (no children) and peak intellectual capability, thus they can work harder and in a more productive way than in the years to follow. Additionally, the cost of changing fields, either due to personal preference or direct economic incentives, is significantly reduced. If you finish a four year program and realize that you don't like working in the field of choice, your options are limited to halfheartedly continuing your career, investing in another 4 years of schooling, or choosing a line of work requiring little education — all terrible outcomes.

To be fair, there are some upsides for employers in the current educational system which are worth mentioning. Class selection correlates well with cultural traits that employers look for: workers who perform well due to peer-pressure (from their families and friends). Hierarchy often develops based on the number of post-secondary years of schooling, which may be easier to accept for subordinates (less infighting and psychological harm). Having a post-secondary degree sets a minimum bound to the product of intelligence and perseverance possessed by the diploma holder. And finally, such a diploma proves that a person is capable of completing a very long uninteresting project.

What should we do about this? First, I would split out government sponsored research from the rest of the education system. Second, I would stop subsidizing specialized skills in all education. This means teaching only reading, writing, basic math, and social education (social education gives students recommendations on how to react to situations that frequently occur in one's life: for example using a condom during intercourse). All specialized education must not be subsidized in anyway. The market forces driving it would make it applicable, cheap and short. Government subsidies are most appropriate to support capital with very long amortization time for which the future need is indisputable. Incentives to have children are the best example of this. Subsidies are clearly counter productive in the last years of specialized education. Best of all, reducing the total cost of specialized education limits the damage that can be done by service regulators.

Formal Fair Trade

2007-11-11T08:40:00.000-08:00

In a previous post, I mentioned that the fair value of an asset involved in a two party trade can be calculated as the multiplicative average of each party's valuation of the asset, but I did not justify why. An alternate simpler solution would be to settle at the additive average. Various other functions could be proposed, as long as the settling price is between the two parties' valuations. In our current financial system, just about any settling function can be used since the gap between selling valuations and buying valuations is very low for frequently traded assets.

Though the pricing mechanisms at auctions of unique assets (like a painting) don't quite match those of regular liquid markets (like shares), it's worth discussing how auctions settle, since these are infrequent trades for which the gap between the selling and bidding prices is large. The seller at an auction specifies the starting price; below this amount the seller prefers to keep the item for himself (he would buy it from someone else at that price if he did not own it already). The buyers bid (in the extreme case, an incremental dollar at a time) until there is only a single bid remaining; that person has bought the item at the valuation of the second highest bidder, which is likely lower than his own valuation. A more efficient way of doing exactly the same thing, but without going through an endless number of bids, is for the seller to give the item to a temporary trust and set a public reserve value (which matches the seller's valuation). Buyers can then send their bids privately to the trust. Once the auction's bidding has closed, the trust sells the item to the buyer with the highest bid at the second highest bid price, and returns the proceeds to the seller.

When there is only one bidder participating in an auction, the settling price will be the valuation of the seller. When there are multiple bidders in an auction, the settling price will be that of the second highest bidder, which is located randomly between the seller's and highest bidder's valuations. Isn't there a way of splitting the benefits of the trade more fairly between the seller and the buyers?

Lets create a fictitious stock market on which a single share is traded between two people. At noon on the first day of every month, our two protagonists have the opportunity to trade the share; the market is otherwise closed, which means the two people are clearly Frenchmen. Only one of the two persons can own the share at a time (since there is only one share). From the point of view of both persons, the value of the share changes on a day to day basis due to new information, but there is no reason to either calculate or reveal this value between trading days, since trading is not possible. Both persons thus spend all non-trading days at the beach having a good time, during which they don't worry about the value of this share at all. On the morning of the first day of each month, both persons calculate the current value of the share and secretly enter it in the trading system. If the person who owns the share values it less then the person who does not own it, a trade occurs at a settling price calculated by the trading system. What is the fair settling value? Keep in mind that during a month many things may have changed and the two valuations can be significantly different, so the choice of using a multiplicative or additive average makes a big difference in the settling price.

During the month, both persons receive benefits ("dividends" in a broad sense) from the assets they own, might the assets be some money and the one share, or simply more money. So the first Frenchman gets his benefits by claiming he is the most powerful man on the beach (attracting women who like powerful illiquid men), and the second Frenchmen gets his from claiming that he is the richest man on the beach (attracting women who like rich liquid men). These are the only "dividends" that they get from holding the assets. Note that the benefits are entirely consumed by the time the month ends, thus they will not have any impact on the current value of the share: the current value is only based on future benefits. The return on investment captured through these "dividends" during the month is usually not the same for both persons, but it is fair since they chose which assets they wanted to own at the start.

Before the trade takes place, both persons evaluate the current value of the share based on future expected benefits. The one that held the share during the month can calculate his total return on investment during that month by summing the "dividends" received with the difference between the valuation he gave the share at the beginning of the month and its current value (as measured by him only, since he does not know what the other Frenchmen thinks the share is worth yet). This total return on investment is fair, since it is entirely controlled by the guy who owns the share.

