Crawl Across the Ocean

Thursday, March 26, 2009

6. Efficiency

Note: This post is the sixth in a series, Parts one, two three four and five

Efficiency is one of those words that causes trouble because it means different things to different people. Wikipedia has a pretty cool disambiguation page which lists just a few of the different interpretations available for this slippery word.

In order to tie down the meaning for the purpose of this series of posts, I want to use efficiency in one particular sense of the word which is what is known as 'Pareto efficiency'.

Parteo efficiency is the idea that if we have a situation where we could make some change that would make at least one person better off without making anyone worse off, then making that change would improve overall efficiency.

A situation is Pareto-efficient when there are no more changes that can be made that will make anyone better off without making someone else worse off.

The benefit of this type of efficiency is that, theoretically, it should be relatively easy to secure agreement to Pareto efficiency improvements since nobody has cause to object since nobody is being made worse off. Of course, to the extent we always compare our situation to that of others, anything that makes other people better off might make us feel worse off by comparison, even if our position is unchanged (in an absolute as opposed to relative sense) - but the question of what to do about envy is a tricky one that I’m going to ignore for now.

An example may help clarify what is meant by Pareto efficiency:

One of my childhood friends happened to have his birthday on the same day as Halloween. Naturally, a group trick or treat outing was incorporated as part of his birthday celebration. Afterwards, the group of us would pile into his bedroom and dump out our accumulated loot into a pile on the floor (one pile for each person - not one big pile). Note that at this point, the distribution of loot has been determined by the random allocations at each front door, and does not take into consideration each trick or treaters particular tastes. This raises the possibility of making trades that benefit all parties involved. For example, I always liked the Rockets and Mint Laura Secord bars the best, whereas others preferred items such as the Coffee Crisp that I had little interest in.

So the initial distribution was Pareto-inefficient in that changes could be made that would benefit people without making anyone else worse off.

So, naturally, we set about trying to achieve a Pareto optimal distribution of candy in a free wheeling round of candy exchange that would last until everyone was satisfied enough with their adjusted haul such that no further exchanges could be made that were agreeable to both parties.

We didn't necessarily always achieve such a distribution. After a while, when there might be a few useful trades still left we might declare that we were 'close enough' and move on. Or parents might intervene and cut short the trading since it was time for someone to go home.

Note that Pareto efficiency has little to say about ensuring a fair situation. For example, if one kid happened to miss out on the trick or treating for some reason and had no candy, there would be no Pareto efficiency gain from trading for them, since anyone trading with them would end up worse off since they had no candy to trade for (although, if a person gets a psychological benefit from the warm glow of charitably donating some of their candy to the unfortunate kid, then this could still be a win-win exchange).

Even if one kid somehow ended up with all the candy and everyone else had none, this could be considered a Pareto-efficient distribution since any change would make that kid worse off (assuming they were selfish enough not to feel bad about the unequal distribution, and the other kids were restrained enough not to simply take some of the lucky kids excess loot – these may be important assumptions!)

The next post should clarify why I felt it necessary to discuss the concept of Pareto efficiency before moving on...

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Tuesday, March 24, 2009

5. No One Makes You Shop at Wal-Mart

Note: This post is the fifth in a series, Parts one, two three and four

Now who here among us, still believes in choice? Not I.
- The Arcade Fire, Ocean of Noise

This post summarizes Tom Slee's 2006 book, 'No One Makes You Shop at Wal-Mart' The title is a little misleading as the book doesn't really have anything (directly) to do with Wal-Mart.

Instead, it talks about how although right wing folks champion the idea of 'free choice,' there are many situations where free choices doesn't have the consequences you might think (the book's subtitle is 'the surprising deceptions of individual choice')

Slee labels as 'MarketThink' the idea that giving people more choices always leads to better outcomes and that the outcomes from a process of free choices always represent a fair reward to all involved.

