The Triumph of Humanity Chart

One of the greatest successes of mankind over the last few centuries has been the enormous amount of wealth that has been created. Once upon a time virtually everyone lived in grinding poverty; now, thanks to the forces of science, capitalism and total factor productivity, we produce enough to support a much larger population at a much higher standard of living.

EAs being a highly intellectual lot, our preferred form of ritual celebration is charts. The ordained chart for celebrating this triumph of our people is the Declining Share of People Living in Extreme Poverty Chart.

Share in Poverty

(Source)

However, as a heretic, I think this chart is a mistake. What is so great about reducing the share? We could achieve that by killing all the poor people, but that would not be a good thing! Life is good, and poverty is not death; it is simply better for it to be rich.

As such, I think this is a much better chart. Here we show the world population. Those in extreme poverty are in purple – not red, for their existence is not bad. Those who the wheels of progress have lifted into wealth unbeknownst to our ancestors, on the other hand, are depicted in blue, rising triumphantly.

Triumph of Humanity2

Long may their rise continue.

 

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Submitting Merger Lawyers to the Market Test

Matt Levine shall supply the problem:

The way merger lawsuits work is that after a deal is signed, a bunch of plaintiffs’ lawyers race to sue, claiming that the merger was underpriced, the board breached its fiduciary duties, and the whole thing was corrupt. This might sometimes be true, but it can’t be true in every merger, and the lawyers sue in virtually every merger. But then they sign a settlement with the company in which the company agrees to make a few extra disclosures about the deal and pay the lawyers a six-figure fee. The advantage for the company and the board is that the settlement binds all shareholders, so they get a release from future litigation if someone figures out that the deal was actually corrupt. The advantage for the lawyers is that they get the fee. There is no advantage for shareholders.

We shall provide the solution:

Do not pay the lawyers a cash fee.

At a random time, while the market is open, announce the disclosures that will be provided.

Then, pay the lawyers a fee proportionate to the stock’s movement (relative to the overall market) over the next hour (or second, or day, or week).

If the disclosure they heroically provided to shareholders is valuable, they will be rewarded.

But, if the disclosure they provided was a disappointment to the market, they have to pay the company. (And the court).

This system is both fair and efficient. Fair, because the lawyers will be paid if they added value to the company, and punished if they subtracted value. Efficient, because this will encourage them to only pursue lawsuits they think will add value.

Now, the lawyers (and perhaps my readers) will object that news of these disclosures would be but one small thing effecting the price of the stock that day. There would be a lot of noise – how then can it be fair to use such an unreliable method to reward the noble public servants who forced the disclosures?

And other lawyers (and perhaps other readers) will object that this could be manipulated. The lawyers could short the stock in to the announcement, and then cover their shorts when the news broke, and buy a lot of stock instead, to try to temporarily support the stock.

Fortunately, both issues can be solved together. Because this is not a single game, it is a repeated game. Any one time the lawyers might get unlucky and have the stock move “the wrong way”. But if done often enough (and this is their profession) they will come out ahead… if the disclosures they achieve are valuable. And maybe they could manipulate the stock once. But if they try to do it systematically, hedge funds will learn off it and take the opportunity to buy the stock when it is inefficiently cheap before the announcement… and then short it when the lawyers temporarily drive it up. The lawyers would need to burn a huge amount of money to manipulate the stock in the face of hedgies after an easy trade… at which point the whole thing would no longer be net profitable for them.

Does this sound plausible to you? It should, if they are adding value. If they’re on the side of angels, they should leap at the chance to have their worth measured.

Of course, this is rather a stretch. I suspect that if this were implemented, lawyers would cease these lawsuits.

And that would be good.

Ashley Madison was an Effective Altruist Conspiracy

Much as been said about the Ashley Madison hacks. Needless to say, my husband and I agree that anyone committing or attempting to commit infidelity is an abhorrence, who should be shunned by society. But that is not the topic of this essay. The question is, was the creation of the website itself a bad thing? Here is a theory that suggests its creation was actually a grand stroke of Effective Altruism.

