I Don't See Any Method At All

A few months ago Alan and I were eating dinner at a restaurant and looking at the beer menu.  Alan said he wished that one of the beers listed included its style (so that he could anticipate what it would be like).  This stuck in my mind because beer styles are a complicated issue.  In the U.S. there has been a very style-oriented approach to homebrewing, and arguably this has had unfortunate consequences in the commercial beer market.

But styles have their place.  They are a very economical way to convey information, and if they are used properly they don't have to be stifling, I think.  You have to ask:  what would a world without styles look like?

One option would be some other system to convey information.  You could come up with 3 or 4 dimensions:  ABV, IBUs, SRM (a measure of color), final gravity (which is a measure of residual sugars and starches, which add sweetness and/or body).  Then you could tag on a few flavor descriptors if needed.  There would be complete freedom to brew anything within the n-dimensional space defined by those variables.  But there would be learning costs (most people don't know what SRM measures, for instance).  People would have to calibrate their existing impressions to the new system.  And the descriptions would lack a certain elegance and historical resonance.  You might think that's a minor concern, but presentation affects the overall experience more than we would like to admit.

Of course even if you embrace styles, you can still be relaxed about enforcing them.  But the less rigid the styles become, the less information they convey.  It's a tradeoff.  (There is another issue, which I haven't considered here, about whether forcing brewers to work within constraints might actually improve the results, or result in more diversity and creativity.)

This may all be moot, though.  With smartphones and easy internet access, it's possible to pull up a description of almost any beer very quickly.  It would be interesting if, as a result, styles lost all meaning and came to seem quaint.

Dialectic Materialism

When I was growing up I was basically a materialist.  But in the last several years, living in New York and reading Tolstoy and whatnot, I came to think that there is more to life than physical pleasure.  Now, though, I've come full circle and I'm a materialist again.  Still, for some people, moral/religious beliefs can have instrumental value.  If your faith in God is the only thing that keeps you from being miserable, then in what sense would it benefit you to become an atheist?  But I don't believe in God.  Nothing matters but the facts on the ground.

Externalities, Regulation, and Silver Mining

A thought on regulation.  The rule of thumb that a lot of people use is that regulations are appropriate when they address externalities, but not otherwise.  So even libertarians can sometimes get comfortable with rules limiting emissions and that sort of thing.  But people are much less comfortable with using regulation to structure the marketplace in the absence of obvious externalities.  This is too bad, because regulation can be highly valuable even when there aren't obvious externalities such as pollution.  I'll give a few examples of what I mean.

To start, let's look at an example that I used (unsuccessfully) in a law school application essay.  Let's say you are running an early colony in North America.  To keep things simple, assume that people can engage in two activities:  they can farm, or they can search for silver.  (Early colonists in Massachusetts thought they would find silver there.  Let's assume you don't have an opinion on whether or not there is silver—you are, at least, open to the possibility.)  And let's assume that farming involves a certain amount of randomness (so for instance, you don't know exactly how much corn a field will produce, but you have a sense of the range of probable outcomes).  Your colony is small, but big enough that using money (in this case silver) helps the market clear.  Accordingly, colonists have brought along a few dozen pounds of silver.  And finally, assume that there won't be any external trade for a long time.  Ships might show up, but only to drop off more colonists.

Now, from a social perspective, time spent searching for silver has approximately no value.  This is because adding to the colony's stock of silver doesn't accomplish anything.  It's important to have some quantity of silver (because money clears the market better than barter does), but the colony already has plenty of silver for trading purposes.  Adding to the stock of silver simply results in a higher price level, which has mostly secondary effects that are not necessarily positive.  (For any given price level, there is a certain amount of silver that people have to carry in order to transact in the market.  If the supply of silver grows too large, leading to high prices, then it becomes burdensome to carry around the required amount of silver.  On the other hand, if silver becomes too valuable, it may become difficult to sub-divide it into small enough increments to trade.  However, because silver is so soft, and because it can easily be melted back together, it can be divided into very small pieces if necessary.)