Naturally, the first way in which people's choices might not lead to the outcomes they expect/desire is the one I described a couple of posts back, the Prisoner's Dilemma. In fact, making choices that help you but don't lead to the best outcome is pretty much the definition of the prisoner's dilemma.

Slee devotes the first 5 chapters of the book to prisoner's dilemma type situations. Chapters 1 and 2 introduce the concept of the prisoner's dilemma, much as my previous post did.

Chapter 3 provides some more examples, focussing on cases where the prisoner's dilemma leads to private gain at public expense, for example the case of littering (in everyone's interest not to bother putting their stuff in the garbage, but also in their interest not to have a park full of litter), or urban sprawl, where we have an interest both in a compact, livable city, and in a house overlooking lots of open space, but we are able to choose the latter, but can't choose the former on our own.

Chapter 4 talks about the 'arms race' type of prisoner's dilemma in which participants make alternating attempts to get ahead of the other people only to find that the other people retaliate in kind and all parties end up spending a lot of resources while not gaining any relative advantage.

Chapter 5 discusses the conditions in which people can overcome prisoner's dilemmas, noting that where groups are small, everybody knows each other and there is little turnover, people remember what you did last time and will punish you if you do not cooperate. So in a small village there is a stronger push for conformity to local standards of behaviour than there is in a city. As a group of people trying to overcome a prisoner's dilemma grows larger and has less knowledge of each other, the need for a central enforcement mechanism to ensure cooperation grows.

Chapter 6 considers that the nature of many interactions may or may not be a prisoner's dilemma depending on how the interaction is structured. And it is in interest of parties that will benefit from cooperation to remove the prisoner's dilemma element from a situation, while it is in the interest of parties that benefit from a situation remaining a prisoner's dilemma to prevent any escape from the prisoner's dilemma via cooperation (i.e. to promote competition instead, where choice automatically creates competition).

For example, in a workplace, employees pushing for higher wages are in a prisoner's dilemma because any one employee has an incentive to work for slightly less than his co-workers so that they might be fired instead of him if costs are being cut. A union is designed to enforce cooperation by removing the element of choice/competition between workers. This has the effect of levelling the bargaining environment between workers and management. Naturally management has an interest in promoting the freedom of employees to choose to undercut their fellow employees or to work as scabs.

In the same manner, companies have an interest in countering any tendency towards standard corporate taxes across jurisdictions, instead promoting the freedom for any one jurisdiction to profit by undercutting other countries as they so frequently do.

Chapters 7 and 8 move to a different type of situation, one where instead of the negative externalities of the prisoner's dilemma, there are instead positive externalities. Typically, these are cases where what is important is less what you do, and more that a lot of people are doing the same thing you are. The archetypal case is that of the zebra. Even black and white stripes on a brown and green savanna is the best camouflage if that's what everyone else is wearing. Choosing a nightclub to go to is another example of this type of situation. The best club is one that a lot of other people like.

Included in this group of cases is the network externalities that the last post in this series described, where the prototypical case is the 'QWERTY' keyboard (and also the selection of VHS over Beta). What matters is not what the arrangement of the keys is, only that everyone use the same arrangement.

Slee makes the point that in cases that fit this description, the 'winners' can reap huge rewards, and although business magazines will attribute these rewards to the winners brilliance and contribution in the form of value added, much of their fortune stems simply from having their standard chosen over someone else's - something that can often be a result of luck as much as skill.

Chapters 9 covers market failure due to limited information. If one side to a potential transaction has valuable information that the other side lacks (i.e. a used car sale where the seller knows more than the buyer, or a life insurance purchase where the buyer knows more than the seller) simply allowing both sides to make a free choice of whether to make a deal or not may lead to problems because it is hard for the two sides to agree on a fair price when one doesn't know the value of what they are buying/selling. In insurance, this is dealt with by removing the element of choice on the purchaser side (e.g. through universal plans, or group plans through employers). Once the insurer knows they can set a price without fear that healthy people (or people who are low risk, with respect to the insurance being sold) will reject their price while people who are sick (high risk) will accept their price, then the market can function reasonably well - but it rests on removing freedom of choice from those signing up for insurance.

