Madison's Argument for Bigger Govt

One of my usual arguments when discussing systems of government, and incentive systems more generally, is the notion that smaller is better. A local government will be more in tune with the sentiments of the people, hence have better information compared to a government entrusted with a large populace. Better information will allow the government to more appropriately serve its constituents.

This argument faces some opposition in my current read, (American Creation by Joseph Ellis). Its a passage on James Madison's thoughts as he prepares for the Philadelphia convention of 1787.

So Madison reversed the conventional logic [apparently I am one of those conventionalists]. Small republics, like the states, were actually more vulnerable to factional squabbling and sectarian divisions than large republics, because of the larger scale of the enterprise vastly increased the number of competing factions, thereby producing "a greater variety of interests, of pursuits, of passions, which check each other...So an extensive Republic meliorates the administration of a small Republic." It was not just that a fully empowered national government was likely to attract a better class of statesmen more capable of resisting local pressures, though Madison believed that was true too. More fundamentally, an extended American republic, contrary to the prevailing wisdom, made space an asset rather than a liability. (p. 105-106)

I interpret this as nothing other than the age old wisdom of the law of large number, or the diversity principle, whereby increasing the quantity of data reduces expected variation. This is a nice point, but there is a fundamental difference to this view as compared to the conventional view I briefly outlined above. Madison is looking at the negative of government involvement. More specifically the use of government to exact concentrated gains from the unconcentrated whole.

Clearly, this is an excellent point. A very useful way to approach government action. On the other hand it is hardly the whole story. Politicians will always have an incentive to provide valuable services to thier constituents in order to promote re-election. (However, a valuable service must be easily traceable to its source in order for it to be effective. Also, as is all too apparent, politicians may make actions that appear valuable, but in reality are destructive.) The worse the politician's information and the less percentage any single constituent makes up of the whole, the less a citizen can expect his preferences to matter.

Admittedly, this is a big question and I have given an short answer. But, it may reveal a bit of the flavor of this balance/tradeoff.

Which is better, big or small?

Endowment Effect II

So I had a nice discussion about probability distributions concerning ideas. Unfortunately I failed to make a sufficient connection to answer the question.

How would a method of more accurately accounting for the truth of our beliefs counteract the endowment effect?

Normally when considering the probability of alternatives there are two keys parameters: 1.) probability of outcome's occurrence 2.) magnitude of gain or loss given the outcome's occurrence. In this way widely different "projects" become tradeable. For example, I have $100,000. I am proposed an investment opportunity in the stock market with a 5% chance of earning a 100% and a 95% percent chance of earning 0%. The expected payoff for this investment is simply calculated [.05*($100,000*1.0) + .95($100,000*0.0) = $5,000]. One could compare this opportunity with say an investment in alpaca farms. Let's say this opportunity is expected to yield $20,000 during the same time horizon. Although these are wildly different projects, they are tradeable in the sense that they are alternatives.

In the market of ideas, the value of ideas don't appear to be tradeable. Ideas are limited to the topic, within the topic they are tradeable, cross-topic tradeability doesn't hold. So we have millions of topics (could be policy issues, philosophical questions, scientific inquires, etc) and within each topic are alternatives. Each alternative could theoretically have a truth probability. Hence the only value ideas hold are their truth probability. We could conceivably multiply this probability by some measure of the value of the topic in general, which would enable cross topic idea rankings. But that is not the subject of our inquiry. We are concerned with the appropriate level of confidence in our idea's truth concerning a specific topic.

Back to the endowment effect. What the endowment effect means in this context is that ideas that are "owned" are given too great of value. Hence, their truth probability is ratcheted up too high. My argument is for a method that more accurately understands truth probabilities. I do not attempt to counterbalance the bias but instead hope to improve the mechanism causing the error.

Often I find myself falling into the trap of discrete thinking towards ideas. Either and ideas is "right" or "wrong." 0% or 100% probability. When in reality nothing is so cut and dry, especially on complex issues. This flaw seems a natural shortcut for the mind and may be behind the endowment effect in ideas. (Although we certainly haven't proven there is such an endowment effect, and given its different features it may deserve a different title.) If we can learn to think probabilistically, instead of in all-or-nothing terms, we may realize greater rationality in the domain of ideas.

Endowment Effect

The endowment effect is one of many cognitive biases recognized by the behavioral camp of economics. I like the name "ownership bias" better (I think its clearer). In short, the ownership bias results in the placement of greater value in goods that are owed as opposed to ones not owned, but rather out in the marketplace somewhere.

My question is: can this bias be applied to ideas?

Well, first of all, how can we "own" ideas? I'll define the ownership of an idea as the state where an individual moves beyond a stage of fact gathering and has reached a conclusion on the relevant issue.

