Tag Archives: Cowen

The Third Industrial Revolution Has Only Just Begun

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Bob Gordon released a provocative working paper (ungated) back in August that made quite a splash on the blogs. It is an extreme, more pessimistic version of Tyler Cowen’s The Great Stagnation. Gordon argues—rightly, in my opinion—that economic growth is not automatic. There is no a priori reason to believe that real per capita GDP will grow at 2 percent in the future when it has grown at a rate closer to 0 for most of human history. Maybe the current period is unique—and coming to an end.

The question is worth considering, but in the details of his analysis, there is much that Gordon gets wrong. For example, Gordon looks at growth in the “frontier” economy, the economy that is most advanced in each period. This means the UK from 1300 to 1906 and the US from 1906 to 2007 (where he stops his story to abstract from the financial crisis). When looking at a single wealthy economy, global factor-price equalization that results in lower middle-class wages seems like a bad thing. But of course, these lower wages are the result of higher wages elsewhere—they are wages for poor people who can increasingly contribute to the frontier of innovation as they get wealthier. Limiting the analysis to a frontier national economy seems inappropriate when one of the major global trends is a reduction in the discreteness of national economies.

I have a lot of other complaints—for instance, I wanted to refer Gordon to Noah Smith on global warming—but for the rest of this post, I am going to focus only on one particular issue. Gordon divides our progress over the past 250 years into not one, but three Industrial Revolutions. IR #1 was from 1750 to 1830 and gave us steam power and railroads. IR #2 ran from 1870 to 1900 and yielded electricity, internal combustion, running water, indoor toilets, communications, entertainment, chemicals, and petroleum. IR #3 started in 1960 and gave us computers, the Internet, and mobile phones.

Gordon takes the view—entirely defensible—that IR #2 is the one that is the most important, and that it took about 100 years for its “full effects to percolate through the economy.” But both in his definition and discussion, he gives short shrift to IR #3.

The computer and Internet revolution (IR #3) began around 1960 and reached its climax in the dot.com era of the late 1990s, but its main impact on productivity has withered away in the past eight years. Many of the inventions that replaced tedious and repetitive clerical labor by computers happened a long time ago, in the 1970s and 1980s. Invention since 2000 has centered on entertainment and communication devices that are smaller, smarter, and more capable, but do not fundamentally change labor productivity or the standard of living in the way that electric light, motor cars, or indoor plumbing changed it.

Later in the paper, he writes,

Attention in the past decade has focused not on labor-saving innovation, but rather on a succession of entertainment and communication devices that do the same things as we could do before, but now in smaller and more convenient packages. The iPod replaced the CD Walkman; the smartphone replaced the garden-variety “dumb” cellphone with functions that in part replaced desktop and laptop computers; and the iPad provided further competition with traditional personal computers. These innovations were enthusiastically adopted, but they provided new opportunities for consumption on the job and in leisure hours rather than a continuation of the historical tradition of replacing human labor with machines.

I can see how if you’re comparing the advancements of the past few decades to the benefits of indoor plumbing you might come away a little disappointed, and I’m not trying to play IRs 2 and 3 against each other. But I think that Gordon unfairly or unwittingly understates the magnitude of IR #3, because IR #3 has only just begun.

What is IR #3 and where is it going?

Again, Gordon defines IR #3 as the arrival of computers, the Internet, mobile phones, etc. But rather than focusing on the products, let’s focus on the processes and innovations that got us here—computation, miniaturization, packet switching, and so on. These ideas feature prominently in the products that Gordon uses to define IR #3, but they also have much wider conceivable applicability than just those products.

I think we are on the cusp of an important transition within IR #3. So far, we have used these innovations to make ever faster, smaller, and more useful computers, including mobile phones. We have created, as Gordon notes, a whole lot of dot-coms and online services. But we’re already starting to see engineers and companies dabble with new kinds of products. Rather than merely accepting, transforming, relaying, and displaying information, some new computer-based products have more of a physical—really, a kinetic—effect on the world.

The most obvious example of this new kind of kinetic computing is the autonomous car. Rather than simply gathering information and displaying it to the driver, like a GPS mapping system, we are empowering an onboard computer to make decisions about driving. These decisions have consequences, and it is difficult to program a computer to get them right—much harder than, say, inventing Facebook. But despite the difficulty of the problem, we have made a lot of progress in the last decade, and most of us can look forward to one day owning a robotic car or ordering a robotic taxi to come pick us up.

The point is that computing innovation is going to shift, and is already starting to shift, from the virtual to the physical world. The products that IR #3 has brought us so far are great fun, but because they only really display information to us, they leave a lot for us to do. The main benefit of iR #3 is going to arrive when new innovations make and do things for us.

Ambient computing

Golden Krishna wrote an excellent blog post recently entitled “The best interface is no interface.” Read the whole thing. The point of the post is that we have not yet done a good job of replacing early computer interface paradigms like WIMP—window, icon, menu, pointer—with natural, unobtrusive, adaptive paradigms. Instead we slap a display on everything and call it progress.

Read tweets on your speedometer!

Krishna provides some great examples of the alternative vision, what he calls “No UI,” which include the Auto Tab feature of Pay with Square and Nest. What these products and services have in common is that users empower them to make decisions without direct supervision. They require a little human interaction to set up, but from then on, unless something goes wrong, there is no need to do anything to use the product. The product adapts to you, it gets out of the way, and it feels natural.

