PayPal Incentives

I'm not sure which people at PayPal are going to take the blame for this little fiasco, but it would be interesting to know what they were thinking.

A 17-year-old German student found a significant security vulnerability on PayPal’s website, and when he revealed the issue to the company, expected to be rewarded.

But PayPal refused to pay Robert Kugler a Bug Bounty, telling him he was too young to participate in the company’s program that rewards people who find glitches in the system. TechWeek Europe reported that Paypal defended its actions in not paying the bounty because of Kugler’s age and because the bug had already been found.

First of all, they are generating bad press over a topic tangentially related to their existing PR problem of being seen as a company that refuses to pay people money they are owed. But perhaps more importantly, while the bug in this case may not have been critical PayPal is signaling to other hackers that they are not necessarily reliable in their bug bounty program when there are plenty of other people out there willing to buy information on PayPal's bugs.

Reinhart & Rogoff Irony

The Reinhart & Rogoff saga continues.

One point that hasn't been addressed: Outside of the issue about the significance of the data errors, the main complaint seems to be that Reinhart & Rogoff didn't do enough to clarify that the correlation between high levels of sovereign debt and low growth was not necessarily causal. Countries often had debt because they had low growth, the high debt isn't necessarily the cause behind low growth.

Critics of Reinhart & Rogoff then go on to point out that this paper was a major driver behind the austerity movement because politicians supporting austerity often cited this study. I'm not sure if people making these claims really think that Paul Ryan would be okay with budget deficit without being able to talk about a 90% level in debt/GDP, but it's funny that they are making the same mistake they accuse Reinhart & Rogoff of making.

Rationality improvements in the 3rd millenium

The question is simple - what are the biggest ways that people in society are acting more rationally since the start of the third millenium?

1. A/B Testing - Testing two products and seeing which one people like better has been around since New Coke improperly replaced Coca Cola Classic.  What is different in the third millenium is that with so much business being done online it's both easier and cheaper to test various options against each other. Different pages for customer check out, different email marketing campaigns and many other approaches can be tested against each other randomly, quickly and cheaply. Zynga is well known for doing heavy A/B testing in its monetization, retention and recruitment of online casual gamers (unfortunately for them what worked best was some variation of massively spamming online friends or their own Facebook wall in order to receive power ups in game, which Facebook cut down on). At the very least, randomized controlled trials are gaining a much stronger foot in the business community than every before.

2. Rationality communities and rationality materials have spread a lot thanks to the internet. We have websites like overcomingbias.comlesswrong.com and lists of common biases at the tip of our fingertips.  Before the access to the type of material on these sites was restricted to academia, libraries and some relatively specific social groups. Finding books on rationality has also never been easier.

3. Smart phones have rendered debates about most facts relatively useless. If people are wondering who was actually president was in 1969 it's really easy to figure out in a few seconds.  Before ubiquitous access to the internet (Google and Wikipedia), people who disagreed about common factual matters would have to share related facts ("Don't you remember that Nixon called Buzz Aldrin and Neil Armstrong while they were on the moon? The moon landing was also in 1969.") and hope that they could come to a common world view through agreement on peripheral facts. That process has been largely replaced by the internet giving everyone access to most common facts.

4. Scholarly research is more available than ever before. Anyone searching for articles will find that there are still many pay walls, but there is progress being made to open up research access to the general public. However, until old papers like JSTOR also open up the references to older papers in newly published work will still leave those without access behind the pay-wall in the relative dark.

5. Prediction markets. People have started trusting prediction markets more than most experts, though there have been a few exceptions.  Idea futures and expansions on them such as state contingent idea futures has been a pet idea of Robin Hanson for some time.  Regulators haven't been too friendly and/or the market place isn't quite liquid enough for most markets, so while it is interesting that there are places out there which curates an active market for people who want to put their money where their mouth is, a lot more would have to happen on this front for it to be truly significant. 

