Tuesday, April 28, 2009

Tournaments and psychopathic chickens

I recently ran across an article about a fascinating biology experiment. In the experiment, biologist William Muir bred two groups of chickens with similar techniques but one slight difference. In one group, only eggs from the single most productive hen were used to produce the next generation. In the other group, only eggs from the single most productive cage (a group of hens) out of numerous cages were used to produce the next generation. After six generations, the second approach had produced a group of very healthy, productive hens. On the other hand, the first approach, selecting the single most productive hen, had produced only three surviving hens, all in poor health. These were the survivors of on-going violence that had killed off most of that generation. Essentially, selecting the single most productive animal had produced a bunch of psychopaths. It turns out the optimal survival strategy when only one "winner" is allowed is to suppress the competition...attack the other hens, eat their eggs, etc. When a whole group is allowed to win, the optimal survival strategy is one of altruism. Every member of the group must be as productive as possible.

This brings to mind something I read in the book Freakonomics. In one chapter, the "corporate structure" of a crack distribution network is compared to the structure of a typical Fortune 500 company. It turns out, the two are quite similar. Crack distribution networks, and many Fortune 500 companies follow closely a "tournament" model of success.

In a single-elimination tournament, most contestants don't advance very far at all. Half of the participants are eliminated in a single contest, another 25% in the second round, and so on. In a large tournament, only a tiny percentage of entrants will advance to the final round or two where prizes might be up for grabs.

Crack distribution networks, as well as large companies like Wal-Mart and McDonald's, approximate this model very closely. The largest group of workers are at the very bottom, making little more than minimum wage, frequently dependent on public assistance just to get by. As you move up the org chart, smaller groups might make modest salaries that allow them to get by and enjoy a modest middle-class lifestyle without the need for public assistance. And finally, at the very top, there is a very small group of people who enjoys spectacular wealth.

It turns out from the perspective of human behavior and economics, a tournament model is frequently the most effective model for motivating the maximum productivity for the lowest total compensation. The masses of employees working for salaries that don't allow them to escape the welfare system largely do so because they believe they will reach a "later round in the tournament" and compensation will improve dramatically and justify the earlier effort. Because most employees will fail to get this far, the company is able to offer far less than what an employee would normally agree to work for simply by holding out the possibility of excellent compensation at a later date.

The thing that concerns me is how much the tournament model resembles the chicken experiment in which only one chicken is chosen to produce the next generation. If the entire economy was structured on a Wal-Mart model--that only a small number succeed, and they do so individually, not as a group--then aren't we in essence breeding for psychopaths?

Historically, this seems to be the case. Throughout most of human history, societies have tended to follow the tournament model. Wealth distribution has generally looked like a pyramid, where only a few are "winners" at the top. Anybody who has read much history has probably also noticed that societies used to be far, far more violent than today. The US has one of the highest crime rates among developed nations, and even our worst crime rates since records have been kept would pale in comparison to murder rates through-out most of history. Stories of monarchs throughout history are full of tales of murder and genocide, often performed on members of one's own family for purposes of eliminating competition for the throne. Kinda sounds like the psychopathic chicken, doesn't it?

Yet beginning with the advent of modern democracies 200+ years ago, and particularly since WWII, the world has seen a radical re-structuring of wealth distribution in the developed world. In the developed world, wealth distribution looks far more like a diamond than a pyramid, with the vast majority of populations living comfortably, if not extravagantly. And, not surprisingly, as the economic model changed, crime rates plummeted. What has changed is that economic success is less dependent on a winner-take-all model, but on a group-success model. The success of America post-WWII was shared by nearly all of society. Nations with a strong middle-class tend to succeed or fail together, so there is motivation to work together to succeed. Undercutting a member of your own group poses no advantage if success depends on how the group as a whole does. In other words, democracy and a strong middle-class enabled society to stop breeding psychopathic chickens.

This is why wealth distribution is absolutely essential to a strong nation. This is why it's concerning to see the super-wealthy thriving while middle- and low-income people overall are making no progress or even losing ground. Companies like McDonald's and Wal-Mart have demonstrated the (short-term) success of the tournament model of compensation, and unfortunately this model is becoming more and more widely adopted within business. In fact, since government employs roughly a quarter of all workers, a thorough analysis might conclude that government employment is the only thing maintaining a middle-class in our nation right now. Government pay scales are generally far more tightly concentrated around the middle than private-sector pay scales. As a result, it's probably fair to conclude that government workers may well make up nearly half of the workers in the 25th-75th percentiles.