We are only just now getting to the point where products like these are becoming possible. So far in IR #3, we have mainly trusted computers with information, not with decisions about the physical world. But as computing improves, we are going to automate more.

In What Technology Wants, Kevin Kelly writes about the “home motors” you could buy a century ago. The idea was that buy a single motor for interchangeable use in a sewing machine, a mixer, a fan, or an egg beater.

One hundred years later, the electric motor has seeped into ubiquity and invisibility. There is no longer one home motor in a household; there are dozens of them, and each is nearly invisible. No longer stand-alone devices, motors are now integral parts of many appliances. They actuate our gadgets, acting as the muscles for our artificial selves. They are everywhere. I made an informal census of all the embedded motors I could find in the room I am sitting in while I write:

[...]

That’s 20 home motors in one room of my home. A modern factory or office building has thousands. We don’t think about motors. We are unconscious of them, even though we depend on their work. They rarely fail, but they have changed our lives. We aren’t aware of roads and electricity either because they are ubiquitous and usually work. We don’t think of paper and cotton clothing as technology because their reliable presences are everywhere.

Once computer chips become as ubiquitous and invisible as motors, and we get competent enough at using them to empower them to make decisions for us without direct supervision, the result will be something like ambient intelligence. It’s hard to predict what people will use AmI for, but it certainly feels to me like a much bigger advance than Angry Birds and Facebook. We’re probably a decade or two away from high-quality ambient intelligence, but given its reliance on the innovations generated on IR #3, AmI should be counted as an IR #3 innovation when it arrives.

Transport efficiency

The audacious idea that economic growth was a one-time-only event has no better illustration than transport speed. Until 1830 the speed of passenger and freight traffic was limited by that of “the hoof and the sail” and increased steadily until the introduction of the Boeing 707 in 1958. Since then there has been no change in speed at all and in fact airplanes fly slower now than in 1958 because of the need to conserve fuel.

Gordon is right that travel speeds have not increased much in recent decades. If you had told me in that 1980s that by 2012 I would still never have traveled faster than sound (relative to the Earth), I would have been very disappointed. And while some interesting technologies are in the pipeline—scramjets, spaceplanes, and so on—it will be a while before these are commercialized.

But in the meantime, the efficiency of transporting people and goods could explode in the near future. Gordon is well aware of autonomous cars, so I won’t belabor the point, but it seems obvious to me that a morning commute during which I am able to productively get started on my day is almost like no commute at all. An evening commute during which I am able to relax and unwind is almost like no commute at all. If we calculate effective speed by dividing travel distance by wasted time, then technologies like autonomous vehicles and to a lesser extent in-flight Wi-Fi are starting to make up for some of the stagnation in proper transport speed.

I have already written about how revolutionary commercial drones are likely to be. Local deliveries will be made robotic quadrocopters instead of by humans, and FedEx will switch to blended-wing unmanned cargo freighters that will reduce the cost of long-range goods transport by a factor of five, making air transport competitive with (only about twice as expensive as) ocean transport. A key point about the quadrocopter revolution is that it needed the iPhone market to get started:

As Dan Shapiro notes, “A single high-quality gyro used to go for a thousand bucks.  Now, you can get 3 gyros, 3 accelerometers, and a nice CPU to manage the whole thing for under a sawbuck.”

Commercial drones face some regulatory hurdles, but assuming these can be overcome, they will be an important contribution of IR #3.

Matter compilers

Traditional printers have a kinetic effect on the world—they put ink to paper—but not really. We value them for the informational quality of the printed product, not for the physical structure of the object that comes out of the printer. 3D printing is not that different from traditional printing, but its impact is likely to be much larger. It is another element of IR #3 that is still in development.

When I got a chance to see a 3D printer in person earlier this year, I was underwhelmed. There is still very little that consumer 3D printers can produce that I would actually want. But future generations of printers will almost certainly be much more useful as they become able to print in a wider array of materials.

In particular, I am excited to see chemical printers. People will be able to make their own drugs—both medical and recreational. This may sound dangerous, and perhaps it will be. But with the adoption of quantum computing we will be able to simulate chemical reactions in advance, something that we still cannot do efficiently with classical computers. Such simulation will greatly improve the feasibility of moving quickly to human trials on new drugs, including self-experimentation. The combination of quantum simulation and chemical printing could lead to a golden age of pharmaceutical discovery.

Synthetic biology

Relatedly, synthetic biology is another area where we seem to be observing rapid progress. I am woefully ignorant about synthetic biology—I am ashamed of this and will remedy it soon—so I should probably not be making very strong claims. But it seems important to mention that few if any of the advances in this field would have been possible without computers or prior research that has made heavy use of computers. Consequently, these advances are attributable to IR #3.

Online education

Total educational spending in the United States is something like 7 percent of GDP (5.5% of GDP is public expenditure, I believe around 1.5% or so is private expenditure). And the quality of education for anybody but the best or richest students is not especially good—the US routinely posts middling scores in international comparisons for primary and secondary education. Even at the college level, where the US excels, a lot of students are being underserved, often because they need remedial help.

We are still using a medieval technology, the lecture, to educate our students. But increasingly entrepreneurs—both for- and non-profit—are looking for better ways of teaching. Many of the new crop of online educational institutions, such as Khan Academy, Udacity, and Marginal Revolution University, are completely free.

