TruthCoin, Prediction Markets, and Anarchy with Zack Hess

This episode of Economics Detective Radio features Zack Hess. Zack is working on a project called “TruthCoin,” a decentralized prediction market based on the technology behind bitcoin.

Prediction markets are a highly effective way to bring together dispersed information and insight into prices that reflect the likelihood of any future event. However, recent attempts to create centralized prediction markets have been thwarted by governments under antiquarian anti-gambling laws.

Enter TruthCoin. TruthCoin is a prediction market (currently in beta) that will not depend on any central server or organization. This online market will be dispersed among all the participants and thus more difficult to shut down.

Furthermore, TruthCoin will not depend on a central arbiter. The main difficulty faced by the creators of TruthCoin is in creating incentives for human arbiters to judge the outcomes of bets correctly. The solution is for judges to be set against one another, for each judge to get a higher payoff when other judges are wrong. Then any attempted collusion between arbiters falls apart.

Zack is an anarchist, and he sees a proliferation of prediction markets as a potential end run around the political class. Prediction markets where people could bet on the outcomes of given policies could force politicians to do what the prediction markets indicate is best. If, for example, a politician proposing a war claims it will have few casualties, a prediction market in “the number of casualties given that war is declared” could contradict the politician’s claim and make the war politically impossible.

You can find Zack on github, as well as the TruthCoin project itself. There is also a TruthCoin forum.

Download this episode.

About Those Monotonic Transformations…

Well, this is awkward. You told us that utility was strictly ordinal, that utility functions were unique up to a monotonic transformation. But whenever there’s a problem that requires them to be cardinal in some sense, you just revert right back to cardinality, don’t you? Remember how interpersonal comparisons of utility were supposed to be impossible? You made them anyways. You were never committed to the idea of ordinal utility. You just told us that to make us think we were safe. You lied to us.

In my newest post on Mises Canada, I critique expected utility theory on the grounds that it depends on cardinal utilities. Go read it and report back.

Vampires, Zombies, and the Dismal Science with Glen Whitman

In this episode, Glen Whitman discusses Economics of the Undead: Vampires, Zombies, and the Dismal Science, a book he co-edited with James Dow. Glen is an economics professor at California State University and, unlike most academic economists, he moonlights as a TV writer. He first wrote for the TV show Fringe and now writes for the soccer spy drama, Matador.

The book’s website provides the following description:

“Whether preparing us for economic recovery after the zombie apocalypse, analyzing vampire investment strategies, or illuminating the market forces that affect vampire-human romances, Economics of the Undead: Zombies, Vampires, and the Dismal Science gives both seasoned economists and layman readers something to sink their teeth into.

Undead creatures have terrified villagers and popular audiences for centuries, but when analyzed closely, their behaviors and stories—however farfetched—mirror our own in surprising ways. The essays collected in this book are as humorous as they are thoughtful, as culturally relevant as they are economically sound, and provide an accessible link between a popular culture phenomenon and the key concepts necessary to building one’s understanding of economic systems large and small. It is the first book to combine economics with our society’s fascination with the undead, and is an invaluable resource for those looking to learn economic fundamentals in a fun and innovative way.”

Among the topics covered in the discussion are helpful hints such as how to meet the vampire man of your dreams, to choose what to bring on your trek across the zombie-infested wastelands you once called home, and to rebuild civilization after the undead apocalypse.

Human capital will be particularly helpful in the zombie apocalypse; it has immense value and goes wherever you go. Doctors are often depicted among the survivors of the zombie apocalypse, possibly because survivor groups would rather recruit a doctor than kill him. There’s an analogy to pirates, who would press valuable seamen like surgeons or carpenters into service rather than killing them (for more pirate economics, check out Peter Leeson’s The Invisible Hook).

Among the more unexpected chapters of the book is “Killing Time: Dracula and Social Discoordination,” by Hollis Robbins. Robbins connects the infamous Transylvanian villain’s ability to distort his victims’ senses of time to date- and time-keeping standards that some nations had adopted while others had not at the time the book was written.