The consequences of such a bias would be that the individual no longer views all ideas fairly, but disproportionately values the ideas in which he has determined to be "correct" in the past. Such as state would pose a dilemma regarding the individual's hopes for rationality in the consideration of alternative ideas.

Obviously, I haven't tested this. Nor have I checked for similar concepts throughout prior literature. On merely intuitive grounds it seems to make some sense. Observationally, it seems that people exert resistance to changing their minds (of course the variance in resistance must be massive concerning different types of issues). Also when a mind is confronted with unfalsifiable evidence of a mistaken belief, severe cognitive dissonance is the usual symptom. Such a reaction would coincide with the destruction of a large value (the owner's idea) and the gain of a small value (the new idea), resulting in a net pain or loss, even though this new idea must be superior based on the evidence.

With this in mind, how can we restore some semblance of rationality? The first logical answer is to not be hasty towards conclusions. This is good advice, but quite well known and, therefore, boring. At some point for some issues we will inevitably be forced to reach a conclusion. No matter how well thought-through the process of acceptance, according to the ownership bias theory, the end result will be a disproportionate assignment of value to the idea's merit, validity, truth, etc. However, it does stand to reason that on issues where one is relatively uninformed the best policy may be not to reach a conclusion.

Upon reaching a conclusion, a good technique may be to take inventory of the likely truth of your ideas. Assign some sort of probability toward their correctness. It seems that when most utilize this advice they come up with a distribution where a 99% probability is reserved for those ideas of the utmost certainty and a 51% percent probability reserved for issues of a tenuous nature. However, this would only apply to simpler true false questions, where there are only two options. It is important to note that for real world issues there will be infinitely many possible solutions. It is only through the correct framing (e.g. will the human race become extinct in the next 100 years?) that the problem can be circumvented. But this framing often removes much of the importance of the initial inquiry.

The point is that when you consider the probability that your view is correct think of all the possible alternatives. It may be very realistic to hold a 5% chance that your view is correct. This may be a view you have thought very long and hard about. You may be relatively more confident in your correctness on this issue than most of the conclusions you indulge. However, given the complexity of the problem, it is very likely that you are wrong (95% chance). Yet the view you have chosen remains the most likely winner of all possible candidates.

Without resisting the urge to wildly speculate, 5% seems a much more realistic probability than 51% on many social science questions (and the 5% may not even be a relatively tenuous position as the 51% was).

Whether this type of "realistic" probability distribution assignment has the power to overcome the endowment effect or ownership bias, is a question I will not answer.

You Can Never Have "Just One" Regulation

Arnold Kling at Econ Log,

Why worry about the clog in the first place? Because banks have some of these securities, they are marking these securities to market value, which means marking them way down. As a result, their balance sheets show a shortage of capital. To come back into compliance with regulations, they either have to sell new shares of stock (good luck with that) or curb lending. As they curb lending, the economy suffers.

So in order to comply with one regulation (mark to market, an accounting regulation), banks begin to violate another regulation (capital reserve requirements, a banking regulation). See once you regulate in one area, the incentive distortions lead to problems in others. Therefore, a regulation is needed to correct the distortion. Of course this inevitably leads to further incentive distortions. The process never ends.

In some modes of business people seem unfazed by unregulated activity. In others the thought is horrifying. I'll put banking in the horrifying category (along with education, health care, etc.). If you look at contagion effects due to psychology, you can make a case.

In unregulated activity it often may be difficult to perfectly align incentives. Markets don't always work perfectly. Two points though. First, we don't really know how a market in many areas would work since it have never enjoyed a true laissez-fair state. Second, simply because incentives are misaligned in an unregulated state doesn't justify regulation. The analysis is one of degree: to what degree are incentives aligned without the regulation vs. with the regulation. Just because a market can create unfavorable outcomes doesn't mean that there is automatically a top down regulatory solution to create more favorable outcomes.

American Revolution

Many Americans fiercely believe that the American revolution was justified. But a strong case can be made that it wasn't. Regardless of the moral justification of a revolution, revolution in general is pretty messy business. Revolution often results in a bloody mess ending with similar system of governance as before. The winning faction gains power and proceeds to abuse it.

A practical man in 1776 probably would have placed only a slight probably of success for the American revolution. Consider the odds against military victory alone. Next consider the odds of the formation of a stable, democratic government. Cost of defeat? Thousands of lives and a likely loss in degree of civil liberties. The benefit of victory? A gain in degree of civil liberties, but with a high variance in outcomes minus the cost of thousands of lives.

With this perspective maybe our founding fathers took some pretty large risks to secure a relatively small degree of liberties.