Here is my conspiracy theory. Like all conspiracy theories, it ex-post fits the facts well, but probably should not be given a very high credence.

  1. Ashley Madison was set up by an activist who wanted to promote ethical behavior and punish the unjust.
  2. Firstly, it took money from people who wanted to commit infidelity. Taking money from people makes them worse off.
  3. Then, it didn’t provide any services. It never matched any cheaters up.
  4. After having handed over credit card details but not received anything, the would-be cheaters realized it was a scam.
  5. Then can’t take Ashley Madison to court, because that would be public record.
  6. So they try to get out … but realize Ashley Madison has them in an incriminating position.
  7. Ashley Madison extorts more money from them to delete their data.
  8. Ashley Madison does not delete the data.
  9. Ashley Madison discusses a possible IPO purely for the publicity. It knows it’s a fraud and could never stand up to auditing.
  10. Ashley Madison then hacks itself. This explains why they were able to access the data so easily. They had previously hacked another competing service.
  11. Ashley Madison then releases the data. This provides early downloaders with the opportunity to extort the would-be cheaters.
  12. Eventually all the would-be cheaters are revealed, and face the wrath of their poor spouses.
  13. No-one ever trusts an infidelity website again, making it harder to commit infidelity in future

So the net result is:

  1. Would-be cheaters are effectively fined a significant amount of money.
  2. And then exposed.
  3. And no-one can ever create an infidelity website.

Ideally I would like to test this theory against the third dump of Noel Biderman’s emails. Unfortunately my torrent, like everyone else, seems to be stuck at 93.3%.

Quarantine

June 2nd, 42 After Fall
Somewhere in the Colorado Mountains

They first caught sight of the man walking a few miles from the compound. At least it looked like a man. Faded jeans, white t-shirt, light jacket, rucksack. White skin, light brown hair. No obvious disabilities. No logos.

They kept him under surveillance as he approached. In other times they might have shot him on sight, but not now. They were painfully aware of the bounds of sustainable genetic diversity, so instead they drove over in a battered van, rifles loaded, industrial earmuffs in place. Once he was on his knees, they sent Javid the Unhearing over to bind and gag him, then bundled him into the van. No reason to risk exposure.

Javid had not always been deaf, but it was an honor. Some must sacrifice for the good of the others, and he was proud to defend the Sanctum at Rogers Ford.

Once back at the complex, they moved the man to a sound-proofed holding room and unbound him. An ancient PC sat on the desk, marked “Imp Association”. The people did not know who the Imp Association were, but they were grateful for it. Perhaps it was a gift from Olson. Praise be to Olson.

With little else to do, the man sat down and read the instructions on the screen. A series of words showed, and he was commanded to select left or right based on various different criteria. It was very confusing.

In a different room, watchers huddled around a tiny screen, looking at a series of numbers.

REP/DEM 0.0012 0.39 0.003

Good. That was a very good start.

FEM/MRA -0.0082 0.28 -0.029

SJW/NRX 0.0065 0.54 0.012

Eventually they passed the lines the catechism denoted “purge with fire and never speak thereof”, on to those merely marked as “highly dangerous”.

KO/PEP 0.1781 0.6 0.297

Not as good, but still within the proscribed tolerances. They would run the supplemental.

T_JCB/T_EWD -0.0008 1.2 -0.001

The test continued for some time, until eventually the cleric intoned, “The Trial by Fish is complete. He has passed the Snedecor Fish.” The people nodded as if they understood, then proceeded to the next stage.

This was more dangerous. This required a sacrifice.

She was young – just 15 years old. Fresh faced with long blond hair tied back, Sophia had a cute smile: she was perfect for the duty. Her family were told it was an honor to have their daughter selected.

Sophia entered the room, trepidation in her head, a smile on her face. Casually, she offered him a drink, “Hey, sorry you have to go through all this testin’. You must be hot! Would you like a co cuh?” Her relaxed intonation disguised the fact that these words were the proscribed words, passed down through generations, memorized and cherished as a ward against evil. He accepted the bottle of dark liquid and drank, before tossing the recyclable container in the bin.