Meanwhile, the less farming that gets done, the higher the probability that the colony will starve.  Now it's true that we would generally expect there to be some farming no matter what, since food itself is a valuable commodity, and it is increasingly valuable as it becomes scarce.  In the extreme case, if only one colonist farms, then he can demand an arbitrarily large amount of silver in exchange for his food.  (Assuming the other colonists don't simply take the food under the guise of "necessity" or "emergency" or something.  Let's say the political system doesn't allow for that outcome.)

So there will be farming.  But will there be a socially optimal amount of farming?  I think you can pretty easily come up with numbers that would give you the answer "no."  This is because, as I mentioned, searching for silver has approximately no social value.  In fact, if you think about it, searching for silver is mostly about redistributing existing wealth, not creating wealth.  Let's say the colony starts with 50 pounds of silver, distributed among the colonists (some hold more, some hold less, but everyone needs a certain amount of silver to do business).  Only one colonist searches for silver, and he finds 50 pounds of it.  Now prices will (roughly) double, and so most colonists will have lost half the value of the silver they happen to be holding.  But the colonist who found the silver will now have wealth equal to approximately half of the colony's economy.  No value has been created, it has simply been re-allocated from the farmers to the prospector.

And so we can see that it would be possible to make the colony better off by forbidding colonists to search for silver.  Alternatively, the colony could levy a tax on prospecting, or a tax on purchasing food.  Exactly which regulation is best depends on the circumstances (for instance, how easily can colonists observe each others' behavior?).  But in any case, it's easy to see that there is a possibility for welfare-improving regulation even though there is no obvious externality.  (If you have a liberal definition of "externality" then you can probably find one here, although by the same token a liberal definition of externality will justify a high level of regulation in the modern economy.)

The larger lesson here is that the government must structure the marketplace to serve social needs.  Eliminating wasteful activity is a socially valuable thing even if there are no obvious externalities to be combatted.  This is the logic behind things like bankruptcy law, securities regulation, taxi regulation, and even things like safety regulation.  Just to spell it out a little:  bankruptcy law is intended to prevent a wasteful "race to the courthouse" as creditors try to seize the debtor's assets.  The problem is that the first creditor to get a lien and foreclose on the debtor's property might get 100% of what he is owed.  But that just leaves fewer assets for the other creditors, and if the first creditor seizes something important (like a car or tractor), he might eliminate the debtor's ability to earn income and repay other creditors.  The last creditor to show up might get nothing.  An early creditor is a bit like a silver prospector, in that he draws wealth from a common pool.  And what really matters is not the absolute time at which a creditor levies on the debtor's property, but the time relative to other creditors.  So there is an arms race, and it might be rational to spend quite a bit of money (for instance, in legal fees) to be the first, even though it's hard to see a social benefit resulting from all that haste.  Bankruptcy law addresses this problem by freezing most creditor remedies and bringing recent payments back into the general pool to be distributed equally among creditors.

So anyway, long story short, it doesn't make much sense to take an "externalities only" approach to law and regulation, unless you define "externality" so broadly that you can regulate just about anything.

Chaos Is Yours and Chaos Is Mine

A little vignette about path-dependency.  In junior high school, my class was taken to a children's science museum, which was doing a display on chaos.  One of the exhibits consisted of a video camera pointed at its own output on a monitor.  There were a few variables you could control:  the tilt of the camera, a light that could shine on the monitor, and a few other things I can't remember.  My friend had set up a pretty cool pattern that looked like a fractal of white and black rectangles spiraling away into infinity.

Without asking, I flipped the light on, which of course changed the pattern on the screen.  My friend was upset, having worked quite hard to make a cool pattern.  I felt bad and said, "Look, it's nothing, I'll put it back," and I flipped the light off again.  But of course the pattern didn't return, and so I felt pretty terrible about having casually ruined my friend's work.

But in a way, the lesson would not have been nearly as valuable if it hadn't come along with an emotional sting.  I'll never forget that day, whereas I've forgotten countless school lessons that were probably no less important.

Path-Dependent Economic Growth, Demand Side

I have been thinking a bit about economic growth.  This is a very rough outline of my thoughts so far.  I hope to refine my thoughts, but who knows, I'm quite possibly on a wrong path.

