The Lucas Critique and Patents

The Lucas Critique is the idea that when policy targets a variable that is supposed to be correlated with a desired outcome, that variable will become decoupled from the desired outcome. That is because by targeting the variable the rules of the game have changed, and with new incentives the variable may no longer be tied to the same causal chains. This critique was originally applied to large scale macroeconomic models that relied on extrapolating observed relationships after one variable is manipulated via policy, but the critique applies more generally as well.

I've posted before about today's disconnect between innovation and patents, but I didn't realize how directly the Lucas Critique applies. Policy was actually set up to increase patents in an attempt to revitalize the economy. Gordon Crovitz explains in his WSJ column: (Hat tip: MR)

Today's patent mess can be traced to a miscalculation by Jimmy Carter, who thought granting more patents would help overcome economic stagnation. In 1979, his Domestic Policy Review on Industrial Innovation proposed a new Federal Circuit Court of Appeals, which Congress created in 1982. Its first judge explained: "The court was formed for one need, to recover the value of the patent system as an incentive to industry."

At the time, policy advisors believed that patents were correlated to economic productivity. This set the stage for today's world, where the correlation between patents and productivity might now be negative. That's because so many of today's patents end up functioning as primarily as a tax on the companies who are moving into new markets. Google spent billions of dollars buying Motorola for its patents to protect its Android ecosystem so it would be armed in the patent wars. Money is being spent on patent portfolios, patents which often describe absolutely trivial ideas, when this money could otherwise be spent on real research (or at least buying companies that did real research and have a functioning product to show for it). 

From 2007 to 2011, the CBO found that 89% of the increase in patent lawsuits come from software patents. A recent bill by the House of Representatives targets patent trolls (20% of the lawsuits come from non-practicing entities), but after IBM and Microsoft lobbied to protect software patents the bill does little to stop the patent arms race between large corporations.

The Supreme Court is hearing CLS Bank v. Alice Corp soon, a case about whether a computerized escrow process is patentable. Reform seems very unlikely to happen congress right now, but it will be interesting to see what comes out of the Supreme Court.

Truth in Nigerian Chain Letters?

Nigeria is looking for $50 billion dollars in missing oil cash. Apparently someone at the Nigerian National Petroleum Corp misplaced the cash.

"The NNPC failed to remit to the government 76 percent of oil revenue earned from January 2012 to July 2013"

Not all of it is missing oil money. Some of the money is missing because oil was exchanged directly for refined product. And even if that is the case it's still likely that some of the refined product was itself stolen from the government. But even though there are probably quite a few Nigerians with this misplaced money, it's pretty unlikely that they need access to a random US bank account. I'm pretty sure they've already figured out how to get it out of the country on their own.

A Protest That Encourages the First Mover

Most protests against the government are costly and dangerous things. Protesting involves leaving work in the middle of the day (a population with a low employment to population jobs makes protests more likely for numerous reasons) to go to a city center and face off against police who are armed and have the existing regime backing them up. It's particularly dangerous to be among the first protestors entering this situation, because the police are much more likely to arrest a small group of initial protestors whereas it is logistically difficult to do the same thing to a large mob.

Given these constraints, it's a wonder that significant protests against the powers that be get started at all.  A small group with a special combination of courage and foolhardiness, combined with a focal point that will assure marginal potential protestors that they won't be the only ones, is generally needed to get the ball rolling.

Recently, large amounts of protestors have taken to the streets in Kiev, where the Ukrainian people are upset that their President Viktor Yanukovych is so far in the pocket of Putin that he blocked an EU free trade deal favored by many. (It might be that Yanukovych gave in to Russian pressure because he worried a recession induced by Russian sanctions would lose him the election in 2015, but the result is the same.) In this case the focal point wasn't just Yanukovych's rejection of an EU trade deal, but the brutal way the police broke up the initial protest composed of those first movers.