In the other room, a box marked ‘ECO’ was ticked off.

“Oh, I’m sorry! I made a mistake – that’s pep-see. I’m so sorry!” she gushed in apology. He assured her it was fine.

In the other room, the cleric satisfied himself that the loyalty brand was burning at zero.

She moved on to the next proscribed question, with the ordained level of casualness, “Say, I know this is a silly question, but do you ever get a song stuck in your head?”

“Errr, what?”

“You know, like you just can’t stop singing it to yourself? Yeah?” Of course, she had no idea what this was like. She was alive.

“Ummm, sorry, no.”

She turned and left the room, relief filling her eyes.

After three more days of testing, the man was allowed into the compound. Despite the ravages of an evolution with a generational frequency a hundred times that of humanity, he had somehow preserved himself. He was clean of viral memetic payload. He was alive.

The Importance of GWWC Cohort Data

There are a few pieces of information that are required to properly analyze the value of Giving What We Can‘s membership.

They’re necessary for GWWC’s managers to evaluate different strategies. If GWWC was an object-level charity, we wouldn’t donate to it without knowing these numbers. And if GWWC were a public company, investors would not provide funding without such disclosure. As such, hopefully these metrics are already being collected internally, and publicly sharing them should not be very difficult, though very valuable. If not, GWWC should start collecting them!

GWWC already publishes the number of members it has at any given point and the total amount pledged. From this it’s easy to derive how many joined in any given year. However, it’s hard to judge what these people did later – how many fulfilled the pledge, and how much did they donate? Worse, this makes it hard to forecast the value of a new member, so we can’t tell how much effort we should put into extensive growth. As far as I can see (sorry if I just couldn’t find the data), we do not currently release the data required to make this analysis.

As part of it’s annual report, GWWC should release data on each cohort: how many of that cohort fulfilled the pledge by donating 10%; how many were ‘excused’ from donating 10% ( e.g. by being students); how many failed to abide by the pledge, donating less than 10% despite having an income; and how many did not respond.

Example Disclosure

In case it’s confusing what exactly I’m suggesting GWWC release, here’s an example (with totally made-up numbers). As part of it’s 2014 annual report, GWWC could report:

  • 2011 cohort:
    • Of the 107 who joined in 2011…
    • 75 donated over 10% in 2014
    • 15 were students and did not donate 10% in 2014
    • 10 had incomes but did not donate 10% in 2014
    • 7 could not be contacted in 2014
    • Total of $450,000 donated in 2014
  • 2012 cohort:
    • Of the 107 who joined in 2012…
    • 50 donated over 10% in 2014
    • 53 were students and did not donate 10% in 2014
    • 2 had incomes but did not donate 10% in 2014
    • 2 could not be contacted in 2014
    • Total of $300,000 donated in 2014
  • 2013 cohort:
    • etc.

While in the 2013 annual report, GWWC would have reported

  • 2011 cohort:
    • Of the 107 who joined in 2011…
    • 45 donated over 10% in 2013
    • 56 were students and did not donate 10% in 2013
    • 3 had incomes but did not donate 10% in 2013
    • 3 could not be contacted in 2013
    • Total of $250,000 donated in 2013
  • 2012 cohort:
    • Of the 107 who joined in 2012…
    • 16 donated over 10% in 2013
    • 89 were students and did not donate 10% in 2013
    • 1 had incomes but did not donate 10% in 2013
    • 1 could not be contacted in 2013
    • Total of $100,000 donated in 2013

This would allow us to see how each cohort matures of time, answering some very important questions:

  • How much is a member worth, after taking into account the risk of non-fulfillment?
  • How much does the value of a member differ with the discount rate we use?
  • How does the donation profile of a member change over time – does it rise as they progress in their career or fall as members drop out?
  • Are the cohorts improving or deteriorating in quality? Are the members who joined in 2012 more likely to still be a member in good standing in 2014 than they 2010 cohort were in 2012? Do they donate more or less?