Chapter 10 makes the point that a voluntary transaction is only voluntary to the extent that both parties have an alternative that is just as good and just as easy to obtain. Buying apples in a farmer's market is a case where if you don't like one farmer's price, the next farmer over may do just as well. At the other extreme, Slee gives the example of a person trapped in a well in a remote area bargaining with a passerby. Given that the alternative to getting help may be death, the person in the well may 'voluntarily' agree to just about anything.

Slee notes the continuance between having good alternatives and making a voluntary decision and having bad alternatives (high transaction costs, lack of a good alternative, etc.) and making a quasi voluntary, quasi involuntary decision. As we move towards the involuntary side of the spectrum, relying on both sides having freedom to choose as the mechanism that will ensure a good outcome instead of employing some stronger moral imperative will lead to exploitation rather than exchange.

Chapter 11 is a conclusion that summarizes the following 7 lessons that the book teaches:

1) Individual Choice Does Not Give Us What We Want
2) Freedom of choice promotes the private and degrades the public
3) Freedom of choices produces inequality based not on merit but on luck
4) Freedom of choice does not preclude the exercise of power
5) Freedom of choice does not preclude exploitation
6) Predictability drives out quality
7) Social Exclusion is Self Sustaining

Some other notes:

1) On page 45 Slee makes the important note that, "wise people often take steps to eliminate choices they know will lead to bad outcomes" and further notes that there are many cases where you might desire all to be bound in a certain way, but not be willing to be bound yourself unless everyone else is. For example, I might prefer not to have a Wal-Mart in my town knowing that it will eventually drive out of business all the local retailers leading to a dead downtown area. But once a Wal-Mart is in my area, and the consequences are set regardless of what I do personally, that it is in my interest to save money shopping at Wal-Mart, notwithstanding my earlier objections. Even while shopping there, I might prefer that the store be shut down, and this is not inconsistent.

2) On page 201, Slee makes the bizarre claim that his is not a book about 'ethics' - the whole thing is about ethics!

3) This ties in with the final conclusion of the book which reads,

"The ideas of MarketThink clearly work within a limited domain. ...To sell this picture of choice as "the way the whole world works," as MarketThink does, is overreaching on an epic scale ... It is time to place collective action back on the table. ... Most of all, it is time to embrace complexity. This book is about a worldview; it does not pretend (as MarketThink does) that a single solution exists to solve all our problems. Jane Jacobs got it right...."

Now if you're me, you're thinking that this last sentence ends by saying Jacobs got it right in her book (Systems of Survival) explaining that we need both the commercial (MarketThink) set of ethics AND the guardian (collective action) set of ethics to make sense of the world. But no. It ends with a quote from Jacobs (from 'The Death and Life of Great American Cities" about how cities are complex and we need to care about the details and complexities of how they work). So a disappointing conclusion, but a worthwhile book all the same.

4) In researching this post, I realized that Tom Slee has a blog, entitled 'Whimsley' (many of the examples in the book are set in the fictional town of Whimsley.)

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Monday, March 23, 2009

The Media, The View from 1878

Some fodder for the post I'll likely never write on the death of the newspaper industry:

"Use of the smallest dishonesty. The power of the press consists in the fact that every individual who serves it feels only slightly pledged or bound to it. He usually gives his opinion, but sometimes does not give it, in order to help his party or the politics of his country, or even himself.

Such little misdemeanors of dishonesty, or perhaps only of dishonest reticence, are not hard for the individual to bear; and yet the consequences are extraordinary, because these little misdemeanors are committed by many people at the same time. Each of these people says to himself, "For such petty services I live better and can make my livelihood; if I fail in such little considerations, I make myself impossible." Because it almost seems that writing one line more or less, and perhaps even without a signature, makes no difference morally, a man who has money and influence can turn any opinion into the public one. Whoever realizes that most people are weak in small things, and wants to attain his own purposes through them, is always a dangerous human being."