People are still experimenting with educational models (and business models), but education that leverages new technologies has several advantages over the old classroom model. For example, in what is known as “flipping the classroom,” students can watch lectures for homework, and do problem sets in class, where they can get help from teachers. The quality of teaching can be higher because everybody can be taught by the very best teachers. And separating the teaching component of school from the coaching and supervision component of school means lower costs and greater specialization, including jobs for people who are not good at teaching but who are nevertheless good at working with kids. At least until the robots can do that too.

Gordon argues that we got a one-time economic boost from educating more people, but now educational achievement has plateaued and we can no longer rely on more education as a source of economic growth. But this seems like a narrow perspective to me. The quality of education certainly has a lot of room for improvement, as does the cost. If we let computers help us teach, we can improve on both of these margins.

While it remains to be seen what the ultimately successful models of online education will be, it would be surprising to me if there is not a major change in the educational industry in the next couple decades. And when that change comes, I bet it will be due to IR #3.

A new phase of IR #3

I’ve tried to review a number of emerging technologies that are likely to transform our daily lives, how we transport people and goods, how we make stuff, our health, and our educational system. Obviously this is an incomplete list; see Wikipedia for more.

There is still a lot of oomph in IR #3. All of the technologies that I have described are in development, and all of them owe their existence to digital computing. Some of them may founder, and some different technologies may turn out to be more important. But it is a big mistake to think that the world of computing can remain separate from the rest of the world for long. Computing started out set apart because it is safer that way—if your browser crashed or your web server goes down, there are not very large external consequences.

Experience and practice in the safe virtual world are leading to a greater desire and capability to extend these technologies to the physical world. It has taken 50 years, but we are now on the cusp of these changes. The remaining question is whether we will welcome them or try to smother them with regulations and arguments over the transitional gains. The best way out of the Great Stagnation is to eagerly embrace and support the new technologies. But they may be coming whether we want them or not, and that is why I am a long-run growth optimist.

Replies to My Critics

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Last week, I argued that the short run is short—that there is good reason to believe that we’re now past the point where monetary stimulus can do much to help the economy. Again, I am broadly friendly to market monetarism and not especially hawkish on inflation. I am not so much against QE3 as skeptical that it will work. I think that the broad facts and a lot of mainstream macro theory back me up.

My post garnered a fair bit of criticism around the blogosphere. Let me make one quick empirical point to get everyone on the same page, and then I will try to respond to my critics point by point.

The empirical point is summed up in the graph below. NGDP grew around 5 percent per year until around 2008, and then it fell, and then it grew at around 5 percent—or slightly less—per year again beginning in mid 2009. These facts are well known, but I bring them up here because they do constrain the kind of stories we can tell about the economy. Any story you tell has to contain a one-time shock that ended years ago, and it has to be consistent with NGDP that has grown at about the same rate over the last 3 years as it did before the shock arrived.

OK, now with that out of the way, let’s take the criticisms one by one.

Bryan Caplan and ADP unemployment

Bryan cites Akerlof, Dickens, and Perry on long-run unemployment as a reason why QE3 might boost employment in spite of the fact that we are out of what we would conventionally call the short run. The ADP model assumes heterogeneous firms and workers with money illusion. At any given time, some firms need to cut real wages, and since nominal cuts hurt morale, higher inflation helps those particular firms cut wages instead of jobs. Consequently, in a low-inflation environment, monetary stimulus can help lubricate the employment market.

This argument is a good one as far as it goes. Unfortunately, I don’t think it goes very far given the stylized facts. As I noted above, NGDP is growing at a rate of 4-5 percent per year, not that different from before the crash. So any long-run ADP-style unemployment should be about the same now as it was before the crash unless there was a structural change in the economy. You can’t have it both ways—if we’re in a low-inflation environment for ADP purposes now, then we were in a low-inflation environment for ADP purposes before the crash as well.

Furthermore, assuming QE3 is a temporary policy, then if unemployment is long-term ADP unemployment, the effect of QE3 on unemployment will be temporary. I would regard a temporary dip in unemployment as a result of QE3 as good but underwhelming, given the claims of many market monetarists. There may of course be interactions between short-run unemployment and ADP unemployment, and for that reason, the dip in unemployment may not literally be temporary, but I would be surprised if QE3 could fix the economy through this channel.

Bryan makes an interesting linkage between my views on the ZMP hypothesis and ADP unemployment. If there is a decreasing secular trend of low-skill labor productivity, then ADP unemployment will become more serious over time. I think this is a good point, and it pushes me at the margin to favor a higher long-run NGDP target than I otherwise would. I was previously inclined to believe that the exact value of the target doesn’t matter once you get to levels of around 3 percent, but now I see more merit in a higher target.

Insider-outsider models

Bryan and some of the commenters at MR say that it is a mistake to focus on the wage demands of the unemployed. Rather, it is the wage demands of the employed that are especially sticky. The failure of insider wages to adjust downward to long-run levels means that there’s no ability to hire outsiders at below long-run levels, either because companies can’t afford to do it or because they are afraid of hurting insider morale.

The problem is that even if this story is true, we are probably, again, out of the short run. NGDP is almost 10 percent higher now than it was at the pre-crash peak. The number of people employed, even with population growth, is still below the pre-crash peak. Even assuming that insider nominal wages are totally inflexible, nominal output per worker has grown fast enough that insider real wages have probably adjusted. Furthermore, in five years, a non-trivial fraction of insiders retire or change jobs.