What's interesting is that there is an idea is floating around for an additional method of protest that encourages Ukrainians to join the protest and join noe. The strategy is simple: Encourage people to move their money out of the overvalued and pegged Ukrainian hryvnia into other currencies. Even better is taking the money out the banking system entirely.  If enough people do either of these actions, the Ukrainian Central Bank will struggle to hold up the banking system. Even if they only change currencies, Ukraine will be forced to weaken their currency as their reserves are low and they are running a current account deficit. This is a really interesting strategy for the following reasons:

1. Symbolically, it has citizens protesting an economic injustice with micro-economic sanctions of their own.

2. Unlike most forms of economic protest, it imparts potential benefits to participants outside of just increasing the chance that their demands will be met. Protests are usually relatively dangerous, but in this case it might be the only way to be safe.

3. It encourages the first movers, as the sooner the currency is converted to a more stable currency the less they risk from devaluation. And if enough people withdraw their deposits then a bank holiday might be declared in which those slow to join in will lose access to their money.

4. If it causes a devaluation then Yanukovych is more likely to lose the next election. 

The potential for turmoil already has Ukraine's Central Bank Governor scrambling, he released a message to the public telling them not to withdraw deposits and vowing that he would do everything needed to ensure stability.

Like all protests, the government has numerous ways of fighting back against this type of move. Figureheads with too much to lose should still be reluctant to join in. And additional capital controls can be imposed once the problem becomes obvious. But the overall lesson of finding ways to make it not just morally right, but safe and prudent for people to join a protest is an idea that more first mover protestors should think through.

It will be interesting to see how the situation in Ukraine develops. 

A Chart of Misallocated Capital

A recent VOX article looks at what has gone wrong with Italy's productivity.  In Italy, total factor productivity has actually fallen over the decade of the 2000s. One of the contributing factors is that there has been investment growth in sectors with falling productivity, rather than investment growth in sectors with higher productivity. 

"Investment and TFP Growth, Italy vs. Germany (1995-2006; 2 digit manufacturing sectors)"

In this chart, Italy's manufacturing sectoral investments are contrasted with Germany's. In Germany, many of the sectors seeing higher productivity growth often receive more investment. Not all sectors require additional investment just because their productivity is rising. Competitors outside the country might outcompete local producers even when productivity is improving or rising productivity might mean that the total demand for the product is taken care of by current producers. But it's instructive to note that there is widespread acceptance that Germany is the healthy economy while Italy is quite unhealthy.

This misallocation of capital is correlated to Italy's inability to incorporate information and communications technology into their businesses the way the United States and other countries have done over the past few decades. Inefficient management practices, such as a focus on tenure and equality over performance based metrics, which have been found to hinder technological adaptation, are more common in Italy than in comparable Eurozone countries.

But this ineffective economy also provides a great answer to those who wonder why capital allocation is important in the first place. When the normal capital allocation process breaks down we will see scenarios like the above chart, magnified significantly. The capital allocation process can break down for many reasons, ranging from group think and herd behavior to government regulations favoring the less productive sectors.  But in either case, it will generate a scenario like the above chart where less efficient sectors are getting unproductive investments at the expense of more productive sectors.

Assorted Links

1. Think tanks, charities and other non-profits need to be more aggressive in combating internal theft/fraud/embezzlement. As long as employees know that the worst case scenario of stealing is that they will have to pay back the money then stealing will be a positive expected value move for those with the opportunity and a lack of morals.

2. Arnold Kling talks about "The Great Factor Price Equalization" in which we are given one of the better explanations for wage stagnation in the developed world.  If it's the second time I've linked to this article it is because it is important. This link was inspired by a really bad article from the CEPR on a similar topic - except the CEPR's economist writes in a such a way to indicate that they believe that an increase in supply should lead to an increase in price. 

3. Beer goggles just got more dangerous. I'm sure comedians will come up with better jokes than that. Referencing this chart, we see that weight limitations mean that plan B does not work among about 25% of white US 30 year olds.

4. Politics is not about policy, and other views from Robin Hanson. This link deserves its own post but is very much worth reading.