When the share ownership changes at the end of the month, the trade allows both Frenchmen to statistically receive more future benefits then would have been possible otherwise, as long as their forecasts of benefits are accurate. In this case, they must each estimate how many other people of the two categories mentioned above they will meet over time at the beach, to maximize the number of hookups. When the share is traded, both men are very happy because they are suddenly better off. The trade commits quickly and the benefits are positive, which gives us a very high return on investment during the time that the transaction was being performed. A fair settling price for the trade would give both Frenchmen the same return on investment over the period of time that both the share and money were tied up in the trading system, however short a time this might be. This requires using a multiplicative average.

To illustrate this, assume that the Frenchman who owns the share values it at 1$, and the other one values it at 4$. Over a given short period of time, if they don't trade, they are both getting 0% ROI, because the share continues to be worth 1$ for the first guy, and the 4$ continues to be worth 4$ to the second guy (trivially). This makes them both miserable, since they are looking for ways to maximize their ROI. By trading, they can both improve their net worth. For the trade to be fair, both should benefit from the same ROI during the very short time that it takes for the trade to complete. Thus the settling price should be 2$. The first guy turned a low value share into twice the amount of money that he though it was worth. The second guy turned a low value toonee (2$) into a high value share, worth twice the amount disbursed. The ROI of this transaction is matched at 2:1.

It is possible to extend this trading system to multiple sellers and buyers. All sellers submit their minimum price secretly to a trust, and all buyers submit their maximum price in the same way. When bidding closes, the trust repeatedly matches the lowest selling price with the highest buying price, until matches are no longer possible (the lowest remaining ask price is higher than the highest remaining bid price). All trades are then settled at the multiplicative average of the closest matched sell/buy order (because identical assets should have a single market price at a given time, all assets are traded at a price matching the closest matched sell/buy order). This allows market participants to place a sell order at 0$, and (usually) not get 0$ for their share. The whole process does not maximize the number of trades, but it globally maximizes asset valuations, while giving the price setting seller/buyer pair the highest ROI possible. An alternate pricing method would be to settle each matched sell/buy pair at the multiplicative average of their prices, regardless of other simultaneous matched pairs.

An example greatly clarifies the multi-party trades of the above paragraph. Say there are four participants in a market where two identical shares are traded. Person A holds a share that he values at 2$, person B wants to purchase a share for 3$, person C holds a share that he values at 7$, and person D wants to purchase a share for 8$. Solution one would be for A&B to trade at 2.45$ and C&D to trade at 7.48$, and solution two would be for A&D to trade at 4$. Solution one makes the world 2$ richer (0.45+0.55+0.48+0.52), and solution two makes the world 6$ richer (2+0+0+6). Solution two is obviously better. In a trading system where sell/buy orders are not placed concurrently, if person A posts his ask price first and person B is (randomly) faster than D in bidding, he will force the market to match A&B and C&D, which is globally sub-optimal.

Like any market, such a system works poorly when there are few traders on either the buying or selling side. This allows multiple consecutive auctions to be conducted to do a "price sweep", detecting the value of the highest or lowest price. Such price fixing is unavoidable in situations of monopoly or oligopoly (might they be on the seller's or buyer's side), or in illiquid markets.

Humans are a strain on GDP growth

2007-11-09T14:13:00.000-08:00

In a previous post, I drew graphs which showed that an investment's "yield average" and "yield variance" are positively correlated. In plain English, this means that a high risk investment will have a better return on investment than low risk investments, even after fully accounting for the risks of delinquency and default. Why does this occur in practice?

There are two opposing forces which influence the "appetite for risk". From an individual's micro-economic perspective, losing all of his money creates more harm to him than the good that would result in doubling his bank roll. That's why it does not make any sense to go to the casino and wager all your assets on black at roulette (even if the green slots were removed, making the wager completely fair). The reason for this is that our appreciation of various products is not proportional to the price of the acquired good or service.

To illustrate this point, lets compare apples and oranges. An apple is worth 5$ of "pleasure" to me, and an orange is worth 9$ of pleasure (I obviously prefer oranges to apples). If the price of oranges is above 9$ and the price of apples is above 5$, I will buy neither. Say I have 16$ to spend, and the price of apples is 4$ and the price of oranges is 8$, I will definitely buy something. What will I buy? 16$ buys me 4 apples, which gives me 20$ of pleasure (I net 4$ of pleasure if I buy apples). 16$ buys me 2 oranges, which gives me 18$ of pleasure (I net 2$ of pleasure if I buy oranges). So despite the fact that I prefer oranges to apples on a 1:1 basis, at some price points I will buy apples rather than oranges.