More generally, I’ve never been a fan of insider-outsider models, at least not for the United States in recent times. Maybe it makes sense as a model of Europe or Detroit in the union heyday. But today in the US, “labor” is less homogeneous than ever, private sector unions have declined, and fewer workers have an expectation of lifetime employment. Yet the past three recoveries have been increasingly jobless! How can you square the fact that at a time when the insider-outsider distinction is weaker than ever, labor hoarding has basically ended and labor market adjustment has become more difficult? I do it by assuming that the insider-outsider mechanism does not play that big of a role.

But again, even if the insider-outsider story was true at the beginning of the recession, there is little reason to believe that it is still true.

Ryan Avent and corporate profits

At the Economist, Ryan Avent focuses on my point that corporate profits are at record highs.

Firms could be enjoying high profits simply because revenues have stabilised while costs are low, perhaps because low expectations for future nominal spending growth have discouraged investment.

First, note that in the series I cited, corporate profits are adjusted for inventory valuation and capital consumption. The purpose of these adjustments is to make the series less responsive to exactly the kind of behavior Ryan posits. If firms decide not to invest in production and simply sell out of inventory instead, that can increase profits, but it doesn’t increase profits adjusted for inventory valuation. Likewise, a firm can temporarily increase profits by making inefficient use of existing equipment, which could lead to faster depreciation. Are these adjustments perfect? No. But they do offset some of Ryan’s concerns. Corporate profits are high even when you subtract some of the temporary gains firms get from not investing. The unadjusted series is here, by the way; I avoided it because I anticipated Ryan’s argument.

Second, whatever firms’ expectations were, as I’ve said repeatedly, nominal spending growth has not been especially low in the last three years. A better story, if you are trying to resist structural theories, might be that firms are wary of investing due to fears of shocks from Europe or Asia, which monetary easing now does little to help. It would be great if the Fed would commit now to keeping NGDP growing at 4-5 percent when those shocks do hit, but in the meantime, I am not expecting a lot out of QE3.

Ryan also makes a couple of other points, but none of them cut to the heart of my critique of QE3 optimism. He gestures to the New Keynesian literature, but of course even the New Keynesians don’t argue that the short run lasts forever. And Mankiw, who is one of the authors Ryan cites, is a well-known proponent of the unit root hypothesis. I do not read Mankiw as expecting a return to trend, no matter what monetary policy is, although I of course do not speak for him and am happy to be corrected. Ryan also quotes Weitzman on how increasing returns creates unemployment, which is true, but tautologous: if there were no increasing returns, anyone who was unemployed could start his own firm and be just as productive as when he was employed.

Bill Woolsey

Bill Woolsey cordially welcomes me, despite my heterodoxy, to the market monetarist club. I am glad to make the cut.

I think that I failed to make myself clear in my original post. Bill says, “Dourado’s version of how shifts in nominal GDP impact real output and employment is based upon an assumption of market clearing.” This is not what I intended to convey. I think that part of the effect of nominal shocks propagates through market-clearing monetary misperceptions (Lucas islands), and the rest through non-market-clearing nominal rigidities, or as I wrote in the original post, “because some wages, prices, and contracts don’t adjust instantaneously.” I am not as New Classical as Bill seems to think. I like some elements of the New Classical school, but in the end I think the correct theory of macro for now is pluralism.

In the long run, I do think that markets mostly clear. And I think that Bill must agree, for he writes at the end of his post:

On the other hand, most of us do believe that firms eventually cut prices and wages in the face of persistent surpluses of output and labor. Most of us remain puzzled by the slow adjustment.

This is my point. If our problems were purely cyclical, “eventually” would have happened already, so our problems must not be purely cyclical. Time to start looking at structural explanations.

Scott Sumner and cutting-edge research

I was pleased to get a reply from the high priest of market monetarism himself, Scott Sumner.

I addressed the plausibility of sticky wages here, and in numerous other posts in reply to Tyler Cowen and George Selgin. I’d also point out that there is lots of cutting-edge research that tells us that the “common sense” approach to the wage stickiness hypothesis is not reliable. By common sense I mean; “Come on, wouldn’t the unemployed have cut their wage demands by now.” Yes, they would have, but that doesn’t solve the problem.  This is partly (but not exclusively) for reasons discussed in this recent Ryan Avent post.

Well ok, I followed the first link, which gives the usual argument and then ends with the line, “Until we get a more plausible theory of unemployment, I’m sticking with stickiness.” This is honest, and it certainly is a common view, but I don’t think it’s a good idea to rely so heavily on a theory just because we don’t understand competing theories well yet. Macro of the gaps, I call it.

We have a long way to go in macro, so I’m glad that Scott brings up the issue of cutting-edge research. If he has particular examples of recent work that undermines the common sense approach, he should write about them at greater length. I assume that when he says “cutting-edge” he is not referring to the papers cited in Ryan’s post, since those are both from the 1980s.

Speaking of cutting edge research, let me point everyone to a paper, “Countercyclical Restructuring and Jobless Recoveries,” by David Berger, a new PhD from Yale, and now a professor at Northwestern. Berger creates a model in which firms grow fat during expansions and respond during recessions by laying off their least productive workers. His model creates jobless recoveries and matches the new stylized facts (they have changed since the 1980s) about business cycles pretty well.