6. Much better analytical tools. I may be a bit biased for even including this idea on the list, but with AI largely disappointing (though many people are now finding a tool like Siri useful), the ability for people to utilize computers in their analysis has vastly increased in the past decade.  With the evolution of tools such as Palantir, it is becoming much easier to look through the connections between large amounts of data.

7. Better ways to organize and present information. Wikipedia, reddit-type threaded message boards and task organizers like Asana and programming version control such as git have been quite useful. Blogs by experts are also very interesting, and their ability to crowd-source their readership for ideas/answers/corrections should not be underweighted. The investors in Quora certainly think this space is valuable. There are enough ideas in here that it could have been at least a few points on the list.

There have also been ways in which rationality has decreased - more and more of public, private and scientific life is becoming politicized. But reviewing the above list makes me a bit optimistic. While not the most important, I think that the rise of A/B testing is probably the most underrated trend, while #3 and #7 should have the widest impact.

Hat tip: Kevin Simler for some of the ideas mentioned above

The SF Fed whiffs it

The Federal Reserve Bank of San Francisco published a letter that tries to look at whether or not regulation and taxes are impacting state level employment. (Hat Tip: MFK)

To look at whether or not regulation and taxes are an issue, they use state level data from the National Federation of Independent Businesses (NFIB) monthly small business surveys and correlate it to state level unemployment. The source they linked to didn't seem to contain the state level data they were given, so unfortunately I am confined to critiquing their economic letter rather than improving upon it.

If you want to look at the only interesting part of their paper, look at this following chart:


It turns out that places with large amounts of household debt relative to income in 2006 ran into problems with sales during the economic crisis. By backing up their previous research with the small business survey, the authors try to show the usefulness of the NFIB survey and imply that because they can't find the same data relationship between business leaders' changing worries about regulation and unemployment that there must not be a significant impact from those regulations.  However, their attempt runs into a few problems.

1. The study looks at percent change in unemployment in many cases - I'm sure North Dakota which has 3.2% unemployment (but it went up by over 10% in their scatterplot!) isn't actually the worst off as it implies in this chart

2. They are looking at the change in the percentage of businesses who are worried about regulation and taxes as their top concern. Again, this is a percent change in a percent - so a change from 10% to 15% of businesses worrying about regulation and taxes is more significant than a shift from 25% to 35%. They are also looking at the change from 2008 through 2011, which largely overlaps with the rise of the tea party. A survey question about sales being a problem isn't that political, but a survey question about taxes and regulation will be far more correlated to political shifts than the actual impact of those regulations.

If Amir Sufi and Atif Mian wanted to do an analysis regarding the impact of high taxes and regulation uncertainty that might look it was done by professors from Princeton University and the University of Chicago Booth School of Business how could they go about it?

First, they should control for potentially exogenous variables like the political shift that came with the rise of the tea party. There is a lot of poll data out there, so seeing which business leaders were complaining about regulation, adjusting for the change in political views of their state, could contain a lot more information.  They should also look to use poll data that ask specifically about state regulations, which is more likely to have a direct connection to state level unemployment. Without adjusting the data like this, it leads to silly inputs that show both California and Texans dealing with similar tax and regulation problems. 

Second, using percent changes of percentages can be very noisy. At the very least, differences in unemployment as opposed to percent changes in unemployment should be looked at alongside the absolute levels (which they did look at). 

Without at least these two steps, a single or multivariate regression wouldn't show any effect from regulations even if there was one. But on top of that, it should be noted that unemployment statistics don't tell the whole story. In Texas it's entirely possible that lower regulation did drive job growth, but the population growth that occurred alongside the job growth has kept the unemployment rate high and therefore this data wouldn't show up in their analysis.

There are lots of ways that this analysis could have been very interesting. It's too bad the authors didn't try them. At least they did provide another example of academics putting out bad arguments in an attempt to elevate the status of their previously published work.

Broken Incentives in US Nuclear Power Regulation

A nuclear powerplant at San Onofre was shut down a year ago after a slight radiation leakage.  Now it turns out that there are allegations that they were aware of potential concerns with the steam generators that broke but neglected to fix them because the fixes would have led to a more rigorous safety review.

