Category Archives: books and book reviews

Human Interaction

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Whereas reason is commonly viewed as a superior means to think better on one’s own, we argue that it is mainly used in our interactions with others. We produce reasons in order to justify our thoughts and actions to others and to produce arguments to convince others to think and act as we suggest. We also use reason to evaluate not so much our own thought as the reasons others produce to justify themselves or convince us.

That is from Hugo Mercier and Dan Sperber, The Enigma of Reason: A New Theory of Human Understanding, a book that I have just started to read.

They call their theory of human reason “interactionist.” They argue that when economists or psychologists find what appear to be errors of human reasoning, we are taking human reason out of its natural context by focusing on individual choice. The authors apparently are going to argue that when human reasoning is used interactively, it works better than one might expect based on looking at the individual capacity to reason.

Regardless of how that argument works out, I think that economists would do well to recognize the interactive nature of human behavior. Treat economics as the study not of autonomous individuals (“human action”) but as the study of humans interacting in the context of production and exchange. Models based on the autonomous individual sometimes work well, but my guess is that once you get beyond the most basic supply and demand story, models become very dependent on the prevailing beliefs, cultural norms, and laws in the society to which one attempts to apply the model.

There is no need for economists to commit to what Deirdre McCloskey derides as the Max U view of human nature. We can instead accommodate the view that man is a cultural animal, and that we learn our habits and beliefs from others.

Taking human beings as social animals subject to various departures from pure rationality, market exchange is still a very defensible mode of human interaction. Markets help to organize large-scale specialization and cooperation. Markets are effective learning mechanisms. If Mercier and Sperber are going to claim that our collective brain works in spite of (and perhaps even because of) the flaws of our individual reason, then I am prepared to claim that the market system is often the best tool for taking advantage of that collective brain.

A kind review of my book

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From an Amazon reader,

the second edition is much better than the first. It’s nearly three times as long (146 pages vs the original edition’s 54), and more importantly gets the ideas across better. And that’s important because this is a very important idea, one that — if read by everyone — would lead to much more understanding all around.

Nonetheless, the second edition of The Three Languages of Politics landed with a thud on Amazon. It’s a book geared toward political peace. But no one is interested in peace when they think they are winning the war.

Bank Lending and Non-bank Lending

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Daniel Nevins, in Economics for Independent Thinkers, a book I mentioned the other day, thinks of non-bank lending as coming from savings and bank lending as created by fiat. I do not think in those terms.

Think of an economy that includes fruit tree growers, households, and banks. The fruit trees represent risky, long-term investments.

The fruit tree growers finance their investment with a combination of debt and fruit-tree equity. Households may purchase some of the fruit tree debt directly. This would be called non-bank lending. Banks purchase the rest of the fruit-tree debt and fund it with a combination of bank equity and liquid deposits. The fruit tree debt that the banks fund is owned indirectly by households.

In the aggregate, households hold everything. Not every household is identical, but in the aggregate they hold the fruit tree equity, the direct fruit tree debt, and the indirect fruit tree debt that comes to the household in the form of bank equity and liquid deposits.

Now, fruit tree growers are households, just like anyone else. So you can think of an increase in bank lending as a bank creating a deposit at the household of a fruit tree grower in exchange for more debt issued by that fruit tree grower. That may be the way that Nevins wants to think of it,, and he thinks that this makes it much different from non-bank lending, because the bank can create a deposit seemingly out of thin air. He would say that it does so without prior saving, although he adheres to the identity between current saving and current investment.

In contrast, I think of bank lending and non-bank lending as doing the same thing, namely funding the debt issued by fruit tree growers. The only difference is that with non-bank lending, households have a direct ownership of the debt, while with bank lending their ownership is indirect.

Households may have a limited appetite for direct holding of fruit tree debt. And they may have a less limited appetite for holding that debt indirectly. In that case, if fruit tree growers and bank managers become more risk tolerant, you may get an expansion of fruit tree investment along with an increase in bank lending. Conversely, if fruit tree growers and bank managers become more risk averse, you may get a contraction.

The bottom line is that I think that bank credit matters, just as Nevins does. But I am not comfortable with his semantics.