You can find Glen online at econundead.com where he posts about the latest in undead economics news or on twitter as @glenwhitman.

Download this episode.

Migration and Open Borders with Nathan Smith

In this episode, Nathan Smith discusses the economics and history of migration and migration restrictions. Nathan is an Assistant Professor of Business Administration: Finance and Economics at Fresno Pacific University and regular blogger at Open Borders: The Case.

We start the episode by discussing the economic impacts of Nathan’s own migration to Fresno. Students gain, as he adds to the supply of economics professors, other economists might lose from his competition in labour markets, people looking for parking near the University might lose, as he slightly reduces the supply of available parking spaces, and property owners gain from his demand for housing. In general, anyone Nathan transacts with gains from the transaction, while those who he competes with may suffer some slight loss.

The big slogan among open borders advocates is that a significant reduction in migration restrictions could “double world GDP.” Nathan’s own most recent estimates show about a 91% increase world GDP, mainly because people would move from places where they can earn very little (e.g. places with dysfunctional institutions) to places where they can earn quite a bit more (e.g. places with well-functioning  institutions, complementary factors of production, highly developed networks of specialization and exchange, etc.). There are complementarities between human capital and unskilled labour. For instance, great managers are more productive when there are many workers to manage, and the workers are more productive where there are great managers.

Nathan’s estimates indicate that as much as 44% of the world’s population could migrate under open borders. This may seem high, but even conservative estimates would put the number of migrants in the billions. While migration would be hard for the first few migrants, diaspora effects would start to make the process smoother and more desirable. In the 19th century, when international migration was less restricted and more common, migrants would form communities within their new countries: there would be a Polish neighbourhood, an Irish neighbourhood, an Italian neighbourhood, etc. These diaspora communities would function as gateways to the new culture, giving people a place to settle while they adjusted to the language and culture of their new country.

Today, with the exception of migration within the EU, there are no countries with open borders. While migration is somewhat easier for high-skilled workers, there are still many barriers. People call high-skilled migration “brain drain,” but that is really a perverse way of characterizing it. Are workers’ “brains” their countries’ property? Are they to be kept as forced labourers for their countries’ benefit? In addition, the idea of brain drain is empirically questionable. If getting high skills is a ticket to a better life in a different country, the possibility of migrating increases the incentive to gain high skills, thus offsetting the loss of those who eventually emigrate.

When people can migrate, or “vote with their feet,” this puts competitive pressure on governments. For instance, governments’ ability to institute very progressive taxation is curtailed by high earners’ ability to move elsewhere. That the Soviets had to build a Berlin Wall to keep their citizens from leaving shows that the possibility of exit was threatening to the Soviet government.

Some restrictionists compare immigrants to the Visigoths in the Western Roman Empire. That is a poor analogy to modern migration, as the Visigoths migrated as a complete political entity.

Not only do immigrants assimilate into the existing industries, they are disproportionately entrepreneurial, founding new industries wherever they go. Nikola Tesla, Andrew Carnegie, Sergey Brin, and Elon Musk were all immigrants. During the era of open borders, many of the innovations (such as Henry Ford’s assembly line) were designed to be complementary with all the low-skilled labour made available by migrants. Much of our modern technological development is focused on economizing on low-skilled labour, but low-skilled labour is only artificially scarce in wealthy countries. Many basic tasks that high earners do for themselves could be contracted out to low-skilled migrants. Childcare, for instance, could be very inexpensive under open borders; skilled parents would not need to leave the workforce to raise their children.

Nathan sees hope for more open borders in the future. Migration restrictions are contrary to people’s consciences, which makes them difficult to enforce. This may slowly erode the restrictions. Furthermore, Christian churches are essentially supportive of open borders. There is hope for the world in moving towards open borders, but it will require moral will.

Nathan Smith can be found online at Open Borders: The Case.

Download this episode.