(from Human All Too Human, by Friedrich Nietzsche)

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Thursday, March 19, 2009

4. Network Effects

links to Part 1, Part 2 and Part 3

The prisoner’s dilemma of the last post was a particular case of negative externalities. This post covers a particular type of positive externalities known as network effects.

Wikipedia, as always, is here to helpfully summarize:

In economics and business, a network effect (also called a network externality) is the effect that one user of a good or service has on the value of that product to other people.

The classic example is the telephone. The more people own telephones, the more valuable the telephone is to each owner. This creates a positive externality because a user may purchase their phone without intending to create value for other users, but does so in any case.

The expression "network effect" is applied most commonly to positive network externalities as in the case of the telephone. Negative network externalities can also occur, where more users make a product less valuable, but are more commonly referred to as "congestion" (as in traffic congestion or network congestion).
Over time, positive network effects can create a bandwagon effect as the network becomes more valuable and more people join, in a positive feedback loop.

So I make a transaction with the phone company that is a win-win for me and the phone company and also for everyone else (a positive externality) who already has a deal with the phone company. The size of my win in the transaction with the phone company depends on how many existing users there are, so after I sign up, the next person to sign up gets an even bigger win, and so on.

In addition to actual networks, standards often have the same structure. If I am using a particular computer file format, every other person who uses that format helps me since I can look at their files without needing to change the format first. The same goes for operating systems, where Windows was able to become the de facto standard for so many years. One of the reasons there is a strong push for open standards in many areas is to avoid having one individual or group extract monopoly rents from all those using the standard in the same manner that Bill Gates became the wealthiest man in the world.

Note that in situations with network effects, there is an initial phase in which relatively small investments / ideas / luck can tip the scales between various people attempting to set up the new standard and then a later phase when one (in some cases two or three) network has emerged victorious and it would take a huge investment of resources or a significant change in the situation in order to remove them from their leadership position.

This is one way to understand the internet gold rush of the 90's. Investors understood that the internet opened up new situations where network effects were strong and that initial investments in money losing companies could pay off later if they were able to win the battle to become the standard. Ebay (the best example of network effects since if you're selling something you want to use the site with the most buyers and vice-versa so every new user benefits all the other users) founder Pierre Omidyar is now a multi-billionaire, much like Bill Gates.

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Wednesday, March 18, 2009

3. The Prisoner's Dilemma

links to Part 1 and Part 2

The last post in this series talked about externalities and before moving along from that topic I want to highlight two particular types of externalities.

In this post, I want to talk about the situation where two (or more) people enter into transactions with other parties that have negative externalities that affect each other - negative externalities that are large enough to wipe out any gain they made from their initial transaction.

An example will make this clearer, and we might as well start with the example that gives this particular type of situation it's name, the Prisoner's Dilemma.

Wikipedia summarizes the classic 'Prisoner’s Dilemma' situation as follows:

Two suspects are arrested by the police. The police have insufficient evidence for a conviction, and, having separated both prisoners, visit each of them to offer the same deal. If one testifies (defects) for the prosecution against the other and the other remains silent, the betrayer goes free and the silent accomplice receives the full 10-year sentence. If both remain silent, both prisoners are sentenced to only six months in jail for a minor charge. If each betrays the other, each receives a five-year sentence. Each prisoner must choose to betray the other or to remain silent. Each one is assured that the other would not know about the betrayal before the end of the investigation. How should the prisoners act?

Let's call one prisoner Larry and the other Curly. Put yourself in Larry’s shoes. If Curly is going to stay silent to protect Larry, Larry would be better off to betray him (and go free). If Curly is going to betray Larry, Larry is still better off to betray him and take the 5 year sentence rather than the 10 year sentence. The same logic holds true for Curly.