Paying with Time

With the holiday shopping season coming up, it's a good time to remind everyone that widely known good deals often have extra costs due to so many people trying to take advantage of them at once. Sometimes the cost is something we are willing to pay - for many cyber deals you just have to be one of the first X customers to buy a good that is on clearance.  This may involve getting ready at a certain time and expending effort to be among the first in line, but the non-monetary cost is generally reasonable if the deal is good enough. But the most common mistake people make is not accounting properly for time spent. The time spent waiting in line, an activity that few claim to enjoy, acts as a large increase in the price of the goods being sold.

When a fast food restaurant like Chipotle or KFC announce they are giving up free food, lines form around the bloc. People will wait over an hour in line to get food that sells at retail value for less than half of one hour's wage. 

And the people camping outside of Best Buy a week before Thanksgiving aren't very likely to find deals that save them more than a thousand dollars.

Going to the mall on Black Friday involves many of these types of transactions, as the extra long lines capture most of the consumer surplus that might be gained from the larger than average sales.

What drives these behaviors?

1. Some people are relatively irrational and either don't consciously value their time or act on the basis of inertia and once they've gone.

2. Some people enjoy the process of waiting in line and getting deals that aren't available to others. This certainly seems to be the case for those camping outside of stores a week before Black Friday.

3. Some people are constrained in the amount they can work, so spending a significant amount of leisure time to save a little more money makes economic sense. Even for those with continuous earnings potential, the next marginal hour of work is likely to be at least slightly less productive than the previous hour of work. (Incidentally, this is why European productivity numbers compare favorably with the US - their shorter work weeks help them prioritize.)

4. Some people enjoy tradition.

People who go for reasons number two, three or four are reasonable. But it is worth rethinking the assumptions as it is likely that there are many people in category 1 who go shopping on days like Black Friday even though they should know better. So before you go shopping and end up waiting in different lines on Black Friday, make sure that you know the true cost of the items you are purchasing. 

D(x) Liar's Dice

One of my best board games purchases was a pound of six sided dice. It means we never are missing dice for our games and it enables us to play Liar's Dice with large groups of people. My group plays the elimination variant, not the drinking one. I recently got another pound of dice from Chessex - but this time I opted for the assorted set. Instead of getting just six sided dice, it comes with d4, d6, d8, d10, d12 and d20. I want to play Liar's Dice with these dice too.

Proposed game: D(x) Liar's Dice (Or Nerdy Liar's Dice).

Each person starts with a full set - (d4, d6, d8, d10, d12, d20). It works like liar's poker, where if someone says "three 4s" they are guessing that between everyone, there are at least three 4s on the table. The next person can either call "three 5s" "three 6s" "four anything" or "bullshit" - in a call of bullshit the dice are revealed and the person who is wrong gives up a dice and it goes until only one player has dice left.

You still only call out a certain number of dice showing numbers between 1 and 6. D4 and D6 work as expected - the number on the dice is the number used. For the other dice it is pretty intuitive. Primes are 1, everything else consists of their factors excluding the number 1:

7 is 1
8 is 4 or 2
9 is 3
10 is 5 or 2
11 is 1
12 is 6, 4, 3 and 2
13 is 1
14 is 2 or 1 (The 7 counts as a 1 in this case unless 1's are wild)
15 is 5 or 3
16 is 4 or 2
17 is 1
18 is 6, 3 or 2
19 is 1
20 is 5, 4 or 2

When playing with wilds, 1's are also wild unless they are called by anyone (if the second person can call 1's then the first person bid too low), so anyone can say "four 1's" if that is a legal bid and then ones are no longer wild. In liar's dice with d6 it doesn't matter which dice you give up, but in this game there is some strategy behind whether you want the potential wilds or you want to keep your d4.