Price Theory and the Minimum Wage

The minimum wage is a contentious issue among economists, and yet it enjoys near-universal support among the public. In my view, public views of the minimum wage are simply the result of a lack of careful thought by most people. Daniel Kahneman’s theory that people, when faced with a difficult question, substitute a simpler question that they can easily answer, applies particularly well in this case. People answer the question of whether they would like people to earn more when the real question is whether government should mandate higher wages (I first heard this argument from Bryan Caplan on EconLog).

A purely empirical argument for or against the minimum wage is methodologically wrong-headed because empirics do not speak for themselves. Sound theory must be the economist’s first tool in understanding the effect of a policy such as the minimum wage.

Before we can understand something like the minimum wage, we must understand the role of prices in allocating factors of production to their various uses. The price of a factor signals to entrepreneurs that that factor is scarce, that it is needed elsewhere in the economy, and that the entrepreneur who can reduce his usage of relatively more scarce factors in favour of relatively less scarce ones can earn profits, while entrepreneurs who fail to do so earn losses. I give the example of a sandwich shop during an oil boom; the high price of labour caused by the oil boom leads the sandwich shop to substitute away from labour in various ways.

The oil boom in my illustration is irrelevant to the story. The sandwich shop would adapt to an increased price of labour no matter what caused it. If the cause is a minimum wage law, the people no longer employed making sandwiches are involuntarily unemployed rather than finding employment in some other industry.

Minimum wage opponents sometimes get into trouble when they draw supply and demand curves to illustrate the impact of the price floor. The problem with this is that supply and demand diagrams come with built-in assumptions that do not hold true in the case of labour markets. Low-skilled labour is not a homogeneous quantity being sold in a centralized market. The simple supply-and-demand story does not capture all the effects of the minimum wage. For instance, firms substitute between different sorts of workers affected by the minimum wage. In addition, the other terms of employment contracts can change in response to a minimum wage law, such as training and benefits.

Download this episode.

Virginia Political Economy and Entrepreneurship with Diana Thomas

In this episode, Diana Thomas discusses the relationship between the Virginia School of Political Economy and the Austrian School of Economics. Diana is an Associate Professor of Economics at the Heider College of Business at Creighton University.

The Virginia School is a branch of public choice, the application of the tools and techniques of economics to the study of political actors. The Virginia School’s founders, James Buchanan and Gordon Tullock, were the first to systematically apply a rational choice framework to the study of politics in The Calculus of Consent.

Two assumptions commonly made by neoclassical economists are the “benevolence assumption” and the “omniscience assumption.” The benevolence assumption is implicit in normative analysis of what governments “ought” to do, as this assumes that political actors are motivated to maximize the common good rather than pursuing their self-interest. This assumption is challenged by public choice economists. The omniscience assumption is at play in economic models that depict the economy as being in equilibrium, whereby nobody is misinformed of or surprised by economic reality. This assumption is challenged by Austrian economists.

The omniscience assumption implies that the economy should be possible to rationally plan, an idea that Mises and Hayek debunked in the socialist calculation debate of the 1920s and 30s.

As Diana states in her paper, Entrepreneurship: Catallactic and Constitutional Perspectives, “both Buchanan and Tullock reference Mises’ Human Action as the central reference for their understanding of methodological individualism.” The Virginia and Austrian schools also share common understandings of rationality and of self-interest.

Diana draws a parallel between Israel Kirzner’s distinction between calculative and entrepreneurial action and Buchanan’s distinction between reactive and creative action. While calculative or reactive action consists in simply responding to known incentives and constraints, entrepreneurial or creative action consists in envisioning a future that is different from the present and in acting on that expectation. Kirzner applies the concept of entrepreneurship to businessmen seizing anticipated arbitrage opportunities in the market. Buchanan applies the concept of creative action to political actors attempting to reform constitutional rules.

Buchanan conceives of constitutional rules as being made behind a “veil of uncertainty” since it is beyond political actors’ ability to predict in precisely what situations the rule will be applied, and whether their own self-interest will be served or hurt in those situations.