One thing that I like about the Berger paper is that it shows why some nominal shocks, if not addressed immediately, are not easily reversible by monetary authorities. Once a firm has fired its least productive workers, it is not going back. If the monetary authority wants to prevent a recession, at least post-1984, it needs to act before firms lay off their workers. This perspective actually bolsters the case for NGDP targeting, because it means that the Fed should have an apparatus in place now so that the economy will be automatically stabilized when the next shock hits. Here is Tyler on Berger.

My question for Scott, since he’s so interested in cutting-edge research, is: “What do you think about Berger’s paper?” I assume that Scott is familiar with the changes in business cycles that Berger documents. Does he not think that Berger’s model accounts for some significant fraction of our current unemployment better than simply sticky wages forever?

The bottom line

None of my critics seem to be willing to make any sort of broadly falsifiable claim about how long the short run lasts. (I should say that Bryan is not arguing that we are necessarily in the short run in the bulk of his post). There is a lot of assuming trend stationarity, talk about output gaps, and pointing to literature I am well aware of—in short, a lot of question begging.

I would like to see a greater emphasis in the blogosphere on understanding stylized facts about recessions, a greater willingness to explore micro phenomena (even if we are not using fully microfounded models), and more macro-ecumenicism. No one school of macro has it all figured out, and that includes market monetarism. There is enough ambiguity in our current situation that reasonable people can disagree about what is going on. But I don’t think that reasonable people can be totally certain that all we need is more nominal stimulus.

Can We Develop Less Wasteful Price Discrimination Techniques?

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Fmb asks:

Request: discuss any literature on and/or speculate wildly about ways to make price discrimination more efficient.

One component of pd is often arbitrary time wasting. Could that be equally effective but more socially useful? Instead of clipping coupons, complete some mechanical Turk task requested by a charity.

Or watch khan academy videos for coupons might effectively achieve the same useful discrimination without actually wasting time (might require some irrationality).

Basically, what’s the total friction cost of current pd schemes? Is that waste totally unavoidable?

On the literature in general, everything I know about price discrimination I learned from Alex Tabarrok (standard disclaimer!), so probably the best I can do is point you to his graduate IO syllabus, which contains a nice list of price discrimination articles.

Fmb is right that price discrimination often imposes costs. In addition to the costs that it imposes on consumers, sometimes producers bear extra costs to be able to price discriminate. The Cowen and Tabarrok principles text discusses the example of HP printers, which are built to force you to buy HP ink, facilitating a cheap-printer, expensive ink price discrimination strategy. The strategy works because HP has a patent on the printer head, and it builds the head into the ink cartridge rather than into the printer. It would be socially efficient for it to be built into the printer, but we instead dispose of perfectly good HP printer heads every time we swap out our ink cartridges.

How about if instead of the disposable printer head strategy, HP relied on cryptography in the printer and the cartridge to authenticate genuine HP ink and reject non-HP ink? It would be imperfect, and hackers would surely find a way to break the system, but it might work well enough. After all, this is how video game console makers prevent a lot (but not all) video game piracy. Sure, you can buy a chip to mod your XBox, but most people just pay the high price for games. Similarly, maybe most people would just suck it up and pay a high price for ink.

One way we could bear fewer costs as consumers is if we were willing to part with more privacy. Governments tax you on the basis of your income (sort of like price discrimination), which you report to them. Universities charge you on the basis of your and your parents‘ incomes, which you report to them. These are pretty substantial invasions of privacy, yet we tolerate them, and many people even seem to think that they are “fair.” This model could easily be extended to other industries, such as groceries. When you apply for your discount card at the grocery store, simply bring last year’s tax return to become eligible for bigger discounts. No more clipping coupons! I’m sure this suggestion (which I don’t necessarily support!) will stir the ire of privacy advocates, who would be quick to point out that loss of privacy is a cost. So it’s really just a tradeoff of one kind of cost for another. However, to the extent that your tax return more directly correlates with what firms want to know in the first place, it could be a more efficient kind of price discrimination even if we value our privacy relatively highly.

More generally, there are lots of ways that we can trade off one kind of cost versus another to effectively signal that we deserve the lower price. For instance, to the extent that we signal with dull time wasting, we can switch to shorter, more unpleasant expenditures of time. Tim Lee complains about spending ten minutes on the phone with Comcast lying to them to get a better price on broadband service. Having to lie, he says, imposes a psychological cost. But it seems better to me than spending 30 minutes on the phone not lying. Tim concludes that “Comcast’s price discrimination strategy is only socially efficient if we assume the aggravation consumers feel from haggling with Comcast isn’t important,” but this is false! It can be, and probably is, socially efficient despite this aggravation. In addition, cable companies probably also rely on information other than willingness to have an unpleasant phone call: they know what neighborhood you live in, your credit score, your service history, and whether you have an HDTV. These do not impose very many costs.

Ideally, you would want pricing to be based on something that is costless for low-value types and so costly for high-value types that they do not even attempt to get the low price. If, in equilibrium, there is no posing as a low-value type, then this form of price discrimination imposes zero social costs. If we accept that in many cases low and high willingness-to-pay are simply manifestations of low and high income, and that say, extreme obesity, is negatively correlated with income, then we should observe some companies offering “fat discounts” to some customers. I suspect that this would get politicized and hashed out in court, if it is already not illegal. And there is obviously something unappealing about creating an incentive, however small, to be so fat.