Tyler Cowen and Russ Roberts

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Self-recommending. As usual, Russ does not just throw softballs at the guest, so you get more interesting at-bats. For example,

[Russ]: I don’t sense the distinction between a less dynamic, more stable economy and a complacent one. So, tease that out a little bit for us.

[Tyler]: In a lot of the late 19th century it’s not even clear according to the numbers that our rate of productivity growth was always so high. Yet American society was not complacent. We had a frontier mentality, an immigrant mentality; we were very likely to move across state lines; we were willing to accept a lot of risk. And that in turn helped us later on, get the rate of productivity growth up higher. But I see today it’s a culture where younger people are more willing to keep on living with their parents, less interested in buying a car, more likely to aspire to being on Disability as a kind of future, and less interested in, you know, protests and social change than, say, they were in the 1960s or in the 1970s. Those to me are all signs of complacency.

And by the way, today the new edition of my Three Languages of Politics is available.

What I’m Reading

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Two books that attack conventional economic modeling, especially in light of the financial crisis. I have a preview copy of Economics for Independent Thinkers, by Daniel Nevins. I have a review copy of The End of Theory, by Richard Bookstaber. I am likely to recommend the former. The latter is certain to make it onto my list of “best books of the year.”

It is interesting that both authors have backgrounds in applied option pricing. So do I. Is it a coincidence that we all ended up taking heterodox positions? If you toss in Fischer Black and Nassim Taleb, you start to wonder if there isn’t something in the option pricing water.

A reader points to Diane Coyle’s negative review of Bookstaber. She writes,

his complaints about economics are both wearily familiar territory and decreasingly true; economics is and has been changing a lot. In finance specifically, think of Andrew Lo’s new book, Adaptive Markets.

I disagree with her on all counts. One indication that Coyle has missed the point is that she thinks that Bookstaber’s critique applies only to macro/finance. I can readily apply it to the way economists model the demand for health insurance, the demand for home ownership, and principal-agent contracts, among other microeconomic phenomena.

I am drafting a review essay, which reads in part,

If I could reduce it to a bumper sticker, it would read, “Stare more at the world and less at your model.”

…All of the major fields in economics are inclined to follow strict technical procedures at the expense of realism. In the 1500s, if mapmakers had been similarly inward-looking and rigid, they would have continued to draw maps of the globe that ignored the lands discovered by Columbus and subsequent explorers, insisting that “The state of cartography is good.”

Turning to a relatively minor passage that resonated with me, here is Bookstaber’s description of the role of collateral in repurchase agreements and derivative bets on p. 159:

Let’s say your bookie demands that you put up $20,000 of collateral for a marker on a $15,000 bet. You give him your gold Rolex watch, worth $20,000. He comes back to you a week later and tells you that you need to put up another $3,000. Why? “People, they aren’t so much interested in these Rolexes anymore. It’s marked down to $17,000.” …You say, “Wait, I see prices for watches just like it, anywhere from $20,000 to $24,000.” He says, “Hey, do you owe them money or do you owe me money? You’ve got the marker, and I’ve got the watch, and I say that today it’s worth $15,000.”

By appraising collateral, notably mortgage securities, at low values, investment banks like Goldman Sachs caused runs on other firms. Gary Gorton termed it the “run on repo.”

[note: the following paragraph is my own. Although I cannot confirm that Bookstaber would endorse it, to me it seems likely that he would.]

But it was not just repo. The run on AIG was to demand collateral for credit default swaps. Think of a credit default swap as flood insurance and think of collateral as used because you don’t entirely trust that the insurance company will have the wherewithal to pay off. You have a house near a river, and when you get flood insurance you have the insurance company give you some Treasury bills as collateral, until the insurance policy expires. Then, a big rain comes, and the river starts to rise. Your house is still dry, but you are more worried, so you ask for more Treasury bills as collateral. That is what Goldman Sachs and the other investment banks did to AIG during the crisis. As it turned out, most of the houses never got flooded (that is, most of the bonds that AIG insured did not default), but the demands to put up more safe securities as collateral became impossible to meet, especially because similar demands were being made all over Wall Street for firms engaged in derivatives and repurchase agreements.