There are some other numbers that might be nice to know, for example breaking the data down by age, sex, nationality, or even CEA employee vs non-employee, but it’s important not to impose too high a reporting burden.

Why this is not idle speculation

This might seem a bit ambitious. Yes, it would be nice if GWWC released this data. But is it really a pressing issue?

I think it is.

Bank problems: Extend and Pretend

Sometimes banks will make a series of bad loans – loans which are repaid at a significantly lower than expected rate, perhaps because the bank was trying to grow aggressively. When the first signs of this emerge, like people being late on payments, banks have two alternatives. The honest one is to admit there is a problem and ‘write down’ the loan – take a loss to profits. The perhaps less honest one is to extend and pretend – give the borrowers more time to repay and pretend to yourself/auditors/investors that they will come good in the end. This doesn’t actually create any value; it just delays the day of reckoning. Worse, it propagates bad information in the meantime, causing people to make bad decisions.

Unfortunately they neglected the Litany of Gendlin:

What is true is already so.
Owning up to it doesn’t make it worse.
Not being open about it doesn’t make it go away.
And because it’s true, it is what is there to be interacted with.
Anything untrue isn’t there to be lived.
People can stand what is true,
for they are already enduring it.
—Eugene Gendlin

GWWC: Dilutive Growth?

About a year ago, people were concerned that GWWC’s growth was slowing – only growing linearly, rather than exponentially. This would be pretty bad, and people were justifiably concerned. However, GWWC made a few changes with the aim of promoting growth. Most pertinently:

  • Allowing people to sign up online, rather than having to mail in a hand-signed paper form. This happened between April and June 2013.
  • Adjusting the pledge to become more cause-neutral, rather than just about global poverty. This happened late 2014.

GWWC signups labeled

source

The latter change was somewhat controversial, but I didn’t see much discussion of the former at the time.

The concern is that, though these measures have increased the number of members, they may have done so by reducing the average quality of members. Making it easier to join means more marginal people, with less attachment to the idea, can join. This is still good if their membership adds value, but they dilute the membership, which means we shouldn’t account for the average new member being signed up now as being equally valuable as the members who joined up in 2010. Additionally, the reduction in pomp and circumstance might reduce the gravitas of the pledge, making people take it less seriously and increase drop-out rates. If so, moving to paperless pledges might have reduced the value of sub-marginal members as well as diluting them.

The comparison with banks should be pretty clear – a bank that’s struggling to grow starts accepting less creditworthy applicants so it can keep putting up good short term numbers, but at the cost of reducing the long-run profitability. Similarly GWWC, struggling to grow, starts accepting lower quality members so it can keep putting up good short term numbers, but at the cost of reducing the long-run donations. This makes it harder to forecast the value of members, and might lead to over-investment in acquiring new ones.

This seems potentially a big risk, and it’s the sort of issue that this data would allow us to address. Of course, there are many other applications of the data as well.

And GWWC in fact has even stronger reasons than banks to report this data. The bank might be wary of giving information to its competitors, but GWWC has no such concerns. Indeed, if releasing more data makes it easier for someone else to launch a competing, better version of GWWC, all the better!

If you liked this you might also like: Happy 5th Birthday, Giving What We Can and GiveWell is not an Index Fund

Utility Regulation: The bad, the ugly and the good.

Summary: in an attempt to solve one problem, the regulation of public utilities unwittingly introduces another, potentially much worse one. But there is hope – we also discuss a potential improvement.

The Bad: Unregulated Natural Monopolies

Water, electric and natural gas utilities are often used as an example of natural monopolies – a service where the economies of scale are so great that it is efficient to only have one supplier in an area. This company would then be incentivized to charge inefficiently high prices, causing deadweight loss, as they prevent some customers from purchasing who otherwise would have at a competitive price. As such, people argue, they need to be regulated by the government, to ensure they don’t charge so high a price. As an added benefit, the regulation can ensure that they serve everyone in the service area, including those in hard-to-reach rural areas.

Which sounds very nice in theory. Unfortunately, in trying to fix this problem, regulation introduces another problem.

