Relevant and even prescient commentary on news, politics and the economy.

Zombie Rationality

In this excellent post, John Quiggin somewhat understates his claim

The key passage

“the same fundamental confusion I pointed out last time, trying to claim that rationality assumptions are both important and unfalsifiable.”

and later at greater length

“Williamson wants to have his cake and eat it. Most of the time he wants to help himself to the strong implications of rationality as represented in standard micro texts, and to demand that macro be built on this basis. But, when this model is challenged on empirical grounds, he retreats to a concept of rationality that is tautologically true. This is a classic example of John H’s “two-step of terrific triviality”.”

My problem is that, while the concept of rationality is tautologically true, Quiggin is reluctant to stick to that claim. Instead he flirts with qualifications involving consistency or regularity.

“a brief, purely mathematical point. Any consistent pattern of choice among objects (of any kind) that we can observe, can be represented as optimization, that is, as the maximization of a function. “

So far the truth but not the whole truth, since the claim is true without the qualifier “consistent.” The reason is simple. If there is no limit on the class of functions to be maximized then calender time can be an argument of the function. In other words if I have to assume that the function of X being maximized changes over time, I can just interpret it a one function of time and X.

I beat a dead Buridan’s ass after the jump.

Quiggin knows this. He writes “Even choices that are inconsistent in various ways can be represented by more general notions of optimization.” I’d go a bit further. This claim means that *some* apparently inconsistent choices can be represented as optimization, but, in fact, all choices can be represented as optimization.

The proof by contradiction is elementary. Assume that there is a non-empty set S of series of actions which is inconsistent with maximizing any utility function at all. Consider a hypothetical agent whose sole desire in life is to make things difficult for rational choice modelers. The agent has a utility function which yields one util if the agent chooses an series of actions in S and 0 otherwise. It is optimal for the agent to chose a series of actions in S. But S was the set of series of actions which are not optimal for any utility function. This is a contradiction. Thus I have proven that S is empty.

There is no series of actions which can not be reconciled with utility maximization.

There can be no doubt that this claim is true. You have just read a rigorous proof.

This ‘Competitiveness’ Thing Is a Scam

This ‘Competitiveness’ Thing Is a Scam

What is ‘competitiveness’? It’s an important part of the euro area leaders’ negotiated terms in the July 21st Summit announcement by the European Heads of State. The first paragraph, #4, and #11 of the announcement all refer to this issue of ‘competitiveness’:

We also reaffirm our determination to reinforce convergence, competitiveness and governance in the euro area.

create a Task Force which will work with the Greek authorities to target the structural funds on competitiveness and growth, job creation and training.

All euro area Member States will adhere strictly to the agreed fiscal targets, improve competitiveness and address macro-economic imbalances.

It’s not totally clear what they mean by ‘competitiveness.’ However, I note that they separate the term ‘competitiveness’ from ‘macro-economic imbalances’. Current account imbalances across the region should be included in addressing ’macro-economic imbalances’.
Therefore, it’s bigger than the OECD definition of international competitiveness measure of a country’s advantage or disadvantage in selling its products in international markets.

See, ‘competitiveness’ is an elusive concept that is often associated with relative price movements, real exchange rates, or openness to international trade. But if we look at a May 2011 speech given by German Finance Minister, Wolfgang Schäuble, what he (and by association, the Germans) thinks of ‘competitiveness becomes more clear (h/t Marshall Auerback and bold by yours truly):

“All Eurozone governments need not only convincingly demonstrate their commitment to fiscal consolidation but also to increasing competitiveness to restore confidence of markets as well as their citizens.

Besides, one does not resolve one’s own problems of competitiveness by asking others to become less competitive and one cannot permanently close the gap between expenditure and income by asking others for more money.

the Eurozone has to put additional emphasis on strengthening the competitiveness of all its members. Consumption developments, bubbles in housing markets and the accumulation of external and internal debt in some Member States deepened the impact of the crisis and constrained the capacity to respond. This is why a new procedure for detecting and correcting economic imbalances will be introduced. This procedure will concentrate on curing the root causes of macroeconomic deficits by forcing Member States to ensure a high level of competitiveness.

Competitiveness is about strong macro-prudential policy, infrastructure, efficiency and income gains, saving, etc. Schäuble used the word ‘comopetitiveness’ 14 times in this speech – it’s an important part of his (and perhaps more broadly Germany’s) vision of the euro area’s structural construct. After reading the speech, you realize ‘competitiveness’ isn’t just about international trade and exports, it’s about the efficiency of an economy as a whole.

Now we’re on to something. The World Economic Forum measures competitiveness as a composite of various factors that describe institutions, infrastructure, macroeconomic environment, health and primary education, higher education and training, goods market efficiency, labor market efficiency, financial market development, technological readiness, market size, business sophistication, and innovation (.pdf link here, and composite technicals listed on .pdf page 49). The chart below illustrates the rankings of the euro area 12 and the USA (for comparison) as measured by the percentage of countries that rank below it across 142 developing and developed economies (.pdf page 15).

(Click to enlarge chart)

In 2011-2012, Germany ranks #6 out of 142 countries, where 95 of the 142 countries are less competitive than Germany. Also ranked below Germany is every euro area economy except Finland. So when a German finance minister says that he wants economies to increase competitiveness, he’s effectively saying that he wants economies to be more German. From the bottom up, countries should reform their education, financial markets, business sophistication, innovation, etc., all the while emulating those institutions in Germany.

Better put: being asked to increase competitiveness is really a scam to get these economies to become more ‘German’. If I were Italy or Spain or even Ireland (who by the way is very open but less ‘competitive’ according to this measure), I’d have a problem with that.

originally published at The Wilder View…EconoMonitor

Free market mechanics and healthcare…

by Michael Halasey

Free market mechanics and healthcare…

Now, I hear something all the time in my work in the health policy realm, and that is that the “free market” could lower prices.

I even recently had someone approach me after I mentioned that the PPACA had resulted in an extra million people aged 18-25 having health coverage this year. His statement? “That’s exactly the wrong direction, we need to have less people, far less people with health insurance.” I asked him his reasoning…of course, already knowing what his response would be. He reasoned that it would force people to compare prices, shop around, and would dramatically lower prices through the mythical, magical “free market”….

Of course, this ignores some rather real problems with this line of thinking. For starters, healthcare does not behave like normal commodities for a variety of reasons.

To start with, healthcare does not lend itself to price comparisons, and comparison shopping. The high costs are often related to trauma and emergency care/hospitalizations. It is simply not practical to ask which hospital in the area offers the best rates on cardiac catheterizations while you are being rushed to the hospital in the midst of an MI.

This impracticality also lends itself to probably the biggest problem. That is irrational behavior. Any of us who have taken even undergraduate economics remember the discussions of rational actors, and how prices were sensitive to rational behavior. Much of health care involves emotionally charged, heated, and oftentimes difficult decisions. Most patients and families can hardly be expected to act in a rational fashion about receiving the news of a terrible diagnosis such as cancer. Real world experience reveals this to be true. I wish I could count how many times I have presented various treatment options to patients, only to hear “Do whatever it takes”.

Hayek once wrote that spontaneous order was a result of market economies, and that it was “a more efficient allocation of societal resources than any design could achieve.” This of course, assumes rational behavior, and assumes that a market can be symmetric.

Because of this behavior, and because people view healthcare not as optional, but as a necessity, price elasticity scores generally trend around 0 or -1. This indicates an inelastic market.

Of course, the next time I have a 21 year old kid who comes in after a farm accident without insurance, and is badly injured, I’ll make sure to tell him that perhaps he should have shopped around.