This variation should make the strategy more interesting than traditional liar's dice, because now it is actually less safe to move up from 2 to 3 or from 4 to 5, while in the classical game it was always optimal to make slightly aggressive bids of the number of 4's and 5's so people would bid that there are the same number of 5's or 6's on the table rather than having to call bullshit. Now no number is safe, though bidding a slightly aggressive number of 3's to let the person after you bid the same number of 4's or a higher number of 2's seems like a decent strategy.

This game definitely needs some tweaking and play testing - maybe it should be played with more D20s and less D8s. Maybe dice should be drafted or handed out randomly to allow for asymmetric play. 

I'm probably going to need more dice.

Are Walmart and McDonald's Welfare Queens?

Barry Ritholtz, the man behind the Big Picture trading blog, has a column on Bloomberg View where he chastises Walmart and McDonald's for their large number of workers on welfare.  It's titled, How McDonald's and Wal-Mart Became Welfare Queens. He gets right to the point.

"According to one study, American fast food workers receive more than $7 billion dollars in public assistance. As it turns out, McDonald's has a “McResource” line that helps employees and their families enroll in various state and local assistance programs. It exploded into the public when a recording of the McResource line advocated that full-time employees sign up for food stamps and welfare.

Wal-Mart, the nation’s largest private sector employer, is also the biggest consumer of taxpayer supported aid. According to Florida Congressman Alan Grayson, in many states, Wal-Mart employees are the largest groupof Medicaid recipients. They are also the single biggest group of food stamp recipients. Wal-mart’s "associates" are paid so little, according to Grayson, that they receive $1,000 on average in public assistance. These amount to massive taxpayer subsidies for private companies."

Ritholtz highlights three different possible solutions to the scenario that highlight the extent to which McDonalds and Walmart are abusing the system.

1. Raising the minimum wage.

2. Taxing companies for any public assistance their employees need.

3. Implement a guaranteed basic income for all adults like is currently proposed in Switzerland.  

(It seems appropriate to note that while basic income replacing welfare is an interesting theory, the proposal on Switzerland's ballot is absurdly high, as they are attempting to guarantee income equivalent to $67,000 a year for a married couple.)

The first solution references a long running debate among economists. If wages are forced significantly higher, it's likely that some current employees will be better off and a lot of potential future employees will be never be hired. Automated cashiers are basically a solved problem, and it's no coincidence that McDonalds are rolling them out in Europe where labor costs are higher before we see them here in the United States. Walmart also has cashiers that could be replaced if costs were higher.  It's a little ironic that people complain more about Walmart and McDonalds hiring cheap workers than they do about Amazon, which bought the robotic company Kiva Systems in order to reduce their need for human workers. If labor costs get high enough, Walmart might start to look at this type of automation more seriously.

The second solution jumps out as being immediately farcical. Before jumping to tax companies that employ anyone needing assistance we should stop and think about what that would mean for the hiring prospects of anyone that looks like they require this assistance. This is an example of the type of regulation that actively hurts those who it is designed to protect.

The third solution, which Ritholtz acknowledge as extreme, is interesting in theory. A guaranteed basic income, properly designed, is not very different from a negative income tax or our current Earned Income Tax Credit.  Negative income taxes theoretically work quite well, their main downside being that they lead to high marginal tax rates and reduce the ability of a society to be open to poor immigrants. The main problem with guaranteed income plans comes with the exceptions - the income is designed to replace welfare but there are always some groups that are seen as slightly more deserving and the process will inevitably allocate them a little more than others. This turns what was supposed to be a simple catch all program into one that merely magnifies the current problems of the welfare state. 

Thinking about whether or not Walmart and McDonald's are abusing the current system is an interesting question. But when we look at proposals to fix the problems it becomes apparent that the alternative to paying a lot of workers a bit of money could lead to these companies investing more in capital and paying fewer workers. 

Without employment opportunities at Walmart and McDonald's and other similar work places, many of these workers would have no jobs at all. The government would then have to pay out even more benefits to support people with no other incomes. It's not like they are perfect corporate citizens, McDonald's and Walmart have lobbied federal, state and local government for various rules that help them and hurt their competitors while they take advantage of every tax break they can. 