Return on investment is usually measured in dollars invested against dollars paid back (put dollars in, then wait some amount of time and get dollars out). When consumer goods are purchased in retail sales, the return on investment must be measured as dollars in, then wait some amount of time (usually very short), and get pleasure out. For a transaction to be completed, the selling party has to own an asset which he values less than the buying party. As long as the price of the transaction is between the two valuations, both parties will gain from the trade. The fair price for the trade is the multiplicative middle. If a seller and buyer simultaneously value an item at 1$ and 4$ respectively, then the fair trade value would be 2$, so that each person gets a return on investment of 2:1 on the transaction; in practice there are multiple sellers and buyers of a given item, and the market price is set to the multiplicative average between the two closest prices, which are always very close in any liquid market.

At first glance, markets do not seem to obey the rule of trading at the multiplicative average of the valuations. Take water as an example: if I can't buy water on a daily basis, I will die. So the value of water is very high for me (at least 25$ dollars a day), much more than the 1$ I pay for a 2L bottle of water (good for 1 day's worth of water consumption). The ROI that I am getting on water is 2500% a day (10^508 % a year). So why isn't the price of water 24.997$ for a 2L bottle (at this rate, the yearly ROI is 5%)? If there was only one person that owned all the water in the world, he could set the price at 24.997$ and I would grudgingly buy it. But this person would probably not be respecting the fair price of trade stated in the previous paragraph. That's because an individual highly values 2L of water per day, but he has very little use of the 10^19 other litres of fresh water available on Earth. Thus water for him is worth very close to 0$ per litre. The multiplicative average of 0$ and 25$ is darn close to zero (the 1$ cost comes mostly from packaging, publicity, distribution and retailing; it is fair, so don't write a letter to your MP complaining about the "Big Water" lobby).

The average person has an extremely good return on investment in buying water and basic foods (these are cheap and keep you alive!). In decreasing order of priority, most people would then buy clothing and housing, better tasting food, transportation, and luxury goods. The return on investment for consumer spending is called utility. The utility of an extra dollar of income is always lower or equal to the utility of the last dollar spent (this means that you don't wait for your salary to have reached 30K$ a year before you start buying food!). The function is thus decreasing (or flat) by definition.

The utility function that I use for myself has three steps: the first 10K$ covers my essential living needs (pleasure ROI > 100%), the next 20K$ covers my discretionary living needs (pleasure ROI > 25%), and I have yet to find a use for the 30K$ and above money, so I barely care about it at all (pleasure ROI 0+%). Say I stumble upon a winning lottery ticket tomorrow morning, and I suddenly receive 10M$. I'm lazy, so I decide to never work again, and I have 50 years left to live. How do I invest the money? I can't afford to be short of pleasure at either 100% or 25% interest rates, which means that I pretty much have to guarantee an income of 30K$ a year for 50 years. So I will set aside 1.5M$ in AAA government bonds (their effective yield after inflation and taxes in Canada is 0%!). And since my utility function is flat for the rest of my money, I'll invest the 8.5M$ remaining in the highest average yield and highest variance instrument that I can find. I'm using an extreme example to illustrate how a non-flat utility function necessarily leads to a "balanced" portfolio requiring different investment instruments which bear different variance and average yield. To balance your portfolio, you must choose investments with risks and yields that maximize the dollar value of pleasure that you will consume in your life. Note that at 100% ROI, being short of essential living pleasure at any time is horribly expensive.

That's force number one: the utility function of humans is not flat. Might we have a flat utility function (if happiness was linearly proportional to income), variance would not affect our investment decisions at all. Everyone would invest in the highest average yield assets, which means the riskiest investments. This would greatly increase GDP output.

Force number two is in the opposite direction: it encourages us to take risks. In a financial system that only allows collateralized loans, the worst that can happen to you is that you lose everything (all your assets). That is not so bad in occidental countries, since the state guarantees about 20K$ a year of cash and services, which supplies us with the first 10K$ of essential living needs (it prevents us from dying of thirst, or otherwise loaning ourselves essential living needs at a usurious rate of 100% a year!).

Better yet, in a financial system that gives us loans without collateral, the worst that can happen to you is still that you lose everything (all your assets), because bankruptcy prevents your total net worth from going too far in the negatives (it is actually based on cash flow, not on net worth, but the result is very similar). Yet borrowing without collateral allows you to leverage your investments, reaping much larger rewards than would be achievable might you only be allowed to invest your hard earned assets. How does this make any sense?!? Why would someone loan you money to invest (either on the markets or in your own pleasure) that you may not payback? Obviously you are getting a better yield than the loaning party offered you, otherwise you would not have accepted the loan. Why shouldn't they invest the money themselves directly instead? For one thing, they can't benefit from your pleasure. So if the lender has a ROI of 5% on his pleasure, and you have an ROI of 10% on yours, by all means he should lend you his money. The same applies to traditional investments also (stocks especially). When the bank loans you at 6%, and you invest in the stock market and get 10%, you are either more risk tolerant or smarter than your banker (probably both!). You and your banker are getting a good deal out of the loan.

So the social safety net and bankruptcy laws encourage us to take risks on the one hand (increasing GDP growth), and our utility function for consumer spending pushes us to hedge our portfolio, rather than betting everything on the statistically fastest horse (decreasing GDP growth). William Poundstone should have read this paragraph before going ballistic on Kelly's criterion.