Boxer's letter adds new weight to a longstanding — and unresolved — question at San Onofre. Did Edison modify the generators so extensively before they were installed that the company should have sought an amendment to its operating license, a process that can take months or even years?

Essentially the story is that the utility faced a cost benefit analysis that compared the cost of the following.

P = Reduced probability of steam generators breaking from potential modifications
C = Cost of steam generator breaking
S = Cost of additional safety modifications
L = Cost of Licensing from the NRC

And they decided that S + L > P*C so they shouldn't change anything about the design to reduce regulatory oversight. It turns out it was the wrong decision. 

Barbara Boxer's office is now alleging that they have proof that executives thought P was significant but believed that L was too high.  Senator Barbara Boxer's office broke this story and they seem to want to make L more mandatory so that the utility company would not have had to enter that variable into their cost benefit analysis. There is also a believe that L would lead to a further reduction in the probability of new machine parts breaking.

However, I haven't seen many people covering the story mention just how perverse these incentives are that safety modifications would have cost too much in licensing requirements to be implemented. In this regard maybe the US should look more to Japan and France's streamlined licensing and certification procedures rather than use any excuse of problems to hike costs for nuclear energy even further.  

It's too bad Japan's tsunami put people off nuclear power. Clean energy isn't perfectly safe. Take hydroelectric power, where a broken dam also has the potential to kill many people. But nuclear is scary and dams and floods are common so the opposition to dams is based more on environmental grounds and people living downriver while the opposition to nuclear power comes from across the country and is based largely on ignorance. When the costs of making any changes are high, the benefits of plants running newer technology are minimized. In Japan, the newer power plant that was closer to tsunami fared much better than Fukushima Daiichi plant.  We can see from San Onofre hints that under a system where any change is penalized with years of costly licensing review the chances of a disaster might actually go up, not down. 

Financial links

1. An ironically titled blog post from Reuter's Felix Salmon. I think he was thinking about "black swans" in the place of "tail risk." When one of the obvious causes behind a large standard deviation move in asset markets has become much less likely it's okay to say that tail risks have decreased. 

2. The IMF has an interesting analysis that clearly explains why a country like Japan has lower sovereign risks than their total debt levels suggest. Central banks and domestic investors reduce funding risk, so the interaction between high debt levels and an unstable investor base is generally more important than one of those factors by themselves.

3. I haven't touched on the Herbalife financial soap opera yet. For those of you who haven't heard of it, it really started when Bill Ackman gave a speech at Ira Sohn and then released a report accusing HLF of being a pyramid scheme. His price target for the stock is zero. If you are interested in whether or not this is a good trade then check out Bronte Capital's post. It seems that while Herbalife is ripping off their customers by overcharging them even after the discounts they are giving their so-called distributors, their multi-level marketing model has created many different nutrition support groups that may not be extremely profitable for people running them but are still generating real value for their customers and thus much of Herbalife's revenue is stickier even in light of the bad press. This means that the only real way the short will work is if the government goes after Herbalife, and their track record in this type of thing is pretty bad.
 
Why did I call this a financial soap opera? Outside of the arguments between Bill Ackman and Herbalife, fund managers are jumping in on all sides of the trade. Daniel Loeb and Carl Icahn are both rumored to be long HLF. David Einhorn was rumored to be short HLF in 2012 when he asked a question on a conference call a few months before Ackman made his presentation. If you want to see two hedge fund managers on different sides of the trade (one of whom is showing signs of senility) go at each other on live TV then watch the video at the link.  More recently, Herbalife hasn't been helping their credibility when they go and register domain names related to the name of Bill Ackman, the person shorting their company. Actually, this might be more of a comedy than a soap opera.