The Ugly: How Utilities are regulated in the United States

At present utilities are basically allowed to earn a profit on whatever services their regulator thinks they should provide. So the utility identifies certain projects that need to be done – putting in new transmission lines, or substations, or generation1, and present these projects to their regulator. The regulator approves the projects, and approves an ROE – (Return on Equity) – for the utility. The collection of approved and completed projects is called the utility’s Rate Base. The utility is then allowed to charge its customers enough to cover its costs and earn that ROE on its Rate Base.

So if a utility identifies a $100m project, and is awarded a 10% ROE, they make the investment, and then can charge customers enough to cover both their direct costs (labor, fuel, taxes etc.) and earn a $100m*10% = $10m profit on top.

This profit is very stable – it’s been granted to you by the government, who won’t allow anyone to compete with you2 – so investors are happy to fund the project. In fact, they’d be happy to fund the project even at lower ROEs – why ROEs have stayed high while interest rates have fallen is a mystery with basically no explanation other than regulatory capture. Suppose investors required a mere 6% return – then the extra 4%, or $4m in the above example, is pure monopoly profit – exactly what regulation was meant to avoid occurring!

But that’s not the main problem.

Utilities are not really businesses.

Normal businesses make money by selling stuff to customers for more than it cost them to make. If they can cut costs – use less of the earth’s precious resources – they can make more profits, either by earning more per unit or charging customers less and selling more units. As such, firms are incentivized to be as efficient as possible.

With utilities, however, you’ll notice this is not true. They’re allowed to charge customers enough to cover their costs and make a profit – if they cut costs, their regulator will make them return the savings to customers by lowering price. So utilities don’t really have any incentive to cut costs.

Worse, if they cut costs they might end up over-earning – earning a higher profit than their regulator has allowed – in which case they’ll be made to give money back to customers. To avoid this happening, utilities are deliberately wasteful in their operating expenses to ensure they can control exactly how high their costs are. They deliberately waste resources.3

But this is not even the worst part.

Remember how we discussed the $100m project earlier? It’s well known that the cost of construction projects is hard to estimate – government projects routinely go 100% over-budget. Well, what happens if instead of a $100m project, it was a $500m project? The utility would be allowed to earn a 10% on its Rate Base of $500m, or a $50m profit. So by building a more expensive and less efficient project, the utility makes 5x as much profit. And this is not idle speculation – utilities deliberately do this.

As a result, utilities are basically on a constant mission to find as many capital projects as possible, and to pay as much for them as possible. They spend twice as much to build a power plant as competitive firms spend to build one of the same type and capacity.

So regulation has taken one problem – utilities charging a high price and earning high profits – and replaced it with a far worse one – utilities charging a high price, earning reasonable profits but wasting most of the money on unnecessary spending. At least with unregulated monopolies someone benefits!

It’s possible that a similar thing might be happening with healthcare insurance companies now, as maximum Medical Loss Ratios mean that spending on drugs/treatments/etc. increases the amount they’re allowed to profit, but this is a relatively new issue for them – only becoming nationwide with obamacare. Utilities, on the other hand, have had this trouble for about 100 years.

The Good: How to save money by allowing unlimited profits

The problem is that utilities basically operate on a cost-plus basis. Here’s a simple alternative.

  • The utilities is allowed to charge a certain amount – either a total revenue sum or a per-kWh amount. This will rise by 1% a year.
    • Slightly below the current rate of increase. Alternatively you could tie this to inflation, say CPI -1%
  • The utility is legally obliged to connect all customers within its service territory.
  • The utility is fined for every blackout, with the fine set by a formula (e.g. $15/kWh not provided, which is roughly 100x what they would have charged for that kWh).

Now the utility is incentivized to be as efficient as possible. It can’t raise prices, but every dollar of savings will increase its profits. All of a sudden it goes from being a sleepy and inefficient company, whose only purpose is corrupting the regulator, to being a lean cost-cutting machine, dedicated to supplying electricity as efficiently and reliably as possible.