The basic idea is that demand can play an underappreciated role in economic development.  I am not talking about a Keynesian shortfall in aggregate demand.  That's important, but it's not my current preoccupation.  What I am more concerned with is the way in which the value of economic activity is context-dependent.  To put it very briefly, it appears that there are two distinct ways to grow an economy:  you can improve physical production (for instance, by designing a soda can that uses 20% less aluminum without any sacrifice in quality) or you can improve the dollar value of existing production (for instance, by running an ad campaign to convince people that your soda is delicious).  In the latter case, there are no immediate changes that are visible "from 30,000 feet."  It's just that where people were willing to spend $x per can of soda, now they are willing  to spend $y > $x, and so the economic activity of producing soda is now more "productive" than it was previously.  (I am not using the concept of productivity in its technical sense.)

Now it may sound as though I am skeptical about this second source of economic growth.  But I'm not.  It might be relatively unimportant in the very early stages of economic development, when demand is overwhelmingly for basic goods like food and shelter.  But I don't see how a modern economy could grow without expanding its "sphere of demand" to encompass more and more products with highly contingent value.

I'll give a few examples to show what I mean.  First, there are the classic examples of technologies that are worth nothing outside of a specific context.  The first fax machine was entirely useless until the second fax machine came online, and then its value grew as more and more machines came into use.  This isn't a new observation, of course.  Everyone knows that the value of a fax machine is contingent on a specific background of technology and network effects.

But take something like craft beer.  As far as I know, the technology for beer production hasn't dramatically improved in the last fifty years.  (We know this on an intuitive level because the Belgians have been making excellent beer for all of that time.)  Now it's true that hard-to-detect changes in things like transportation costs can have a big effect, but I think it's safe to say that it would have been perfectly feasible to brew and sell something like Smuttynose's Old Brown Dog Ale 50 years ago.

But what actually happened was that beer production was hugely consolidated after Prohibition, and good domestic beer only gradually started emerging in the last quarter of the 20th century.  And when it emerged, it emerged slowly.  It sort of "ratcheted up," as beer drinkers were exposed to more and more variety and started to demand higher and higher quality.  In other words, even when it was abundantly obvious that you could profitably make and sell high-quality beer in this country, it took decades for the market to mature into today's embarrassment of riches.  It seems highly unlikely that the "bottleneck" was on the production end.  Consumers had to be "educated" to appreciate craft beer, and they had to be "conditioned" to paying a lot more per ounce of beer.  And to some extent culture had to evolve to confer status on people who understand and appreciate good beer.  (Very fancy restaurants now have beer menus—I don't think that was always the case.)

The same thing goes for all kinds of products.  Frozen orange juice was a very important development at one point, but its value was contingent on relatively cheap and widespread refrigeration.  But then as refrigeration got even cheaper and the nation got richer, frozen orange juice lost a lot of market share to "fresh" orange juice.  Its value was contingent on a context that prevailed for a few decades and then faded away.  (Although I think frozen orange juice still enjoys considerable market share.)  Frozen orange juice is a good example because its trajectory reflects both classic technological factors and "demand-side" factors like national income and taste preferences.

A more demand-oriented example is canola oil.  Canada is capable of producing a lot of rape plants, but for one reason or another consumers were not enthusiastic about buying rape or rapeseed oil.  A simple rebranding to "canola" ("Canada" + "oil") allowed the market to flourish.  (Note that unprocessed rapeseed oil is poisonous and is used only for industrial applications, so please don't imagine that the product currently labeled "rapeseed oil" can be substituted for canola.  Canola, though, is one of the healthiest cooking oils.)  The same thing happened with Chinese gooseberries, which were rebranded as "kiwi fruit."  Or the Patagonian toothfish as "Chilean seabass."

It's discomfiting to realize that an economy's basic health can be so dependent on marketing and consumer perceptions.  It's also a potential avenue for recessions to have strangely long-lasting effects.  A given supply/demand equilibrium might be a fragile thing, and a sudden shift in perceptions might be hard or impossible to reverse.  (Just by way of example, what if consumers had shifted massively back into the frozen orange juice market to save money?  Then orange juice production would be disturbed for a while, and the big question would be where consumers would end up when the dust settled.  In the meantime a lot of "productive" economic activity would suddenly be unprofitable, which is to say unproductive in an economic sense.)  I think this sheds at least a little light on the old conundrum about an economy producing at an "unsustainable" level.  Krugman typically points out that the previous level of production was obviously achievable, since the economy reached it without inflation.  But was the previous pattern of demand sustainable?  Maybe not.  During the bubble there was a lot of "demand" for housing that obviously couldn't last.