Fmb makes a good point: it would be great if proof of low willingness-to-pay could be based on public goods production. For this to work, the public good would need to be something that can be produced effectively by low-value types and is preferable to just working, earning more money, and spending the extra money on the good. No American is going to collect litter for an hour to save $2 on groceries. Unfortunately, I think this fact puts a ceiling on the gains that we can really expect from better price discrimination techniques. If low-value types were that much better at producing public goods than they were at producing market goods, they would probably be compensated for that value some other way already. If not, they are better off just producing market goods and spending their extra income at the higher price. That’s one reason that wasteful modes of price discrimination stick around.

The Post-Westphalian Order and the Age of the Network

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In my work on WCITLeaks and on my latest working paper on cybersecurity (paper, blog post, podcast), I’ve had the occasion to think a lot about governance structures. In particular, what happens when there is a mismatch between a governance structure and the problem that people need to be solved? Do, and how do, governance structures evolve?

I came across a great quotation yesterday from Toomas Hendrik Ilves, the president of Estonia. In remarks that he made in June at a conference on “cyber conflict,” Ilves said:

We must choose between two paths – either we can change the nature of the internet by placing a Westphalian regulatory structure on internet governance, or we can change the world.

To my mind, this is an intriguing way to frame the issue of Internet governance, and it is impressive that it comes from the president of a nation-state. I’m not especially familiar with the issues under discussion at the particular conference at which Ilves made this statement, but I can tell you how it relates to WCIT and cybersecurity. To a large extent, the Internet developed without top-down control. As a result, non-Westphalian Internet-native governance institutions emerged to solve the problems that netizens had. For example, on both the issue of accounting for data transfer costs and that of maintaining security, a system of zero-priced at-will peering emerged between networks at the core of the Internet.

Now that the Internet has become so important, the Westphalian order wants to remake the Internet in its own image. We’ll take it from here, it says. But my daydreams are now filled with the idea of an Internet that replies, “No, no. We‘ll take it from here.”

This might be crazy, but is it so crazy? The Peace of Westphalia was concluded in 1648. Westphalian sovereignty has had an impressive run, but why assume that it will be around forever? At some point, the Westphalian system will end, and something new will come after it. That something new will depend on a lot of real variables, not on legal fictions, just as the Peace was a ratification of the distribution of power, not a creator of that distribution.

In my new paper, I link the spontaneous provision of Internet security to the work of Elinor Ostrom, but I’ve realized that in a crucial way, my work contradicts Ostrom. She argues that the governance of large common pool resources needs to be accomplished through a nested system, a federal structure. Essentially, she solves the problem of bigness with a vertical cascade of punishment. This is a form of hierarchy. But Internet security is a large common pool resource, and as I show in the paper, it is provided non-hierarchically. Instead of a vertical cascade of punishment, there is a network cascade of punishment.

This is a big deal. One aspect of it that is especially intriguing to me is that it provides evidence for David Friedman’s critique (ungated) of Tyler Cowen’s argument (ungated) on anarchy. It also can give us a way to anticipate the real variables that may define the post-Westphalian order.

In particular, is the world becoming more network-like? I think so. Globalization means trade networks. War increasingly means non-state actors: “terrorism” networks. The plummeting cost of communication means thicker meatspace networks, not just more computer networks. Think about the rise of hacktivism and Anonymous, a loose network of online prankster-vigilantes.

We may be entering the Age of the Network, but a remaining question is to what extent networks are becoming more prominent only because they have the consent of the Westphalian order. As much as nation-states want to regulate the Internet, they don’t exactly want to shut it down. They want to ensure it remains domesticated, too weak to represent a serious alternative to their power. At some point, we may witness a genuine conflict between “sovereign” institutions and network institutions. If and when the network institutions start to win, I will interpret that as the beginning of the end for the sovereign nation-state.

A Straussian Reading of *Launching the Innovation Renaissance*

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This is a post that I promised to write several months ago; I hope that in spite of its tardiness, you will find that it contributes much to the issues of the day.

You may recall that Tyler Cowen included hidden meanings in his short ebook, The Great Stagnation. It turns out that he is not alone. Tyler’s Marginal Revolution co-blogger, Alex Tabarrok, also has an esoteric style. Whereas Cowen points us to the future by looking at the recent past, in Launching the Innovation Renaissance, Tabarrok points us to the more distant past by ostensibly talking about innovation in the future. Underneath all the sensible-sounding evidence-based arguments for reform is a hidden, retrograde manifesto that establishes Alex as one of today’s leading reactionary thinkers.

In case you think I am making this up, let me start by noting that the book literally begins over 700 years ago, in 1296. “From father to son, to son again, the architects, stonemasons and artists of Florence labored with love and devotion to produce the greatest cathedral the world had ever known” (26). Since that time, things have gone mostly downhill, as the institutions that made medieval Florence great have foundered. The questions that Tabarrok wants you to ask yourself are these: “When I go to work, do I labor with love and devotion? Am I producing something of transcendent value, like a cathedral, or am I just doing a mundane job? How can we go back to a simpler time of less turbulent change and greater personal meaning?”

Of course, Tabarrok cannot dwell on the medieval period throughout the book without giving away his occult hypothesis to even his slower readers. Consequently, he discusses several different eras of the past and how they are superior to the present. For instance, lamenting the modern patent system, he writes, “As early as 2,500 years ago the Chinese were breeding new roses, and Confucius tells us that the emperor had hundreds of books about roses and rose breeding in his library. The world did not appear to lack new roses even though, until 1930, no roses were ever patented” (83). This is a telling metaphor. The “old roses,” the old books, the old ways—they are just as good as, if not better than, the new roses.