So Larry makes a win-win transaction with the detective (to betray Curly) but this transaction has a negative effect (externality) on Curly. Similarly, Curly makes a win-win transaction with the detective that has a negative effect on Larry.

To summarize:

Transaction 1, Larry makes a deal with the detective: Detective +, Larry +, Curly --
Transaction 2, Curly makes a deal with the detective: Detective +. Larry --, Curly +
Net Result: Detective ++, Larry -, Curly -

Now, you might argue that if Larry thinks Curly is going to stay silent to protect him, then Larry is not better off to turn Curly in, because Larry owes Curly the same sort of protection, or that Curly will remember that Larry turned him in and take revenge once he gets out of jail or because Larry will feel bad about turning Curly in. All of those things may be true, but if they are, that doesn't mean that this is a case where the prisoner's dilemma can be 'overcome' it just means that a true measure of the costs and benefits of each action needs to incorporate more factors than just the length of the prison sentence.

But, as long as we are in a situation where Larry’s payout (including the number of years of jail time, his own sense of ethics, concerns about retribution from Curly, etc.) is higher ratting on Curly vs. reciprocating Curly’s loyalty, then the situation is a prisoner’s dilemma and Larry will rat on Curly. The situation where some other factors at work lead Larry and Curly to stick together and not cooperate with the police is some other situation, not a Prisoner's dilemma.

In other words, the point is not how do we get someone to cooperate in a prisoners dilemma, the point is how can we change the payouts such that the situation is no longer a prisoners dilemma. For example, an organized crime family uses a 'law of silence' to introduce a moral code of loyalty which shifts the incentives for the prisoner's to rat each other out. On top of that, a credible threat to kill anyone who talks to the police shifts the relative payouts even further.

The result of the prisoner’s dilemma is that, for the people in the dilemma, they take an action designed to further their interests, but the end result does not end up serving their interests as they expected. Larry and Curly will both end up serving 5 years in jail when they could have just served two if they had only cooperated (with each other, not the police).

It is important to realize that the Prisoner's Dilemma is not just some contrived situation that hardly ever occurs in the real world, it is in fact almost ubiquitous in our lives. In the human world any time a party has something valuable to 2 or more other parties and plays them off against each other (e.g. an auction where people have to bid against one another, a customer that negotiates a lower price based on what a competitor is offering, etc.) you have a potential prisoner's dilemma.

In the natural world, any time two or more parties are sharing a common resource you have a potential prisoner's dilemma (e.g. tragedy of the commons)

Note that in the case of the two prisoners, they were reacting not to each other but to the offer made to them. There was no sense that first Larry would make a decision and then Curly would make a decision in response to Larry's decision. But the Prisoner's Dilemma can arise in that sort of reactive situation as well, only here you tend to get into 'Arms Race' type situations.

For example, I decide to tear down my modest house and build a monster home because I have a desire to have the largest house on the street. This is a win for me because it increases my satisfaction to come home and pull in to the largest house on the block. But it is a negative for my neighbour who now feels inferior - so he tears down his house and builds a bigger house on his lot. A win for him, but a negative for me. So I tear down my monster home and build an even bigger home. Each transaction is voluntary and is rational in the sense that it benefits the people making the transaction, but again the net result is that people are worse off because the zero sum nature of their goal (only one person can have the biggest house on the block) means that the negative externalities from each transaction outweigh the benefits.

Another more realistic example is when a Province decides it can lure away business from other Provinces by offering a lower corporate tax rate. This benefits that Province, until other Provinces retaliate by lowering their tax rates. Given the time lags, you can always point to how one Province is benefitting from lowering their corporate tax rates (for a while) but in the end, they all just end up collecting fewer taxes and there is no net benefit since there can always only be one jurisdiction with the lowest tax rate.