La conclusion de l'histoire: if humans had a flat utility function (or if the social safety net was 30K$ a year and everyone's utility function matched mine), the average yield of all investments would be exactly matched with GDP growth, making the previous post's graphs one dimensional, and making the deflation problem's solution trivial. Lady GDP puts it this way: "Humans: can't live with them, can't live without them!"

Before all you socio-communists reading this blog suggest dishing out 30K$ a year in social safety nets to increase the appetite for risky investments (thus GDP), keep in mind that the utility function that I use for myself is not universal. Most people actually know what to do with their 30K+ income tranche: that's how Porsche stays in business. Those that don't care about the 30K+ income tranche won't put any effort in producing this income. I'm a workaholic exception, so the pleasure of working and investing money brings my ROI above 30K$ from 0% to 0+%, which makes a huge difference. If I was the only human alive, I would produce 2000 Kg of bananas a year, even though I only consume 1000 Kg, just for the fun of producing more bananas. Thankfully, I live on a planet inhabited by lazy monkeys.

True Charity

2007-11-07T18:11:00.000-08:00

I don't give money to beggars for several reasons. For one, it does not use my time or their time efficiently at all. They produce nothing and I work 15 seconds less that day in an effort to avoid them.

I'm all for charity, but beggars in Montreal make over 25$/hour; I would prefer giving money to the poor single mothers who make 8$/hour. Just based on this simple fact, it makes no sense to give beggars more money than they currently receive.

Just because they are there in front of you and it is easy to give them your coins does not mean that you are doing the most good (though sometimes giving directly can be more efficient because you save various fixed costs that organized charities must pay, taking a cut out of donations). But giving directly allows you to feel good immediately and often, by helping people right in front of you at a low cost in terms of money and effort (alternately, it may allow you to avoid feeling bad because you declined to be charitable). Helping people in your "heightened field of sympathy" gives you much more satisfaction than giving to people you only know through statistics read in the media.

Giving to a charity in a yearly fashion is much more efficient in helping people (per dollar spent), but you don't feel "fuzzy inside" 50 times longer because you gave 100$ in one lump sum, rather than 50 times 2$. This subject is well covered by a very good article in Slate: http://www.slate.com/id/2034/ .

Moreover, I prefer teaching a man to fish over handing him a fish. In today's world, that means giving to charities that do research over those that provide palliative care. Unfortunately, this gives me very little of that "fuzzy feeling", but it is what does the most good to the most people.

To be fair, charity is a form a "feel good" product that does give something back (good emotions) to the person that donates. Thus giving small amounts many times to causes that are dear to our hearts makes economic sense. Perhaps charity should be taxable, as the charitable soul is actually paid back fully in kind.

Also to be fair, beggars probably facilitate the process of giving, as giving money without regular solicitation would make charity prohibitively expensive for most. A good parallel is that of saving (for yourself!): prior to owning a house and making capital payments, most people can't save any money at all! Perhaps beggars could collect money for organized charities, legally taking a 33% cut for their services. A squeegee with a cause... that would be much better!

How I was short changed by the fiat monetary system

2007-10-31T13:55:00.001-07:00

The conclusion of this paper on deflation is that putting money under your mattress greatly helps productivity growth by eliminating low yield assets and concentrating all efforts in producing high yield assets. In the extreme case, the most risk tolerant person will own all assets worldwide.

The paper assumes that return on investment is purely technological and that the period of ownership of intellectual property is short. This prevents the accrual of assets by risk tolerant investors, which would allow them to recuperate the bulk of the cash held by low risk investors through the sale of some of their assets (this would allow them in effect to corner the market).

In conclusion, it would seem that low variance investors increase the overall variance in GDP growth by allowing other risk savvy individuals to decide which investments are made. Cash is simply a non-voting share in an investment vehicle which invests in/owns the entire economy. Indeed, investing their money with a negative interest rate is the only way to regain their voting rights and reduce macroeconomic variance.

Mechanisms of socio-democracy

2007-10-23T13:53:00.000-07:00

This is a follow-up to a previous post.

As mentioned by Tom in the post's comments, socialism —as it is applied in practice by occidental governments— has a much wider scope than the narrow definition that I gave. Governments can change services, regulations and taxation at any time for various reasons, provided that they somewhat respect the will of the electorate. These policies can be split into three main economic categories.

Category 1: state interventions aimed at equalizing income. These consist mainly of labor laws, subsidies and import tariffs (which favor workers whose occupations have become less valuable over time) and progressive/negative taxation (which favors low income individuals). Such policies aimed at equalizing income can be summarized as "income insurance", a combined insurance for occupation, talent and aptitude for work (laziness).

Category 2: state interventions which insure against infrequent events, such as medical insurance, unemployment insurance, invalidity insurance.

Category 3: state interventions to protect property rights, such as the police, military and judiciary.

I have omitted two large chunks of government spending from the categories above. Government managed retirement programs for workers have been excluded. When properly managed through individual accounts, there is no difference between investing yourself or letting the government do it for you — albeit, things don't work out that way in practice. When pooled accounts are used, this becomes another form of income insurance.