Not only was the past a simpler and more satisfying time, the excesses of the modern world are deeply disturbing. One can almost feel Tabarrok recoil in horror as he relays the story of the OncoMouse, a genetically engineered monster. To the modern mind, this is a great advance; but a careful reader can discern Tabarrok’s deep reservations about this kind of coarsening of the value of life. He notes that mice “share 95 percent of their genes with humans” (205). It is bad enough that people might conduct experiments on creatures that are 95 percent human; must we also play God with these close cousins of ours by modifying their genes? And must we, of all things, patent them?!

Tabarrok is perhaps at his most persuasive when he points out that the deterioration in American education is caused by ill-advised “advances” in the rights of women:

One of the reasons for the poor performance of U.S. education is that teacher quality has declined significantly over the past four to five decades.

In the 1970s smart women became teachers. In fact, in 1970 about half of all college-educated women were teachers…Many smart women have exited teaching and entered the professions because of declining discrimination in the professions… (454)

It seems obvious—is it even worth pointing out?—that the simplest way to improve teacher quality is to bar women from entering professions like law, medicine, and business. This bit of subtext, needless to say, is completely lost on Alex’s less attentive readers.

Another problem with the modern world, according to the esoteric Tabarrok, is that people no longer have respect for the station in life in which Nature has put them. In a word, people are uppity. This causes countless problems, not least of which is higher education. “College has been oversold, and in the process the amount of education actually going on in college has declined as colleges have dumbed down classes and inflated grades to accommodate students who would be better off in apprentice and on-the-job training programs” (525). If only we could return, says Tabarrok, to a time when people knew their place.

Launching the Innovation Renaissance represents Alex Tabarrok standing athwart history, yelling “Back up 700 years!” You may think that these ideas are unlikely to gain much traction. Nevertheless, I think they have great relevance in today’s political debate. In fact, although Alex has not yet publicly endorsed a presidential candidate, I bet I can predict who he will be supporting.

Finite and Infinite Games

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I recently read Finite and Infinite Games, by James Carse, poolside while on vacation. Excerpt:

Seriousness is always related to roles, or abstractions. We are likely to be more serious with police officers when we find them uniformed and performing their mandated roles than when we find them in the process of changing into their uniforms. Seriousness always has to do with an established script, an ordering of affairs completed somewhere outside the range of our influence. We are playful when we engage others at the level of choice, when there is no telling in advance where our relationship with them will come out—when, in fact, no one has an outcome to be imposed on the relationship, apart from the decision to continue it.

To be playful is not to be trivial or frivolous, or to act as though nothing of consequence will happen. On the contrary, when we are playful with each other we relate as free persons, and the relationship is open to surprise; everything that happens is of consequence. It is, in fact, seriousness that closes itself to consequence, for seriousness is a dread of the unpredictable outcome of open possibility. To be serious is to press for a specified conclusion. To be playful is to allow for possibility whatever the cost to oneself.

The book is obviously not about game theory, and it lives up to its subtitle, “A Vision of Life as Play and Possibility.”

It is a book that I wish were more widely read, not merely because I enjoyed it, but because it would enable for me a new mode of discourse. In the short time since I read the book, I have found myself on numerous occasions wanting to say, “So-and-so is playing a finite game,” and be understood. When Tyler invites Krugman to come out and play, and Paul responds with “This is not a game,” Paul is playing a finite game. When Mike Elk trashes bloggers in general and Matt Yglesias in particular, Elk is playing a finite game.

I read the book as pro-blogging, even though it was written before the invention of blogging, and pro-anarchism (of a certain kind), even though I doubt Carse has read the anarchism literature. More broadly, it promotes bottom-up processes not on Hayekian or consequentialist grounds, but on the grounds of meaning and personal satisfaction.

I recommend the book to people who are highly Open (and to a lesser extent non-Conscientious) on the Big Five personality model.

Technologies of Control and Resistance: Making Sense of our Stagnant Dynamism

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I’ve just read Race Against The Machine, a new Kindle Single by Erik Brynjolfsson and Andrew McAfee, which argues contra Tyler Cowen’s The Great Stagnation that we are witnessing not a slowdown, but a positive acceleration of technological change. Brynjolfsson and McAfee argue that the fast pace of innovation is creating mismatches between humans and new technology, which has resulted in a lot of technological unemployment. The jargon is skill-biased technical change (SBTC). All recessions bring unemployment, but recent recessions have resulted in “jobless recoveries” that are the result not of cyclical forces but of deep structural change in the economy.

Brynjolfsson and McAfee are not wrong, but I think a better picture emerges if we attempt to reconcile their argument with Cowen’s rather than viewing them as contradictory. As Tyler argues, we have not had the kind of growth we might have expected 40 years ago if we had extrapolated based on the prior 40 years. See this chart on total factor productivity by David Beckworth. I think McJolfsson’s view and Cowen’s view are complementary if viewed from a sufficiently “big picture” perspective; the slowdown in TFP and the speedup in SBTC are, after all, decades-long trends.