The quoted passage does not in any way capture the book’s larger, more ambitious theme. I was struck by it because it fit my understanding of what happened, which policy makers at the time seemed to me to miss. Had they been cognizant of the real problem, they would have applied a remedy closer to the one that I was proposing at the time. I called this the “stern sheriff” model, and it would have meant telling Goldman and other firms to stop making their outlandish collateral calls.

Arguments for Liberty

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That is the title of a new and recommended book. From my review:

Arguments would make an excellent book of supplemental readings for a course in political philosophy. Such a course could use another supplement, consisting of readings of philosophers arguing for non-libertarian ideas.

Later, I write,

After reading this book, I could not help pondering why it is that libertarianism does not hold sway among most philosophers or with the general public. My answer is that people rely on what I call small-community intuitionism.

If I were an editor

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I would be very hard on a lot of manuscripts. As a result, fewer published books would fail to meet my standards. By the same token, a lot of authors would be really frustrated, and they would give up trying to meet my standards.

I thought of this when I received a review copy of Andrew W. Lo’s Adaptive Markets from Princeton University Press. Lo is highly respected and warmly regarded in the field of finance. He could write a book consisting of “Mary had a little lamb” written forward and backward 10,000 times and still get good blurbs and lots of library purchases. So as a publisher you don’t want to throw an aggressive editor like me at him.

But gosh. The introduction does not tell the reader anything about where the book is going. There is no conclusion to tell you where you have been. The middle reads like a transcript of every lecture he has ever given to first-year students or business practitioners.

This book makes me appreciate Sebastian Mallaby and Greg Ip all the more. In Foolproof, Ip gave us the distinction between economists as engineers and economists as ecologists. Lo speaks the language of ecology, yet on p. 371, he writes,

if there’s one single proposal that unambiguously moves us closer to a more stable and robust financial ecosystem, it’s to develop better measures of systemic risk.

Spoken like a true engineer.

There are a lot of fun stories in the book, and I imagine that would entertain a young finance student. But not me.

Re-reading Bobos in Paradise

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On p. 47, there is this:

For one reason or another the following people and institutions fall outside the ranks of Bobo respectability: Donald Trump, Pat Robertson, Louis Farrakhan, Bob Guccione, Wayne Newton, Nancy Reagan, Adnan Khashoggi, Jesse Helms, Jerry Springer, Mike Tyson, Rush Limbaugh, Philip Morris, developers, loggers, Hallmark Greeting Cards, the National Rifle Association, Hooters.

That is David Brooks, copyright 2000. Unless you think I have a photographic memory, I did not recall this sentence when I first wrote that the 2016 election was along the Bobo vs. anti-Bobo axis.

Seaweeding

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Seasteading is a new book by Joe Quirk, with Patri Friedman. I cannot resist calling it quirky. If you are expecting the book to consist mostly of wacko libertarian ideas, you are wrong. It consists mostly of wacko environmentalist ideas. Apparently, there exist visionaries or crackpots, or both, who think that seaweed and other ocean life can provide cheap food, cheap energy, and cheap carbon sequestration. Here are some random excerpts:

Ricardo has shown that his most basic sea farm costs only $200.00 US to construct, covers only a half hectare in size, and supports five people with year-round harvests of diverse crops. (p. 85)

an ultrahealthy algae species called dulse. . .smoking it as if it were meat they were astonished to find it tasted like [bacon] (p. 98)

The authors suggest that adding iron to the Southern Ocean circling Antarctica alone could reduce carbon dioxide levels by 15 percent. (p. 146)

the ocean’s stored energy can be tapped by OTEC, or ocean thermal energy conversion. . .OTEC produces no greenhouse gases, blights no land, is not visible from shore, requires minimal maintenance, and runs twenty-four hours a day, 365 days a year. p. 146-148

If you take away any message from this book, it is this: Seasteading is about emigrant rights.
p. 301

1. I am skeptical that there are these twenty-dollar bills lying on the sidewalk floating in the oceans.

2. Even if there are twenty-dollar bills floating out there, it is not clear to me that you need to live on the ocean in order to collect them.