Subsidized education has also been left out. As long as education is individually profitable, it can financed in a private manner: thus no state subsidy is needed. If education is not profitable for some individuals, then the subsidy needed to bring it back to profitability can either be labeled as invalidity insurance (for individuals with disabilities) or income insurance (for individuals disinclined to take on a profitable occupation).

Though the status quo usually prevails, policies helping poor individuals are the cheapest way to harvest popular support: this yields the most votes per government dollar spent, since it is much cheaper to make a difference for someone whose top income dollar bears the most utility. This incentive structure produces a great deal of adverse selection, due to the fact that once a person has reached voting age, he knows where he stands in the distribution of income and of health, thus he will support new government policies which maximize his future benefits — at the expense of others. This effect is as self-evident as it is unfair. A clear illustration of the problem: if more than half of the electorate is below the average per capita asset level, a referendum for equal distribution of all assets within the population (in effect, temporary communism) would pass, as long as such a referendum was forever banned thereafter, and property rights forever restored.

In this series of posts, I will continue using the narrow definition of socialism, in which adverse selection does not occur: socialist mandatory insurance terms must be agreed upon prior to knowing how well individuals will fair in the future.

Libertarians call the adverse selection produced by the above democratic process theft. Unfortunately, they usually attribute all the socialist mandatory insurance to this mechanism, which is not accurate: some insurance is justified due to sympathy, as was demonstrated in the previous blog entry. So where do we draw the line?

Socialism vs. the "nanny state"

2007-10-21T08:36:00.000-07:00

These two concepts are often not distinguished. Yet they should be.

Socialism is a form of mandatory insurance that is imposed on everyone. It prevents the emotional hardships caused by the sympathy we feel when exposed to the bad fortunes of others. For example, I feel terrible after seeing children who are visibly sick but don't have access to medical services. Thus, before admitting a person within my geographical region —that is, in my field of heightened sympathy—, he must be sufficiently insured so his observable misfortunes distress me minimally. There are various methods available to finance this mandatory insurance, which involve both individual and collective contributions. It's an expensive but necessary fiber in the fabric of modern society.

On the other hand, the "nanny state's" usefulness stems from the high cost of making rational and educated decisions for individuals. The ineffectiveness of individual decisions becomes particularly evident when applied to infrequent choices or longterm commitments. For example, choosing to embark on a long private educational program (such as K-12) at the cost of accrued interest and with first rewards reaped in several years is a very hard choice for any person—let alone a five year old! Another good example is private medical insurance: what ailments should I be protected against? Is it reasonable to expect individuals to research the incidence, cost of treatment and discomfort of all existing diseases? Definitely not. Educating individuals to make better long term choices is necessary to have a functional complex society, even on things as trivial as using a condom during intercourse with irregular sexual partners. Both government and non-government bodies can make such recommendations, and these recommendations usually apply across national borders.

Knowing what is "the right thing to do" for their own welfare is not always sufficient for persons to follow this path, in which case legislation is required to force them in the right direction. For example, educating children is mandatory, and not a choice left to parents. These rules can often be bypassed via emigration (to poorer countries), or become stale as "the right thing to do" changes over time. They should be kept to a minimum and often revisited or reverted back to non-binding recommendations when the right choice no longer seems universal. Occidental countries are plagued with obsolete regulations kept in force by lobbyists whose industries thrive through regulatory protectionism. One blatantly obvious example of this is pharmacists who have a monopoly of retail prescription drugs sales in Canada. Why can't I buy drugs for which I have a prescription from a Mexican pharmacy? The exact same drugs are cheaper in Mexico. The direct cost of maintaining "nanny state" recommendations and regulations is quite low as compared to the cost of mandatory insurance, since it mostly involves research and dissemination of information. The indirect costs can be quite high since obsolete industries survive longer than necessary, sustained by regulatory legacy.

The socialism paragraph above intentionally omits discussing how the mandatory insurance provides direct help to some insurees, though this seems to be another key benefit of the policy. In taking private insurance contracts, each individual must weigh his tolerance of risk. The less variance one can tolerate, the more insurance one buys (at a cost, obviously). This remains a strictly personal choice, which is guided by your culture and "nanny state" recommendations and regulations. Thus the amount of insurance one buys to maximize one's own utility is not a fixed quantity. Weighing in only their personal benefits, some persons will require more insurance than is provided by the socialist mandatory insurance, and others will require less. The good news is that you can buy as much private insurance as you want when the state has forced too little insurance upon you. The bad news is that you can't buy less: you can't opt out of mandatory insurance. Buying more insurance than you need makes you worse off, in the typical case, so measuring the benefits of a sub-group of insurees (namely those that fell into adversity) is an analytic fallacy. Mandatory insurance in no way helps one's own fate; only "nanny state" recommendations and regulations on how much insurance you should buy helps you directly.