Diana believes that political action is more entrepreneurial than most economists recognize.  But while market entrepreneurship is guided by profit and loss towards those processes that best serve consumers, political entrepreneurship has no such guiding principle. Political entrepreneurs may innovate in ways that actually harm their constituents, but these innovations may nonetheless thrive and endure.

Poll numbers and bad press can motivate political actors, but these signals may not conform to the actual impacts of the policy. Good policies are often derided as evil, while bad policies are often popular. A US President can boost his popularity by declaring war, but US military ventures have a terrible track record in terms of their ultimate consequences (see Chris Coyne’s After War). Market innovations such as Lyft and Uber clearly benefit consumers, and yet there has been a political backlash against these popular businesses.

Public choice economists recognize that voters are “rationally ignorant,” since becoming informed about issues is costly, while the benefit is only manifested in better policy if the specific voter happens to be the swing vote in an otherwise tied election. Given these incentives, it would be irrational to be informed about policy, so it’s surprising that so many people vote at all. Diana explains it in terms of “expressive voting.” Voters vote because they want to express their views, not because their vote is particularly potent in shaping political outcomes.

Diana argues that policies aren’t particularly strongly affected by who is elected to office, rather they stem from institutional incentives. The median voter theorem demonstrates how, under plausible conditions, politicians attempt to please the most people by converging to a centrist policy. Another theory says that policy is not directed primarily by elections but by the lobbying efforts of special interest groups (see Olson). Since these groups get concentrated benefits from preferential policies, they have a strong incentive to agitate for them. Those who pay the costs of these policies (usually consumers) have only a small incentive to agitate against them, as the costs are dispersed among a great number of individuals.

Specific examples of policies made for the benefit of concentrated special interests are the US sugar quota, and Canadian customs duties charged for the importation of dairy products (leading to absurd cases of cheese smuggling).

You can read more from Diana Thomas at her professional website.

Download this episode.

Economic Calculation and Education

A key difference between Austrian economics and the neoclassical-mathematical economics developed in the mid-twentieth century by Paul Samuelson and others is the assumption by the latter that people are essentially omniscient. What neoclassical economists call “rationality” effectively means omniscience. When the agents in neoclassical models face any uncertainty, the uncertainty is always fully understood in advance; for instance, a stock’s value tomorrow might be drawn from a normal distribution with a known mean and variance. Without the assumption of omniscience, the Austrian school faces the important question of how people can make economic decisions in a complex, uncertain world.

Ludwig von Mises’ answer (see his 1920 essay, Economic Calculation in the Socialist Commonwealth) was that capitalist entrepreneurs calculate in monetary terms. That is, they use the prices of the immediate past as their starting data, and attempt to direct factors of production in such a way as to maximize the spread between costs and revenues. If their predictions of price changes are good, they earn profits. If their predictions are bad, they earn losses. Thus, their direction of scarce resources is subject to immediate and consequential feedback allowing a selective process for only the best entrepreneurial forecasting methods. Without monetary exchange and prices, the problem of directing factors of production to their highest uses becomes intractable.

An interesting thing about Mises’ calculation argument is that it does not only relate to socialism, but to free, capitalist societies also. Mises states that, “Economic goods only have part in this system [of monetary calculation] in proportion to the extent to which they may be exchanged for money.” Thus, when a good cannot be exchanged for money, for any reason, it is subject to a Misesian calculation problem.

One type of capital good that I have identified as facing a calculation problem is education. The present value of an education is nowhere represented as a market price. The rental rate of the education is represented in the price spread between educated and uneducated labour, but the present value of the education is not a price because the education itself cannot be exchanged.

The present value of the education would correspond to the expected discounted stream of income generated by the education, but this income is not represented in prices until years after the education is complete. Thus, students cannot use monetary calculation to allocate their time, funds, and efforts to being educated. They cannot refer to the present value price of the education in their initial estimation of the education’s value, nor can they refer to that price to evaluate their decisions in real time.