As I said, these are just my rough thoughts.  I'll have a lot more to say as I work through these issues.

Expensive Cheap Processing Power

Imagine that you run a factory.  In the status quo, workers perform the tasks that are assigned to them by managers, who must perform a series of calculations to organize the work.  The calculations are burdensome, and you doubt that the factory's organization is "optimal" (except in the sense that it is the best you can do given the limited managerial skill and processing power at your disposal).

Now an entrepreneur offers to sell you a computer to replace the managers.  The computer does the same thing that managers do:  it gives instructions to workers in order to organize production at the factory.  But unlike the managers, the computer does not have to be paid a salary, and it may also give better instructions overall.  As a result, there is a potential for improving the profitability of the factory (either producing the same output at a reduced cost, or producing more output at the same cost).

So this machine at least has the potential to be a worthwhile purchase.  But of course you aren't just going to cut a check on the spot:  you want to make sure the machine is actually worth the purchase price.  So you ask:  how do I know that the instructions generated by the machine will be the "right" instructions?  After all, it would be easy enough to build a machine that gives clear, unambiguous instructions but doesn't improve the factory's performance.  It could just tell every worker at every moment, "Take it easy, you're on break."  Then you would have saved a lot on managerial salaries, but the factory's output would plummet.  You would also get a bad result if the machine gave instructions at random - and in that case, the results might be dangerous for the workers.

The seller of the machine assures you that its instructions are much better than random.  But he admits that the machine sometimes instructs workers to do things that are counterproductive.  So actually, the suggested strategy is to retain enough managers to override the machine when it gives a bad instruction.  You ask the vendor for an assurance that you will still come out ahead with this approach.  But the vendor is honest, and he tells you that he doesn't know.  It just depends on how often the machine gives a bad instruction, how many managers it takes to catch these mistakes, how bad the mistakes are, etc.  It's a complicated question that can't be resolved by pointing to the machine's incredible efficiency.  Terrible instructions, however cheaply they are generated, are no bargain.

And this is where we find ourselves with the economic calculation problem.  We know that capitalism transmits "instructions" somewhat cheaply (although capitalism does seem to have a voracious appetite for smart, educated people to run the financial system).  But this, by itself, is not a reason to prefer capitalism to socialism.  You also have to assess the quality of the instructions (in this case, price signals), and the cost of monitoring them and overriding them when they go wrong.  Recall that in almost every year of the Irish famine, the price system induced Ireland to be a net exporter of food.  The "instruction" from the machine was:  remove food from a starving nation and deliver it to a well-fed one.  And no one overrode the instruction.  The Irish were left to starve.  A socialist is free to argue, I think, that capitalism's cheap processing power comes at too high a price.

This is another way to view the Coasian point about the size of the firm.  At low levels of complexity, we may prefer to keep the human managers and dispense with the machine, because its huge processing power doesn't make up for its glaring shortcomings (in terms of bad instructions or other pathologies).  So we don't run families, churches, or corporations on a market basis.  Arguably the machine's benefits start to outweigh its costs at large enough scale, but this is not a question that can be answered in the abstract.  It depends on how good our non-market institutions are, how much it costs to maintain them, and what value we place on, for example, Irish lives.

So the economic calculation problem is not the end of the discussion, it is the beginning.  Unfortunately, that's the opposite of the way it is usually presented in economics classes, in my experience.

And even if you are convinced that capitalism is a virtual necessity in a modern economy, it doesn't follow that its dictates are irreproachable and beyond human review.  There is still a debate to be had about how and when to override the allocation chosen by the price system.  And a lot is at stake.  That's why it's obnoxious that, again, economics instruction essentially truncates the discussion by recognizing only very limited kinds of market failures.  All the time economists will say things like, "There's no externality here and therefore no justification for government action."  As if economists have somehow discovered a trick that allows them to bypass human values in formulating policy.  As if Irish lives don't matter.