Both socialism and the "nanny state" are required to make each of us happier. "Nanny state" recommendations save me hours of research in making infrequently encountered choices. "Nanny state" recommendations and regulations protect me from bad decisions I make in striking a compromise between my immediate and longterm wellbeing. And socialism helps me out by reducing the misfortunes of others, which affect my happiness through my sense of sympathy. Until we can knock out the sympathy gene and the hyperbolic discounting gene, we are suck with high taxes and zealous regulators. Libertarians should be spending less time blogging, and more time investing in genetic research!

Fair and Efficient Health Care

2007-09-30T16:05:00.000-07:00

The United States are about to overhaul—or perhaps apply an expensive patch to—their health care system. Given a blank sheet, what would be the fairest efficient universal health care system?

Lessons learned from Quebec's system
An effective way to limit costs without recourse to patient disbursement is to increase waiting times for both small and large interventions. Getting oral contraceptives prescribed requires waiting a couple of hours at the doctor's office. Getting knee surgery requires waiting six months. The value of one's time combined with hyperbolic discounting raises the effective cost of treatment far above 0$. Often, ills fix themselves faster than the health care system can, at some cost to the patient's comfort and productivity. Less frequenty, irrecoverable harm such as death occurs during the waiting period.

Anyone who has ever spoken to a human teller at a bank knows that waiting is not limited to public services. Without building significant spare capacity, queues arise naturally and delays follow a poisson distribution. Waiting is generally a bad thing: auctioning off the priority of access to medical services —not the access itself— could get around the poisson distribution problem by properly valuing people's time. But such an approach is quite unpopular, and not entirely fair. Charging a small flat cost could also avoid unnecessary cases, but this is still too controversial to be accepted. Lesson #1: limiting the supply of a medical intervention is not a fair or efficient way to limit costs.

The state runs all hospitals and sets prices for all private practice interventions. This monopoly position allows medical professionals' wages to be kept artificially low, which is quite unfair to doctors, but a good deal for the rest of us. Lesson #2: markets should set the wages of medical professionals, otherwise they are not getting fair compensation. State run facilities are inefficient in the administration of the services. Privatization of all medical facilities would increase the wages of the medical staff; this increase in wages may not be entirely offset by increased efficiency in the management of the facilities. Assuming that wages should be increased to free market levels, the quality of service offered to patients would increase dramatically at no cost. Lesson #3: privately run facilities deliver better service at a lower cost.

It is very difficult to sue your doctor in Canada. And in the unlikely event that you win your case, compensation is rather limited. This is a major difference between the Canadian and American system, which significantly reduces malpractice insurance fees paid by hospitals and practitioners. Lesson #4: keep medical malpractice insurance costs low.

Health related immigration is an issue. Uninsured foreigners come to Canada to be treated, sometimes as refugees, other times stealing the identity of Canadian citizens to do so. Lesson #5: immigrants should cover their health insurance costs.

Other practical issues
The insurance system always ends up being split into two: the baseline universal government sponsored insurance, supplemented by private insurance and self insurance. Human lives are too long to keep the division between what is covered by public and private insurance programs constant. Generally, public services are increased as productivity and technology improve. Such increases will force single risk private-insurance contracts to end prematurely, which will result in an overpayment (thus a refund) to the private insurance customer. Very exceptionally, costs may increase (eg. inflation caused by a receding population) or government budgets may decrease (eg. a depression). Good planning by the government is required to avoid decreasing services, as this is extremely unpopular. Decreasing government insurance coverage is the equivalent of defaulting on their insurance contract. For high risk persons, acquiring private insurance after a government default will not be possible. Lesson #6: the government should be conservative in the size of the baseline insurance package to avoiding defaulting.

Discrimination in insurance is a very delicate matter. Some things you can discriminate on, others you can't. Race and DNA tests are currently not acceptable ways of pricing private insurance. Should they be? The answers are not obvious. Of course if you offer identical and adequate health insurance to everyone, no discrimination whatsoever occurs (for better or worse). Discrimination is generally a bad thing when no incentives are at play. But some things you choose affect your insurability: should you choose smoking or lower insurance premiums? Should you risk giving birth to a child which will likely be unhealthy as shown by the results of an amniocentesis? To be fair with both the insuree and insurer, full information about risk should be disclosed to all parties prior to entering a binding insurance contract. If the insuree has more information than the insurer (as is the case now), high risk individuals will acquire more insurance coverage at the cost of others. Lesson #7: information used by the insurer and insuree to enter in an insurance contract must be identical.

Private insurance contracts may pay a fixed amount for a given illness, enough to cover the costs of the necessary medical intervention in most venues. What happens when some medical facilities charge more or less than the covered amount? Should the difference be payed or received by the patients? Would patients intentionally become sick to collect the difference as a source of revenue? If no medical assistance is required by the patient for an illness, should the sum be entirely given to him? Ideally, I would answer yes to all these compensation questions. Some costs have to be incurred in preventing, investigating and paying fraudulent claims. I hope these are not too high. Treating an illness quickly usually increases productivity, which is a collective good. Productivity loss is an externality imposed on others through reduced taxation and trade. Thus making health insurance claims redeemable in cash may not be optimal for society as a whole. Then again, it is the only way of putting downward pressure on the price of medical services. Lesson #8: achieving downwards pressure on price of a medical act is not possible without cash compensation paid directly to the patient. Cash compensation to the patient can be easily abused for some illnesses, and may lead to reduced overall productivity.