In my view, the way to introduce economic rationality to education is to have a well-functioning market in student debt. Student debt can be priced in the market, and can thus be efficiently allocated according to monetary calculation. The value of a student loan is related to the value of the student’s education. To the extent that the availability of credit can affect people’s educational choices, lenders will be able to steer the allocation of resources towards more productive lines of education.

The student loan markets are not healthy, however, because of decades of government interventions intended to increase the availability of credit for students.

Garrett M. Petersen is an economics PhD student at Simon Fraser University. You can find him online at the economics detective blog.

Download this episode.

The Austrian Cult and Mathematical Economics with Ash Navabi

In this episode, Ash Navabi discusses whether the Austrian School of Economics is a cult and the value of mathematics in economic theory. Ash is an economics student at Ryerson University.

Ash wrote an article responding to recent criticisms of the Austrian school by Keynesian bloggers Noah Smith and Paul Krugman. Krugman approvingly referenced Smith’s attacks on the “hermetic system that is Austrians.” Just a week later he made the following telling comment about the economics mainstream:

“And modern academic economics is very much an interlocking set of old-boy networks; to some extent this has become even more true since the decline of the journals, with most discourse taking place via working papers long before formal publication. I used to refer to the international trade circuit as the floating crap game — the same 30 or 40 people meeting in conferences all over the world, reading and citing each others’ work; it’s the same in each sub-field. And to some extent it’s inevitable: there’s so much stuff out there, and you have to filter somehow, so you mainly read stuff by people you know and people they tell you are worth reading.”

Ash was quick to point out that, by the logic of the people who deride Austrian economists as “cultish” because they interact mainly with one another, each of the “old-boy networks” Paul Krugman refers to (that is, each sub-field of mainstream economics) must also be a cult.

Gary Becker, another Nobel Laureate, referred to the Austrian school as a cult in a letter to Walter Block. Becker’s definition of a cult was “a small number of dedicated followers who speak mainly to each other, and interact little with let us call them mainstream economists.” This definition is problematic, to say the least. When people hear the word “cult,” they don’t think of Becker’s dry definition but of animal sacrifice and mass suicide. The word “cult” also implies unquestioning devotion to the cult leaders, but modern Austrians frequently criticize Mises and Hayek, in highly un-cultish fashion.

Ash also wrote an article on mathematical economics versus so-called “literary” economics. John Cochrane recently referred to non-mathematical economics as “literary,” a mild slur that goes back at least as far as the 1940s when Mises responded to it in Human Action. The Austrian method is not “literary” in the sense of using airy prose and fuzzy logic, rather it uses a highly rigorous form of verbal logic to derive causal chains from the basic axioms of human action.

Mathematical economics forces economists to start their analyses from unrealistic assumptions in order to put all problems in mathematically tractable terms. However rigorous the mathematics itself is, the foundation is flawed so the conclusions are flawed.

Austrians conceive of economic theory as a descriptive science rather than a predictive one. That is, pure theory cannot tell you how the future will turn out, nor is a theory tested by its empirical predictions. An entrepreneur can have a true theory of how the economy works, and yet he can still make wrong predictions if he misjudges the actual factors at play.

Ash can be found online at the Mises Canada blog page.

Download this episode.

Mainstream Economists Rediscover the Marginal Pair

I have published my first blog post over at Mises Canada. The post relates Böhm-Bawerk’s price theory to modern job-matching models. Here are the key paragraphs:

[M]odern labour economists’ use of discrete reasoning in job-matching models should be lauded as a step towards greater realism. In these models, there are a discrete number of unemployed workers seeking to fill a discrete number of job openings. These models are summarized by Alvaredo, Atkinson, Piketty, and Saez:

“[I]n the now-standard models of job-matching, a job emerges as the result of the costly creation of a vacancy by the employer and of job search by the employee. A match creates a positive surplus, and there is Nash bargaining over the division of the surplus, leading to a proportion β going to the worker and (1 – β) to the employer.”[4]

In these models, as in the real world, workers and employers must find each other before they can engage in exchange. Often, the model is set up such that only one worker and one employer find each other at a given time, making their exchange a case of isolated exchange. If multiple workers or employers discover each other at the same time, then Böhm-Bawerk’s analysis of one- or two-sided competition applies. Both workers and employers form their valuations based on their expectations of the other opportunities they might find if they engage in further search.