So the prisoners dilemma represents a special case of externalities in which the parties simultaneously or sequentially impose negative externalities upon each other such that even though every transaction is a win-win for the parties involved (Larry’s deal with the police is a win-win, and so is Curly’s deal with the police) the negative externalities mean that the parties stuck in the dilemma end up worse off.

The Prisoner's Dilemma is central to the points I eventually want to get to (I think) but there's too much material to cover in just one post, so I'll definitely be coming back to it in later posts. There's just one other point worth mentioning in this introduction and that is to note how the Prisoner's Dilemma gets harder to deal with as the number of parties involved escalates.

There are two dynamics at work here. One is that with a large number of parties, even an action that has a small negative externality per person affected can be a net negative. Take, for example, littering - the impact of litter on any given person is small, but since it affects many people the overall result is negative. The second element is that with a large number of people it is harder to change/structure the incentives so that the situation is no longer a prisoner's dilemma. With just two prisoner's, maybe Larry and Curly have a strong enough bond of loyalty to not rat each other out, but with a dozen prisoner's, somebody is likely going to talk.

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Tuesday, March 17, 2009

Two Digressions

This post takes a break from my buildup to a discussion of ethics in order to highlight a couple of excellent posts that I didn't want to let slip by without mentioning.

1. Karl Denninger talks about fractional reserve banking. Finding good commentary on this topic is hard because the mainstream won't discuss it and the non-mainstream that discusses tends to just take it as given that it is a bad thing (and a fraud) without needing to go into any more detail.

Denninger first explains what fractional reserve banking is (see wikipedia for a more basic intro), and then shows that it is not a fraudulent system because at any given moment, the deposits at the bank are matched by some combination of cash in the vault and loans to other people.

I'm a bit skeptical of his belief that if people came for their deposits en masse, the bank could simply liquidate its loans (sell them to other banks, I suppose) and repay the depositors with no harm done. Certainly the history of banking prior to the institution of deposit insurance was one of bank runs and people getting little, if any, of their money back.

Furthermore, there is an element of, if not outright fraud, then at least deception in that most people who deposit money at a bank expect it to stay there and be there when they need it. If they were explicitly asked if they wanted the bank to lend their money out to other people such that getting their deposit back was contingent on enough of the bank's debtors not defaulting, I'm not at all sure they would agree.

Denninger then moves on to explain the primary advantage of fractional reserve banking which is that, by allowing banks to increase their leverage, it allows them to lend money with a lower interest rate than would otherwise be necessary, and these lower interest rates support a much greater level of entrepreneurial activity than would otherwise be the case.

Then he talks about the downside of this leverage. The only way the interest on this leveraged money can be repaid is if the money that was loaned out is invested for productive purposes that more than cover the interest. Given that the interest rate charged by banks is always higher than the rate of economic growth, this is impossible (unless we create new money to pay the interest with).

As the unpayable interest piles up, eventually the economy has to have a recession in order to reset debt levels back to a lower level (from which they can be increased again). [Or, I suppose, the central bank could just force interest rates lower and lower to allow people to carry more and more debt until finally even with central bank interest rates at 0, the debt load is still too much and we have a depression instead of a recession, but I digress.]

Denninger sees the implicit cyclicality (debt expands then crashes) as a benefit of the system in that it allows those that borrow to invest productively to survive, while wiping out (bankrupting) those who borrow for unproductive purposes. Provided, of course, that the cyclicality is kept from becoming excessive, which he feels can be done by maintaining and enforcing reasonably high reserve requirements for all institutions that lend money.

Note: There's a followup post by Denninger reiterating his points here.

Overall, I agree with Denninger's analysis and with his assessment of what the pros and cons are, but I disagree with his assessment of the magnitude of the pros and cons. I am more optimistic than him that we could find a way to provide funding for investment at reasonable interest rates without having to rely on fractional reserve banking, and I weigh more heavily the costs of the instability associated with the system and I'm more skeptical about the ability/willingness of the authorities to actually enforce reserve requirements.