A theoretical solution
The really clean but not too practical answer to this insurance mess is to force parents to insure their unborn children for a lifetime of baseline health insurance in one lump sum, which pays fixed benefits for a each illness. You could decide to either to test parents' DNA or the fetus' DNA for accurate pricing. The baseline insurance would be subsidized by the state at a given amount, say 250K$. If the baseline insurance cost more than 250K$, parents would have to pitch in the difference. If the insurance cost less, they would get the balance returned to them with interest over some period of time (say 18 years). This system is fair and seems to work quite well. Immigrants would go through a similar flow, except they would be tested later in life and priced accordingly (and not subsidized!). All pricing is private and competitive, thus reflects actual costs of offering the insurance.

One problem could arise if an insurance company when bankrupt for some reason. You would end up with uninsured citizens, some of which are now individually uninsurable. The government would have to regulate insurance companies and underwrite them, avoiding loss of coverage.

A much larger problem is the uncertainty in determining how much the coverage will cost when it will actually be needed: in seventy years! At a minimum, the seventy year bond market would need to be created. It is not possible to reasonably price such long term commitments. Additionally, the baseline service set would need to be changed over time to include more medical conditions as they become cheaply treatable. Older citizens whose contracts were negotiated at birth would not include the same coverage as they younger compatriots. Modifying their original contracts to add coverage necessarily leads to discrimination based on medical history, again making some people uninsurable for services added to the package. Clearly the lump sum at birth approach is impractical as long as 70 year forecasts remain a shot in the dark.

So one important flaw in private insurance is the time-line: long coverage periods come at significant increase in cost and decreased flexibility. Even in the purely libertarian approach, where everyone is rich enough to buy insurance plans from birth without any financial help from the government, such contracts would provide poor long term health coverage. Lesson #9: private insurance contracts must be limited to short periods.

Regularly renegotiated private contracts would definitely prevent unhealthy people from rolling over their insurance contracts, thus defeat the entire purpose of universal insurance. Limiting the information available to insurance companies in pricing their policies is essential in avoiding this. Giving them only the data available at birth fixes this problem fairly well. Only mandatory baseline insurance can be priced this way, otherwise customers who know they are more at risk than their birth data implies would skew their insurance choice to their advantage. Some problems remain. If the data available at birth include the customer's DNA, improving DNA analysis may reprice individual risk even if the dataset at birth has not changed. Also, insurers with the best service would end up getting all the sick customers, rather than their fair share of sick customers. Lesson #10: there is no good way for private insurance to provide universal health coverage.

Elements of a practical solution
- Private enforcement and execution of medical acts.
- Low awards for malpractice lawsuits.
- Health taxes and coverage must be different per age group, and may vary over time (though this is not entirely fair).
- Compensation should be paid out per illness as much as possible, and not always matched to the cost of a medical act. The government should set such compensation to the price most venues offer for the service. This is a messy gray zone.
- Parents having children with high/low health cost should pay or be paid for the difference (not too popular, this one).

Immigrants should be required to have the minimum "immigrant baseline health insurance", similar or identical to the one provided by the state to native citizens of the same age. These immigrants should be exempt of the health tax burden of native citizens. The health case of individual immigrants is too complex and fragmented to be priced efficiently by the government. Only private insurance companies can do this efficiently. Also, immigrants could have the option of continuing to pay health taxes in their native country as a partial or complete substitute to private insurance, as long as it matches the minimum "immigrant baseline health insurance". For example, citizens of most western countries could be allowed to immigrate because their native health coverage is considered sufficient, though not necessarily a superset of the native insurance required by their host country. Upon emigration, native citizens should continue payment of the health tax to their native state in order to continue receiving the same coverage in an other country. Calculating accurate compensation between the individual and the state for early termination of the health insurance coverage is not easy (many factors are at play here).

Macro effect of driving less

2007-07-06T06:15:00.001-07:00

I recently renewed my car insurance, and one of the main questions was "How many kilometers do you drive a year?". I initially thought that the insurance price for collisions should be directly proportional to this number.

But in reality, the function should not be linear, since by not driving I am changing the density of drivers on the road at any one time, thus reducing the likelihood of collisions occurring per car hour. It may take a monopoly (i.e. a single insurer) to be able to pass on such savings in a non-statistical manner.

Credit and insurance

2007-06-12T15:00:00.000-07:00

It is quite frustrating to buy insurance without ever needing it. When the cost and the benefits balance on a short-term basis, this frustration is tolerable: you pay premiums for the next month to cover your risks for that same period.

Some types of insurance balance out over longer periods, such as life insurance: you pay too much for life insurance initially and too little for it at the end of your life. At least you know that you will collect on this insurance at some point.