How did a stable government form? A big question in history for sure. I'll blurt out that it might have something to do with numerous competing factions instead of a single overthrowing party. The revolution succeeded militarily through the consolidation of the states. The same may be true for the success of government, but for opposite reasons. In order to remain a viable government they needed to consolidate to ward off future invaders. The initial pressure to form united states may have provided the pressure needed to keep diverse groups practical, enabling compromise. Although some states were clearly more powerful than others, the disparity of power seems thin. Equal yet competing agents may have been a critical ingredient towards the acceptance of disagreement and establishment of a tradition of compromise. The emergence of these cultural norms may have contributed to the production of both governmental stability and liberty.

Financial Crises and Regulation

Following a financial crisis the topic of regulation in inescapable. The default response by an overwhelming majority seems to be "we need more." Isn't there logically another response though? Couldn't it just as well be that we need less?

My Model of the Body's Energy System

Based on two simple observations, I have produced a model of the body’s system of rest and energy. I have no training in biology, but I have noticed two strange facts of personal disposition.

1. A good night’s sleep does not assure me to feel good the next day
2. Exercise feels good and increasingly so with frequency

Many might assume the more sleep enjoyed the night before the better one will feel the next day. Through my experience this simpler observation does not hold. Or at least not so directly. Often it takes many days of consistently good sleep to produce an energetic state of body and mind.

It may not seem strange that exercise feels good (and by feel good I mean after it is done.) But in one sense, exercise is the very activity we should wish to avoid and minimize. Exercise requires more calories relative to the resting state. As a result pleasure in the activity signals a human to find more food than would otherwise be required. This is inefficient. Donning the evolutionary lens, food is scarce. A human that utilizes less calories to survive will outcompete one that requires more. So why would the body reward us for this wasteful behavior?

In summary, humans are constantly preparing for the unforeseeable stressful event. The world usually follows a mundane routine. However, occasionally (I won’t define a time period for “occasionally”) an unforeseeable crisis arises. This crisis requires great energy. If this energy threshold cannot be met death follows. You can never lose (at least not until you have fathered or birthed some children).

In order to prepare for the stressful event, the body maintains an energy reserve (adrenaline?). The energy reserve is a fixed cost that the body pays nearly every day. The energy reserve maintains the annoying property that it doesn’t store well. It needs to be continually replenished. It doesn’t go down to zero every day but continually needs a topping off.

Once the energy reserve has been satisfied the body feels free to release extra energy to the regular workings of the day. Now obviously this is a tricky relationship. The body doesn’t strictly release energy after the reserve has been satisfied, since this would mean regular operations couldn’t take place until the reserve is met. It’s more like the body delegates energy between regular activity and the reserve until the reserve is met. It is only when the reserve is met that the body releases extra energy. This release can be noticed through a positive attitude or natural exuberance.

The key here is consistency. In order to consistently feel “good” the reserve must be met every day and enough energy produced to consistently exceed the reserve. A good night’s rest for several nights will slowly improve a person’s natural mood. The fact that the improvement is slow implies that the energy reserve is a significant cost. Consistency is also good in that it allows the body to plan. Erratic rest may signal erratic times.

Where does exercise come in? Exercise can be thought of as an investment. During the process it feels terrible—the unavoidable cost. Shortly after, the body often releases a short term pleasure emotion. Usually if someone rarely or never exercises this short term benefit is largely outweighed by the short term cost. (The nature of these costs and benefits are not static.) But exercise also has a long term benefit. This is what an investment is: the exchange of a current cost for a long term benefit. Exercise challenges the body and in the processes improves the efficiency of energy production. Exercise is practice. It not only prepares the body for the future unforeseeable stressful event but also improves the body’s ability to produce the energy reserve along with the daily energy requirement for regular tasks. The short term pleasure signal, which seems strange, signals the mind to invest in the body.

The key here is also consistency. For simplicity sake let’s say that exercise costs net $1 today (to the body) and benefits $3 three days from now. If invested in every day the effective yield is a $2 benefit every day. The consistent benefit improves the incentive to continue exercising. In this way it can be thought of as a positive feedback cycle. This positive feedback serves as a subtler signal. "When I exercised in the beginning it hurt a lot, but felt good at the end. As I continue, it doesn't quite hurt as much and I am able to enjoy the benefit" (a stronger net benefit through time. If inconsistent the signal is much less clear. There is a net cost on the initial day of exercise rather than the net benefit experienced for the consistent exerciser.

This concludes my simple model. A fixed toll must be paid each day to the energy reserve. Exercise is an investment with a positive feedback cycle. This simple model has one simple policy prescription: if interested in feeling good, sleep and exercise consistenly. (Prescription might be good, but the model may be just pandering to it.)