Here’s my model. First we need to differentiate between two kinds of innovation and think about their effects. The first kind of innovation is geared toward brute maximization of production. It is typically centralized and makes use of economies of scale. Examples might include an assembly line factory or a big, coal-fired power plant. Because these innovations tend to be centralized, they introduce points of control. The capital is typically fixed and therefore easy to tax and regulate. It’s well known in the development literature that it’s really hard for governments to control rural peasants who live off the grid. Once they move to the cities and plug into centralized services, it is easier to require them to send their children to school, for instance. Because these innovations introduce points of control, I will call them technologies of control.

On the other hand, not all innovations are about brute maximization of production. Some are about producing things that we already know how to produce in ways that have ancillary benefits. An important ancillary benefit is evading control. Examples of these innovations include 3D printers and solar power. The evasion of control that is possible with 3D printers is the subject of Cory Doctorow’s short story Printcrime. And portable solar power cells can make people harder to control by supplying electricity without the need to register an address, have a bank account, stay put, and so on. These are obvious examples, but control can be evaded through more subtle innovations as well. I will call innovations that circumvent points of control that can be used by governments or monopolies to exploit, tax, or regulate technologies of resistance.

Now, postulate some background rate of innovation. How many resources will be devoted to technologies of control and how many to technologies or resistance? The answer is that it depends on how invasive the state (or other monopolies) are. When the state is invasive, at the margin the incentive is to find ways to circumvent the points of control; a greater proportion of resources will go into technologies of resistance. When the state is non-invasive, at the margin the incentive is a purer maximization of production; a greater proportion of resources will go into technologies of control, which results in higher growth.

What determines how invasive the state will be? Call me a cynic, but I think it correlates strongly with the availability of points of control. When factors of production are fixed, when demand for government supplied public goods is inelastic, when there are lots of points of control, the government will exercise more control. When the opposite is true, when there are few points of control, the government is unable to act invasively.

As you can see, there is a system of feedback. But the countervailing forces need not push outcomes to a stationary equilibrium. As we all know, time-to-build can result in cycles. Since technologies take time to change direction and develop, and since politics is slow to adapt, we should expect a non-stationary equilibrium. I think this is consistent with the broad facts. A hundred years ago, at least as it concerns white males living in the US, the government was relatively non-invasive. As a result, they developed centralized technologies that created a lot of growth, technologies of control. As new points of control were introduced, the government became more invasive. The modern state was born. At some point, innovation gradually increased toward technologies of resistance. The low-hanging fruit from the prior era eventually petered out, and sometime around 1974 we began to see lower TFP growth. As technologies of resistance improve relative to technologies of control, I can’t say exactly what will happen. A lot depends on whether government becomes gradually less invasive as points of control disappear or whether it continues to overreach; if the latter, we could observe some kind of interesting political turmoil.

So far, I’ve been pretty general about technologies of resistance, but I want to tie it back into McJolfsson’s story about rapid skill-biased technical change. The key point is that labor is extremely regulated; firms that use labor are subject to intense government control. In part this is because policies that give labor a “bigger piece of the pie” are popular with voters, and in part it is because labor can complain and enforce its rights in a way that machines cannot. If you own a business and you are subject to intense government control, you are going to invest resources in circumventing the points of control. In our economy, that means getting rid of lots of labor as cheaply as possible, which means skill-biased technical change. As Arnold Kling has said, “if a job can be defined, it can be automated or outsourced.” But it’s because there is so much control exercised in the labor market that the incentive to automate and outsource is so high.

On the other side of the labor market, I wonder if post-materialism is not also part of an attempt to evade control. A lot of talented people are scaling back their labor efforts, and while surely not all of this is due to taxes and regulations, some of it may be. And other innovations which seem truly new, such as the development of autonomous vehicles, are the result of control of which we may not even be aware; for instance, how profitable would it be to develop autonomous vehicles if Pareto-improving trade with immigrant drivers were not made impossible by immigration and labor restrictions?

The Internet has been somewhat insulated from the kind of political control that I am claiming leads to the cycle of control and resistance. As a consequence, I think we observe an epicycle there. Internet technologies can be centralized at the company level or standardized at the protocol level. Email is an example of a technology that is standardized at the protocol level, and it was developed in the early days of the Internet, when market power was a serious concern. Today, there are so many competitors in the online messaging field that market power is not a real problem. Consequently, we observe services like Facebook and Twitter, which are centralized and can provide “higher production” by reducing spam, for instance. If Facebook and Twitter ever abuse their market power too much, that is when distributed, protocol-based substitutes such as Diaspora and Status.net will take over. And when the government starts exerting more control over the Internet, we’ll observe the adoption of new technologies to circumvent that control, such as encryption and mesh networking.

In a strange way, this theory is a partial vindication of Ayn Rand; the only problem is that she was too literal. The productive people do not go on strike when they are over-controlled. Instead, they innovate around the points of control. They go on strike at the margin. And it doesn’t take a big, dramatic exit. A little bit cumulatively over decades is sufficient to both be noticeable in the data and to reduce the amount of control that can be exercised.

At the risk of being accused of now-more-than-everism, I’ll point out that the problems associated with a greater focus on technologies of resistance and with skill-biased technical change could be much ameliorated by a government that dramatically reduced its control over its citizens. Stick to supplying public goods and providing a small safety net. It won’t fix everything overnight—technology has momentum—but it will make things better than it otherwise would be. However, I think there is little chance of this happening. It requires out-of-equilibrium political play. Instead, if my theory is correct, we will find out what happens when large, invasive governments overextend and are forced to shrink.