However, while Böhm-Bawerk and his heirs in the Austrian school are satisfied to leave the determination of price unspecified within the range bounded by the marginal pairs, modern economists feel the need to uniquely determine prices within their models, thus the addition of Nash bargaining and the nebulous “β” term, the “bargaining power” of the worker. β must be precisely specified and known so that the homines economici in search models can form their valuations based on perfect knowledge of the random processes determining the future outcomes of search and of their exact payoffs under all possible matchings. If economists were to admit that the division of surplus is inherently idiosyncratic and unpredictable, their models would break.

Furthermore, simply by referring to “bargaining power,” economists imply more than their models can support. Suppose that the marginal pairs determined that the price of a given item should fall between $396 and $412. If the actual price attained is $400, should we conclude that buyers’ “bargaining power” is four times that of sellers, or that they settled on $400 simply because it is a round number acceptable to both buyers and sellers? One cannot know.

Read the whole thing.

Gold and the Great Depression with James Caton

In this episode, James Caton discusses the classical and inter-war gold standards. James is an economics PhD student at George Mason University.

Gold has many qualities that make it an ideal money: It is valuable, scarce, divisible, and easy to transport. It is also easy to verify the value of a given amount of gold: The Old Testament references weights and scales being used to measure gold. Ancient people could verify the purity of the gold by observing its water displacement.

Before 1870, only Great Britain was on a gold standard, while gold, silver, and other metals would circulate freely alongside one another throughout the rest of Europe. The classical gold standard began in the wake of the Franco-Prussian War, when the victorious Germany demonetized silver in favour of gold and the rest of Western Europe followed suit (see Caton on the deflation that resulted from the demonetization of silver). America converted to the gold standard in 1879 upon redeeming the Civil War greenbacks for gold.

The classical gold standard operated as a fixed exchange rate regime. As England was the center of global finance, the Bank of England held a privileged position whereby other central banks would follow the Bank of England to keep their currencies constant against the Pound Sterling (see Eichengreen and Bordo). This was the case until the First World War.

Europe’s governments suspended the convertibility of their currencies into gold during the First World War. These governments created a great deal of inflation to finance the war, but they were reluctant to devalue their exchange rates after the war had ended. They wanted to return to their pre-war exchange rates.

At this point, the Fed did something crazy: It slashed the US money stock by over 40%, increasing demand for gold, and causing a general deflation. Before 1925, as gold flowed into the United States, the Fed did not increase the monetary base in tandem with the increasing gold stock, thus sterilizing the gold inflows’ influence on prices. After 1925, when Europe returned to the gold standard, the Federal Reserve did increase the monetary base alongside the gold stock. The typical Austrian narrative about the Great Depression (see Robbins and Rothbard) blames the Fed for the 1920s inflation that created an unsustainable boom resulting in the eventual crash that became the Great Depression. However, James disagrees with the blame put on the Fed in this story, as the ratio between the base money stock and the gold stock was fairly constant from 1925 to 1929.

From 1925, the Bank of England was acting as Europe’s central bank, holding most of Europe’s gold. This was politically unpalatable for the French, who began hoarding gold in 1927, devaluing the Franc and causing gold to flow into France (see Irwin). Between 1927 and 1932, France went from holding 7% to 27% of the world’s monetary gold. The resulting deflation exacerbated the Great Depression.

The Bank of England went off gold in 1931, sounding the death knell for the international gold standard. FDR devalued the dollar and outlawed private ownership of gold in 1933, ending what was left of the gold standard. Although this mitigated the ongoing institutional collapse in the American banking sector, the Great Depression continued on until after the Second World War.

See also: Irwin and Rustici on the Smoot-Hawley Tariff.

James can be found online at his blog, Money, Markets, and Misperceptions, and at the George Mason University website.

Download this episode.