Without the stabilizing effect of government employment, our nation might already be closer to a pyramid economic model than one based on a robust middle-class. If history is any guide, and it usually is, such a change would inevitably lead to tremendous spikes in crime, massive drops in economic productivity (because, of course, far fewer people would be able to afford goods), and a general destabilization of the entire nation. Ultimately, the psychopathic chickens would once again rule the roost.

Monday, April 20, 2009

Explain this capitalism thing to me again...

Recently I've run across a lot of articles like this one explaining that people making $250,000 annually or a little more really aren't that well off. Of course this is in the context of potential tax hikes for incomes exceeding $250,000/yr. The article quotes one person in particular who claims to be "barely getting by" on an income of $400,000 per year.

Maybe I misunderstood this one in my Economics courses, but I thought the idea behind capitalism was that people are financially rewarded for being smart and resourceful and productive. Ideally, somebody making $400k annually--or more than 99% of the population--should be smarter and more resourceful and productive than 99% of the population. Maybe the ideal scenario doesn't always work out, but still, I would expect people with incomes in the top 1-2% would at least be pretty damn smart and productive and resourceful the overwhelming majority of the time. But apparently people who make this much money are struggling, not sure how to make ends meet on a paltry $250,000 income.

Yet, oddly enough, there are plenty of people in this country (half of them in fact), who manage to make ends meet on about 1/5 or less of what these top earners make. Look, if I've got a choice between two engineers for a project, and one of them can meet the project specifications with 1/5 of the resources required by the other one, I know who I believe is the smarter engineer. Yet in whatever bizarre form of capitalism we're practicing in this country, we seem to have rewarded the people who are less intelligent and resourceful.

As somebody working on building my own business, I want to believe that success comes through intelligence and resourcefulness and creativity and hard work. But it appears people at the high end of the income scale are seriously lacking in most of those qualities. If this is how capitalism works in America, maybe socialism is worth a try after all...

Thursday, April 16, 2009

A simple health care proposal

One of the strengths of the US is the fact we have 50 different states that can function as 50 different "laboratories" for trying different approaches to tackling society's problems. Since many states are very different politically, and have very different ideas of the best way to do things, it's often best to let states choose how they want to address a problem within certain parameters.

Here's a simple proposal for taking advantage of this to tackle our health care problem in this country.

We currently spend about 17% of GDP on health care. This is far more than any other nation. Let's start by bringing this down to 15%. Currently 2.9% of payroll is collected for Medicare/Medicaid. The Federal government should turn this money directly over to the states to administer a health care system. Then the feds should offer to double this money (with funds from general income tax revenues) as long as the state meets two criteria:
-Everybody has access to health care.
-Nobody has to pay more than 10% of their income for it.

This will limit health care spending to roughly 15% of all economic activity. The states will be free to try whatever solutions they like. They can try single-payer, private health insurance with limited government involvement, or anything else they want. After several years, it's likely one approach will emerge more efficient than others, and all states will adapt some variation of it. Or maybe, because of the various trade-offs in the different methods, it may be that states continue to take very different approaches because certain political trade-offs are more palatable than others to different states. Either way, we wind up with everybody able to get health care at a reasonable price and on a macroeconomic level we finally get a lid on health care costs.

More wasteful government spending...

The Internet

Satellite GPS technology


Interstate Highway System

California Central Valley Irrigation System (responsible for producing about half the nation's produce and $30 Billion in agricultural productivity annually)

Jet engines

National Parks

Transcontinental Railway

As millions protested taxes with their teabags yesterday, I couldn't help but wonder what our nation would be like without the innovations listed above. All of these innovations, not to mention a highly educated populace, a very low overall crime rate, and countless other conditions that make economic prosperity possible, all exist because the government spent tax dollars on creating them.