Notwithstanding my disagreements, it's an excellent post, and one of the best summaries of the topic that I've seen.

2. Steve Keen gives Rory Robertson a valuable and entertaining lesson on why you often need to compare stocks and flows in a dynamic system.

Stocks represents quantities of things (e.g. the amount of water in a reservoir) whereas flows measure the movement of something from place to place (e.g. water flowing out of the reservoir and down a river).

In accounting, the balance sheet keeps track of the stocks (of assets and liabilities) and the income statement keeps track of the flows (of revenue and expenses).

Keen is taking on a pet peeve of mine which is when economists argue that some analysis or argument or concern is invalid because it involves comparing a stock to a flow as if there was some rule that you should never compare stocks to flows (e.g. It is meaningless to compute how many months of interest payments (flows) a company could make from current cash (stocks)) because that involves comparing a stock to a flow.

It's true that, as Keen is well aware and explains, you need to be careful with your measurement units when comparing a stock to a flow, but any time you have a system that is dynamic (in motion, in some way), you often need to compare stocks and flows and, as Keen says, the economy is nothing if not a dynamic system.

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Saturday, March 14, 2009

2. Actions, Transactions and Externalities

Note: This is the second in a multi-part series, part 1 here.

In the first installment I forgot to mention that in addition to summarizing a bunch of books/arguments, I was also going to need to make a few posts here and there explaining some of the terms and concepts used in these books. This post covers the concepts of actions, transactions and externalities.


For the purposes of this series of posts I want to use the word 'action' to mean those activities primarily involving just one person (e.g. I go into the orchard and pick some fruit, I decide to go back to school, I decide to save money rather than buying a new car) and 'transaction' to mean activities that primarily involve two people (e.g. I pay my tuition to a college, I steal a fruit from my neighbour etc.) Naturally there’s some grey area in these definitions but I think the distinction between actions primarily involving just one party and transactions involving two parties is clear enough to be useful.

The next concept I want to mention is the idea of an externality. This is a term primarily used in economics, but there's nothing specifically 'economic' about it. All it refers to is the idea that an action or transaction might have an impact on other parties that were not part of the original action/transaction.

Where those impacts are negative, we refer to a negative externality, where those impacts are positive, we refer to a positive externality.

For example I drive to the car dealership to buy a new car. I have an action (driving to the dealership) and a transaction (exchanging my money for the car) with the salesman. But there are impacts of this action and transaction on other parties besides myself and the car salesman.

By driving there, I am releasing carbon dioxide into the atmosphere that may damage the climate and cause harm to people who had nothing to do with me driving to the car dealership – this is a negative externality.

On the other hand, perhaps I have friends and family members who used to always need to give me a ride places and now I can drive on my own or give them rides – so my car purchase contains a positive externality for these people.

On the other (other) hand, my neighbours may now derive less satisfaction from their car because I have a newer, fancier car then they do and they may feel the need to go buy a better car of their own – so there is a negative externality for them. And so on.

It’s a simple concept, but a very important one, so I wanted to explain it as clearly as possible before we continued on.

For more on externalities, here is the excellent wikiepdia entry, which has a number of examples, goes into more detail on a number of interesting fronts and defines an externality as follows:
'In economics, an externality or spillover of an economic transaction is an impact on a party that is not directly involved in the transaction. In such a case, prices do not reflect the full costs or benefits in production or consumption of a product or service.'

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Wednesday, March 11, 2009

1. Systems of Survival

I've decided to start a series of somewhat different posts than the standard recent fare here at CAtO. The general goal is to talk about ethics and the role of government and markets in society.