3. Do not mistake resources for wealth. Wealth consists of patterns of sustainable specialization and trade. There is plenty of land in the U.S. Land is only scarce in places like New York or San Francisco, where the patterns of specialization and trade are so lucrative.

4. From a PSST perspective, the most promising economic model for a seastead would be as a seaport. Find a part of the coast that lacks a natural harbor, set up a seastead harbor, and build a bridge or tunnel to connect the seastead to the land. That would create new opportunities for specialization and trade.

Best Book of the Year?

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Kevin Laland’s Darwin’s Unfinished Symphony is sure to make my top five and the early favorite to make number one. It got a mention from Tyler Cowen and a brief review from Robin Hanson. I would be curious to know what Jason Collins thinks of it. Laland is a person I would very much like to spend a few hours with batting ideas around.

Laland’s field is evolutionary neuroscience, or so I would guess. The book is focused on the co-evolution of brain capabilities and culture in humans. A central question is how culture came to be so advanced in humans relative to animals. To address that, one must try to understand how culture is developed, transmitted, and retained.

On page 7, Laland offers his definition of culture as

the extensive accumulation of shared, learned knowledge, and iterative improvements in technology over time.

Recall that my working definition of culture is “socially communicated thought patterns and behavioral tendencies.”

Late in the book, Laland uses dance as an example of culture.

The social structure of many communities. . .gain much of their cohesion from the group activity of dancing. Historically, dance has been a strong, binding influence on community life, a means of expressing social identity of the group, and participation allows individuals to demonstrate a belonging. . .there are as many types of dances as there are communities with distinct identities.

Of course, I like this choice of examples. I think that dance illustrates what I see as a trend in recent decades toward narrower, deeper, older.

One of the central scientific studies in the book is the social learning strategies tournament. In the tournament, each player faces an environment that changes gradually over a sequence of turns. To cope with this environment, at each turn the player can choose one of three moves. Quoting from the article,

INNOVATE, OBSERVE and EXPLOIT. INNOVATE represented asocial learning, that is individual learning stemming solely through direct interaction with the environment, for example, through trial-and-error. An INNOVATE move always returned accurate information about the payoff of a randomly selected behavior previously unknown to the agent. OBSERVE represented any form of social learning or copying through which an agent could acquire a behavior performed by another individual, whether by observation of or interaction with that individual An OBSERVE move returned noisy information about the behavior and payoff currently being demonstrated in the population by one or more other agents playing EXPLOIT. . . Finally, EXPLOIT represented the performance of a behavior from the agent’s repertoire

As long as the environment stays reasonably stable, you profit most from EXPLOIT. But as the environment changes, you can obtain higher payoffs by learning. In the simulation exercise conducted in the study, the social learning strategy OBSERVE worked much better than the asocial learning strategy INNOVATE. It seems to me that people who play OBSERVE get to free ride on others who are playing EXPLOIT and to free ride especially profitably on others who play INNOVATE.

Think of a factory worker in Ohio in 1999. If you just go to work every day expecting your job to last forever, you are playing EXPLOIT. If you decide to study the career choices and location decisions of people you think are similar to you, you are playing OBSERVE. If you decide to pick a new career and/or location based mostly on your own instincts, you are playing INNOVATE. The signals you get from playing OBSERVE are noisy. You could end up copying someone who develops computer network management skills and moves somewhere to run a data center. Or you could end up copying someone who goes on disability and gets addicted to opioids.

I think that this very simple model helps one to think about the PSST story for a recession. During boom times, people find patterns of specialization and trade that are rewarding, and they EXPLOIT them. But people may over-estimate the stability of that environment. They think that house prices will never go down. They think that manufacturing jobs are going to last. Then, as the environment changes and as those changes become manifest, a lot of people’s EXPLOIT strategies start to work out badly. They have to go into learning mode. They are used to having OBSERVE work out best, and that may still be the case from the perspective of the individual, but it means that the process of establishing new patterns of specialization and trade will take a long time. To speed up that process, from a social perspective we may need more people to play INNOVATE.

Anyway, there is a lot to the book, and I plan to write a fuller review.