It's interesting that another topic dominating the news lately has been the piracy problem off the coast of Somalia. Now, there's a perfect example of what a nation is like without an active government. Do you think the pirates pay tax on their million-dollar bounties? Of course not. No government is taking their hard-earned money away from them. Of course, no government is providing them with an infrastructure to build a functioning economy with that money. No government is educating the population to engage in productive activity rather than theft. No government is protecting the work of productive people from those who prefer to steal. The Tea Bag protesters clearly don't want a government that does any of those things. Maybe the protesters should simply move to Somalia.

Let me propose a small tax increase to buy all these whiners passage to Somalia. Then the rest of us (and the millions of immigrants who want to come in, pay our relatively low taxes, and enjoy the countless benefits of living in the US) can go about the business of paying taxes and working WITH government to produce the conditions for private enterprise to continue producing economic prosperity.

Friday, April 03, 2009

Taxing our way to prosperity

We hear it over and over again, "We can't tax our way to prosperity." It's a mantra of the right. The left doesn't seem to disagree...they just don't even address it. Well, I've probably written it here before but I'm writing it again now: Yes, we CAN tax our way to prosperity. And WWII is the proof.

We entered WWII with massive deficits and a terrible economy. Beginning in 1940, we raised tax rates to 23% on middle-income earners and as high as 94% on the highest earners (http://eh.net/encyclopedia/article/tassava.WWII). We increased government spending to nearly 50% of GDP. And in well under a decade we had a booming economy ushering in one of the longest sustained periods of prosperity in American history.

What's most amazing about this is the fact the government spending wasn't even very productive. The popular mantra today is we can't increase taxes because it will reduce consumer demand and further damage the economy. Bullshit. What's better for the economy, a smart energy grid or a new big-screen plasma TV in every household? I think the answer's obvious. Both outcomes would cost tens of billions of dollars, possibly hundreds of billions, and therefore have roughly the same effect on demand. But one of the outcomes can be achieved by consumer spending, and one of them can be achieved by taxation and subsequent government spending. We're obviously better off in the long-run if we are all taxed in such a way that generates sufficient revenue for a smart energy grid, even though it means giving up a big-screen plasma TV.

But this isn't just theory. This is exactly the kind of thing that happened during WWII. Americans were asked to sacrifice and make do with less. With increased revenues, the government built lots of bombs and tanks and planes...mostly non-productive assets meant for almost immediate destruction. But part of that money also went to very productive assets, like factories and power plants and transportation networks. It also went to education in the form of the GI Bill. And after the war the government continued to spend on the Interstate Highway System. These productive assets were instrumental in the post-WWII boom that America experienced. And this was accomplished with only a small portion of government spending going into productive assets.

Today the need for military (economically non-productive) spending is far less than during WWII. Despite our fears of terrorism, there is simply no threat to our national existence like there was during WWII. Our current defense spending is almost entirely discretionary. We could bring all our troops home, leave the terrorist networks alone, and face zero threat to our national existence. Of course, we might face an elevated threat of terrorist attacks. But these are entirely different from the existential threat posed by totalitarian national regimes during WWII. Our military spending today is out of a choice we make that we are willing to spend half a trillion dollars to potentially save a few thousand lives every year. And even making this choice, we are still spending a small fraction of what was spent fighting WWII, leaving a tremendous potential for spending on productive assets. If we spent four years devoting a quarter of GDP to creating productive assets (this would still be significantly less than the spending during WWII), we could probably afford to build a national smart energy grid, install renewable energy on a sufficient scale to power the nation, and build a better national transportation system far faster, safer, and cheaper than the Interstate Highway System. We would have to train people to install all of this, and at the end of four years of spending we could unleash our highly-trained workers and our technology on the rest of the world where we could make unimaginable sums of money bringing this technology to other developed and developing nations.

Of course, to accomplish all this would require Americans to temporarily cut back on big-screen TVs, designer clothes, luxury cars, and all the other perishable goods that we've come to love. And I guess maybe we can't have that.

Of course there are limits to this kind of thinking. Government doesn't always know best. After the overwhelming success of WWII spending, government tried to solve every problem...an approach that naturally led to problems of its own until the Reagan revolution took the pendulum back the other direction with considerable success for the better part of two decades. But now that the hands-off approach has run its course, and the pendulum seems naturally ready to swing back...it seems like most politicians are still hesitant to embrace the new direction.