The first few posts will be summaries (not reviews, summaries) of various books I've read that I figure have something relevant to say on the topic. I won't summarize everything in the books, just those elements I found to be relevant. Later on, assuming that my attention span doesn't run out, I might get around to actually trying to pull some of the different threads together and start applying them to various issues that affect us here in Canada. Or not, we'll see how it goes.

To differentiate the posts in this series from the standard 'That Politician Stinks' and 'That Article Was Stupid' posts we do here, I am going to number them , as I have done with this one. They also will get the 'ethics' tag which would be useful if I ever get around to updating my template for tags.

The first book I want to summarize is one I have referenced on the blog in many past occasions, including here, here, here, here, and here. The book is Jane Jacbos' Systems of Survival.


Back in 1992, Jane Jacobs wrote a book called, Systems of Survival in which she built on Plato's Republic to argue that humans have two ways of making a living: our traditional one based on control of territory and taking what we need, and one based on trading for what we need. Humans are set in contrast to other species which only rely on taking what they need and do not make use of organized trading activity to make a living.

Each of the two ways of making a living has it's own set of ethics, with ethical trading relying on shunning the use of force, honesty, competition, openness to novelty, invention, collaboration with strangers and a bunch more.

In contrast, ethical territorial (or 'guardian' as Jacobs calls them) activities (such as government) rely on a different set of values including shunning trading, respect for hierarchy and tradition, loyalty and a bunch more.

In Jacobs' view, unethical behavior inevitably arises when values which are ethical in one way of making a living are used in the other way. i.e. When the two ethical systems are mixed together. An example she gives is organized crime, where the mixture of legitimate commercial activity with activities that normally only a government is allowed to perform (such as use of force) leads to a 'monstrous hybrid' of the two ethical systems.

The two syndromes contain the following sets of ethics:
Commercial Moral Syndrome:

Shun Force
Come to Voluntary Agreements
Be Honest
Colllaborate easily with strangers and aliens
Respect Contracts
Use Initiative and Enterprise
Be Open to Inventiveness and Novelty
Be Efficient
Promote Comfort and Convenience
Dissent for the sake of the task
Invest for Productive Purposes
Be industrious
Be Thrifty
Be Optimistic

Guardian Moral Syndrome:

Shun trading
Exert Prowess
Be Obedient and Disciplined
Adhere to Tradition
Respect Hierarchy
Be Loyal
Take Vengeance
Deceive for the sake of the task
Make rich use of leisure
Be Ostentatious
Dispense Largesse
Be exclusive
Show Fortitude
Be Fatalistic
Treasure Honour

I've covered the main elements of the book, but here are a few other tidbits:

1) Jacobs talks about how historical societies often developed Caste systems which separated the two types of activities. Medieval Europe had feudalism with a guardian class that shunned trade. India still has a caste system with trade and commercial activity belonging to a lower class. Japan had the samurai warrior class with its guardian ethics as a separate class from the commercial class.

By way of contrast, the Bible talks of the Jewish people switching back and forth between the two syndromes as en entire people as necessary during their Exodus.

Although our society does not have a formal caste system, nonetheless many people exhibit certain 'casts of minds' where their thinking hews more to one of the two syndromes.

2)Jacobs identifies Plato's Republic, which was to divided into a guardian class and a commercial class as the original expression of this idea, and suggests that Plato's definition of injustice (one man doing the work of someone from another profession) was meant to reflect the intractable corruption that results when the two syndromes are mixed together.

3) Jacobs identifies two anomalous professions with respect to the ethical syndromes: Law and Agriculture

Law is anomalous because the profession sometimes operates along Guardian lines (courtroom battles) and sometimes operates along Commercial lines (drawing up contracts, wills, etc.). In England, the profession is actually split into Barristers who do the Guardian work and Solicitors, who do the Commercial work.

Agriculture is an anomaly because it is a commercial activity by nature, but because the raw material for agriculture is land, and guardians see guardianship over the land as their primary duty, they have a near irresistible urge to meddle in agriculture that they don't have with respect to other industries.

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