Positive rights, negative rights and corruption

Thinking about how to live in a corrupt country is interesting. It looks like there is a choice between playing by the rules and not getting anything done and making up your own rules or succeeding by bending all the rules but becoming part of the problem in the process.  The only way to win appears to be not playing the game in the first place. And this might be a good reason for businessmen from the developed world to be a little wary of trying to enter developing world markets when they are unwilling expect to bribe people or hire people who will bribe others. The foreign corrupt practices act is another reason to make people wary, leaving the only legal way to do business in a relatively corrupt country to partner with people who are already powerful and don't need bribes to get anything done.

One way to think about corruption is to tie to the concept of positive and negative rights.  Negative rights are things that are prohibited from being done to a person, and includes areas such as freedom from violent crime, private property (freedom from theft), freedom of speech and freedom from slavery. Positive rights are things that society must provide for a person. These include areas such as the right to police protection, housing, a job, food and health care. Many positive and negative rights conflict either indirectly or directly with each other. While a police force might help enforce the negative right or protection from violent crime, it also weakens the right to private property by requiring that citizens have some of their money taxed in order to pay for that protection. Societies with many positive rights such as the right to jobs, housing, health care, etc encroach on economic freedom in order to provide those rights and then economic growth generally suffers

So a person living in a corrupt society who wants to get by but doesn't want to make things worse should think of their corrupt actions in the terms of positive and negative rights.

Negative rights corruption would be bypassing or bribing officials in order to do things they should be allowed to do in the first place. This includes bribing officials to get licenses or business permits that are easily available in less corrupt countries.

Positive rights corruption is any corruption that also involves a significant violation of other people's negative rights. 

People and entities who are taking positively corrupt actions are actively making the country worse for those around them, while those who are negatively corrupt are just trying to function in a corrupt system.  Thinking about a few examples might help clarify what this means.

Walmart's actions in Mexico that landed it in hot water for violating the foreign corrupt practices act looks like a benign version of negative corruption since it seems to have merely involved facilitating the permitting and licensing processes (assuming these permits didn't also give them rights to take or pollute onto other people's land).  They were merely trying to do business and were not using the government to steal from anyone. However, the near monopoly in telecommunications that Mexico gives Carlos Slim by keeping costs high for competition is a definite example of positive corruption.

The officials that are underpaid that take bribes where the payees are acting in a negatively corrupt ways are still positively corrupt themselves, since even if they are taking those payments because they are underpaid they are still acting as if the government owes them a job.

When Chinese development companies have local party leaders force rural workers off their land, that is positive corruption. 

In the 1920's, when speakeasies bribed cops to let them serve alcohol that was negative corruption. When they bribed the cops to also shut down competing speakeasies it was an example of positive corruption.

Amgen's history of payments to Congress which helped them get a paragraph put into the US fiscal-cliff deal that will cause the government to pay them half a billion more dollars over two years is a good example of positive corruption that is still legal in the US.

The list could go on, but the point is that there should be an acknowledged difference between the two. The metaphorical line in the sand between good and bad doesn't start with breaking the law, it starts with breaking the law in a way that violates someone else's negative rights. And in fact a study has found that corruption that isn't associated with government characteristics can lead to higher growth in countries with poor institutions.  So those practicing negative rights corruption in the developing world look like they could be a net positive to their societies*.

*This is assuming that there is no slippery slope between committing different types of corruption. Also, perpetuating low level corruption might mean outperformance of countries in similar situations but it could also prevent a step change towards a society with better institutions in general.

Assorted Links

1. Scoring the United States election predictions of 2012.  When more common metrics than "Did his probabilities of over 50% work out" were used, Nate Silver's score was high but not higher than some other forecasts.  A few forecasters do beat the prediction markets at intrade, but intrade didn't do too badly either.

2. Developers vs unions in Philadelphia. With the internet, it's not just government abuse that can be exposed. Unions will have to be more careful about how they intimidate people into choosing to work with them. (HT: MR)

3. An interesting story of a trade association trying to furnish their office with products made in the US. Not surprisingly, it can get pretty expensive.