But what about insuring a punctual risk with borrowed money? In this case, you know early on if you are going to benefit from the insurance (usually you don't benefit), and you have to pay for it for years to come. Those are some mighty miserable years, paying a loan that did not actually buy you anything!

Welfare and non-regressive taxes systems are exactly this type of insurance. Your capability and willingness to work are basically constant through-out your tax paying life.

Some types of insurance are bound to make the bulk of us miserable. I don't see how I can fix this one, other than eliminating the credit part. This would require really cheap insurance or really rich parents.

Laissez-faire or cost-plus?

2007-06-12T12:46:00.000-07:00

Competition leads to fair pricing. Price reduction comes both from innovation and taming the greed of incumbents. The fair market value of a good or a service is composed of the cost of offering it, plus a reasonable profit margin.

Monopolies, might they be states or corporations, feel little need to innovate and little price pressure. Watchdog organizations must put this pressure on them artificially. This is often poorly accomplished.

A major problem is fairness. Why should phone services cost the same amount in rural areas as cities? Why are there any corporate taxes? Why isn't income tax head based? These are the real costs: they would appear naturally in the absence of a monopoly. Fairness has no place in the market, and should not be promoted by the state through economic manipulation.

Though both are necessary for a viable civilization, socialism and free market economics make awkward bedfellows. They should be kept apart with constitutional rigor, like religion and state.

Maximizing utility

2007-05-26T11:30:00.000-07:00

From a purely economic standpoint, maximizing utility with fixed resources amounts to splitting the pie equally amongst everyone. Yet a good deal of utility comes not from ownership of pie, but rather from the potential of ownership of pie. The lottery is a good example of this (I'm drooling right now, thinking about the range of pies behind this ticket!). Thus cockeyed optimism produces a permanent utility bubble for which we are all better off. To answer Raymond Chandler's question "What do you expect from life—full coverage against all possible risks?", even a theoretical utilitarian must answer no. Perhaps these theoretical utilitarians should form a country after rounding up all the willing cockeyed pessimists. ;-)

From a practical viewpoint, resources are never fixed, so maximizing the size of the pie is overwhelmingly important in maximizing utility, as opposed to dividing the pie equally.

Right to reduced productivity?

2007-05-26T10:08:00.000-07:00

If your personal balance sheet has more debt than assets, do you have an obligation to maximize your productivity in order to avoid default? An explicit example: are you allowed to commit suicide when you are debt laden?

Reducing productivity can be done in many ways. You can work less than full time, take a job that you enjoy more but that pays little, not wear your seat belt, not use a condom, practice various dangerous activities.

Obviously the non-defaulting parties pay either more interest or an extra insurance to cover the odds of default.

The moral of the story: forcing people to wear their seat belts can be fair because it reduces the cost of borrowing for others. However, this measure seems quite marginal as compared to the total potential of reducing productivity by other means.

Problems with previous post

2007-05-25T17:53:00.000-07:00

Prices going up. Insurers can default on their obligations if these are badly managed, or if these are unsustainable in light of unforeseen macro events. For example, the scarcity of future labor makes inflation adjusted fixed benefit insurance vulnerable to inverted pyramid demographics. If there is only one barber left in town with twice as many customers as he can handle, everyone has to live with their hair growing twice as long!

Prices going down. Many remedies to insurable events become cheaper–or possible even–over time. Planning for such decrease is even more difficult than planning for prices going up. Deciding which risks should be covered over a period of 100 years right at the start is impossible.

Non-mandatory private and self-insurance plans are the only way to get around these uncertainties, with all the unfairness linked to such plans.

Socialism - well done

2007-05-25T17:29:00.000-07:00

Socialism, well done, is simply the selection of mandatory insurance that a society imposes on its members, and how to pay for it. Traditional insurance is obvious: medical, dental, death, disability, employment. Add to this intellectual capacity, propensity to commit a crime, laziness, luck and you have yourself a government. You can even add aesthetic insurance, to put that nose in just the right place!

If you want to change country permanently, it becomes necessary for the ensuring parties (and yourself) to balance. If you want to change your insurance policy (the change would be collective in the case of mandatory insurance), it is necessary to balance also. This is because you will necessarily want to drop insurance that does not apply to you, and increase insurance for afflictions that will affect you. Because of this, it is very tricky to balance in fairness.

The solution seems to be that a new generation can only negotiate their collective insurance policy before birth. After birth, only a unanimously agreed change in the law is fair.

A great quote from Seinfeld

2007-05-05T17:19:00.000-07:00

Jerry: Ah, you're crazy.
Kramer: Am I? Or am I so sane that you just blew your mind?
Jerry: It's impossible.
Kramer: Is it? Or is it so possible that your head is spinning like a top?
Jerry: It can't be.
Kramer: Can't it? Or is your entire world just crashing down all around you?
Jerry: All right, that's enough.
Kramer: Aaaaaaahhhhh!

You should feel like Jerry after reading this blog. Enjoy!