It's reasonable to think that many of the tax loopholes used by these companies should be closed and the various laws their lobbyists helped tweak before passage should be repealed. But the fact that McDonald's and Walmart employ low skill labor and pay them at the levels dictated by supply and demand is not something that should be held against them. 

Useful and Wasteful Signaling

One of the goals of this blog is to make sure that I never run for office in the future.  That said, a recent Talking Points Memo by McMillan Cottom, Why Do Poor People 'Waste' Money On Luxury Goods?, looks at an interesting topic. (Hat tip: Gene Z)

"I learned, watching my mother, that there was a price we had to pay to signal to gatekeepers that we were worthy of engaging. It meant dressing well and speaking well. It might not work. It likely wouldn't work but on the off chance that it would, you had to try."

Owning a nice outfit for job interviews or general interaction with the outside world can vastly improve the results. That's why the phrase "dress for success" is generally accepted as common knowledge. And it is a particularly useful strategy for groups that are likely to be discriminated against in everyday interactions. 

However, the point doesn't actually counter the normal critiques of wasteful signaling spending by the poor.  When people discuss the wasteful spending, it isn't about buying a nice suit. They are usually geared towards behavior such as spending more money on large jewelry or flashy footwear.

For those looking for some hard data on this, the 2012 Federal Reserve's Consumer Expenditure Survey found that African Americans had after tax incomes almost 30% lower than Whites and Asians yet spent almost 25% more per year on footwear. On an absolute basis, the only category of people to spend more on footwear were Asians, yet they still spent a significantly lower amount of their total after tax income.

The spending on footwear and jewelry and other such items is still signaling, but unlike buying a nice suit this is signaling at the in-group. The people who respond positively to these signals are generally in similar cultural and social circles. Buying suits or outfits to fit in at a common work environment is signaling an outside group and potentially changing their view in an important way.  Signaling outside groups can be a productive behavior, and if enough people do it then it can change people's perspectives and reduce the need to signal in the long run.  

On the other hand, signaling to inside groups is very wasteful. Everyone is wasting resources in an attempt to establish relative status positions. This type of behavior should not be encouraged unless there are other significant benefits from signaling behavior. An example of a signal that could be useful is parents bragging about their children's educational achievements* or people exercising and eating healthy to be in the best shape.  In the long run, this is much more productive than trying to wear nicer clothes or drive nicer cars. 

Cottom ends their piece with a plea for people to be more understanding of signaling by poor people.

"You have no idea what you would do if you were poor until you are poor. And not intermittently poor or formerly not-poor, but born poor, expected to be poor and treated by bureaucracies, gatekeepers and well-meaning respectability authorities as inherently poor. Then, and only then, will you understand the relative value of a ridiculous status symbol to someone who intuits that they cannot afford to not have it."

It is true that most of us (I'm making demographic assumptions about my 15 known readers here) aren't in a position to understand what poor people go through. But overall the piece lacks an understanding that there are important differences between useful and wasteful signaling. The useful signal helps correct an incorrect view held by others. The wasteful signal is spending limited resources on playing in-group status games with no long term benefits.


*To an extent. Our current obsession with college degrees regardless of the cost or usefulness of the major is actually one of society's current problems.

Anecdotes about Russian Drinking

1. Beer has only recently been labeled as an alcoholic beverage.

2. The etymology of vodka is very closely related to slavic the word for water.

3. "Russia’s official addiction expert, who in the past, according to Heidi Brown, has advised Russians who like to drink a lot with dinner to open their windows a bit in order to get less drunk..." (Hat tip: MR) The rest of the article discusses why Alcoholic Anonymous is not popular in Russia. One of the major reasons is that excessive drinking is not seen as problematic unless/until it causes a person to end up homeless in a ditch.

Less funny is this chart of male and female life expectancy, which shows some of the impact the drinking culture has on life expectancy:

The difference between male and female life expectancy was over 11 years in 2011, the largest difference in the world.