4. The flip side of the coin is a programmer who decided to outsource his own job and capture the profits. Outside of the security concerns this seems like a great idea.  However, that brings to mind the saying "Besides that Mrs. Lincoln, how was the play?"

Kobe beef in the US

For some time I have been thinking about how ridiculous it is that Kobe beef is even not allowed in the US and yet many people think they have eaten Kobe beef.  But apparently that was only true from 2010 through late 2012 when the USDA began allowing some Kobe beef back in the country.  That's good, because it means that the sushi chef who I'm pretty sure used real kobe beef to make nigiri is no longer violating that particular regulation in order to serve amazing food*.

The Kobe beef controversy is related but not exactly the same as the Champagne controversy. To many people, Champagne just means "sparkling wine." Kobe beef and Wagyu beef are used to mean "high quality beef" because people imagine that they are eating a very specific type of beef from Japan.  When the beef isn't actually from Japan and isn't even a purebred Wagyu, the issue is closer to fraud. 

Champagne producers already won the battle of forcing sellers to label where the bubbly actually came from.  They are hoping to push their victory even farther by recapturing a term that has developed a generic meaning. The Japanese beef lobby hasn't even begun to mitigate the fraud perpetuated by the US beef and restaurant industry.  So even though it's actually possible for people to import Kobe beef, think twice before you order Kobe beef in a US restaurant.  It's probably not the real thing, especially if it only seems mildly expensive.

*Maybe I'm not cynical enough, but it seems like people who import other high cost food from Japan such as fresh fish would be more likely to serve the real thing, especially if it is an off menu item.

Rise of the nerds

First, there were articles about how Settlers being talked about as the new golf in Silicon Valley. Hopefully the people who were playing Settlers have figured out where they can find much better games. One of the difficulties in picking a game is to figure out a game where re-playability is high, the dimensions of luck are controlled, the skill to win percent relationship isn't too high, kingmaking isn't easy and the length of time dedicated to the game is known in advance.  With the right board game, socializing around a board game seems like it should provide the same level of mental stimulation and socialization as golf. The main difference in function is that golf provides marginally more exercise and an excuse to get out of the house.

At around the same time, it has become more fashionable to look like a nerd. Well, maybe I should say that it has become more fashionable to look like an athletic person with good skin and thick glasses.

But it isn't just board games and oddly expensive** nerdy glasses that are getting main stream. Web comics targeting nerdy humor are more popular than ever and were the subject of recent article in the Economist. Around the same time, Forbes had a post on the rise of Esports. These are all trends that are hitting critical mass. The creator of The Oatmeal is able to raise millions of dollars for a Tesla museum, Penny Arcade is able to raise millions for Child's Play, a charity that puts video games in children's hospitals and there is currently a lot of money being spent and made on spectator video games. Next year they will be hosting three of their own convention, with the main one filling up Seattle's convention center and selling out in hours.  Maybe money is all it really takes to catch the attention of the mainstream. 

Board games, web comics and E-sports will remain a growing trend as the generations that grew up with gaming acquire more disposable income with age. It will be interesting to see how their inherently niche nature impacts their growth.  There aren't as many people dedicated to debating whether or not football or baseball is a better sport, and when there is a question the existence of the other sport is not questioned as closely. With E-sports many people fear that if another game becomes respectable their favored game will become superfluous and disappear from the scene. This means that the rivalry is much more intense than it is among traditional sports***, especially for games within the same genre. It is still an open question as to which games will be the main representative of their genre 5 years from now and how long any one game can stay at the top given how faster computers and gaming company's desire for more sales leads to newer versions of the same game being released every couple years.

Societal trends like this almost make up for how shows like Jersey Shore are creating celebrities. Almost.

*A high skill differential means that some games cannot be casually between two people. This is case with chess and go.  It's also the case for many board games but they generally have some mechanisms for luck to sometimes turn the game in the less skilled player's favor.
** Hat tip to VP
***It will probably still be a while before a match shoutcasted by Day9 causes a riot in San Francisco.