How should the initial revenue allowance be set? As we already have utilities, it would probably make sense to keep their current revenue allowance. It will take time for them to reform their infrastructure and become more efficient.

But if you were building the system anew, you might auction off regions. So you’d ask different companies to submit bids for the right to become the utility for an area, and accept the company who asked for the lowest revenue requirement. You don’t have to worry about their cutting corners, because electricity is homogeneous, and they’re massively penalized for any lack of reliability.

Unfortunately this would be politically vulnerable. If a highly competent management team reduced costs by 50%, they could increase their profit margins from 20% to 60%, and raise their ROE from 10% to 30%. Customers would see their bills continue to rise (albeit below inflation) and blame the profit-gouging utility. Voters might then pressure the politicians to steal from the utility, which cannot threaten to leave the area. The only way the utility can respond is by lobbying and obfuscating their profits, which basically gets us back to where we are now – highly inefficient cost structures so that profits look small compared to costs. Still, it’s worth thinking about what an enlightened electorate, or benevolent dictator, could do. And actually this is a little like what FERC is doing with transmission in RTOs.


If you liked this post, you might also enjoy How not to reform the insurance industry and The Future of Socialism is Privatizing the Atmosphere.

 


  1. Outside of the North East and Texas, where generation is operates in a semi-competitive market 
  2. I hear you asking: “If it’s a natural monopoly, why does the government need to prevent competition?” 
  3. Source: conversations with CEOs, CFOs, regulators etc. of utility companies. 

Human Capital Contracts

Summary: Human Capital Contracts would allow people sell a certain % of their future income in return for upfront cash, as opposed to taking out a loan. This would be less risky for them, would give them valuable information about different college majors, and would help give people de facto ‘mentors’, among other advantages. Adverse selection could reduce the benefits, and reducing inter-state competition poses a major possible disadvantage. We also discuss two niche applications: parents and divorce.

Debt vs equity financing

There are two methods of financing for companies; debt and equity.

Debt is fundamentally very simple. I give the company $100 now; it promises to give me $105 in a year’s time. They owe me a fixed amount in return. Hopefully in the meantime the company has invested that $100 in a project or piece of equipment that produces more than $105; if so they made a profit on the transaction as a whole. Here the risk is borne by the company; they have no choice but to pay me back, even if they didn’t make a profit this year. This form of financing is familiar to most people, as they personally use savings accounts, credit cards, mortgages, auto loans and so on.

Equity, unlike debt, does not represent a fixed level of obligation. Instead the company owes you a certain fraction of future profits. If you give a company $100 in return for a 10% share, and they made a $50 profit, your share of the profit is $5. Hopefully they will make growing profits for many years, in which case your portion will grow to $6, to $7, and so on. Here the risk is borne by you; if they don’t make a profit, you get nothing. This form of financing is much less familiar to most people; about the only experience they are likely to have would be investing in the stock market, but that is now highly abstract so the underlying mechanics are obscured.

Equity: Less Risky than Debt

One of the biggest advantages of this system is it moves the risk from the individual borrower to the investor. When you borrow money, you put yourself at substantial risk. What if you struggle to find a good job after college? You’re still obliged to make repayments, which could be very difficult if you only have to accept a very low-paying job. Or if you borrow money after college, what if you lose your job? Or have a family emergency? Your circumstances have deteriorated, but you’re still obliged to make the same level of payments – meaning your post-debt income falls by even more than your pre-debt income.

With equity, on the other hand, you don’t have the risk. If you don’t find a job after college, your income will be zero, so your repayments will be X% of 0 – namely 0. If you find a low-paying job, your repayments will be low. The investors will be made whole by the people who instead find high-paying jobs – who can also afford to repay more. So equity investments better match up your repayment obligations with your ability to repay.

Here is an chart showing the difference, in terms of the % of income you’d be spending on repayment, from an example worked out later in the article:

Debt burden under adversity

The risk is transferred to the investor, who now loses out if you don’t have much income. But they are in a much better position to deal with the risk – they can diversify, investing in many different people, and also in other asset classes. Some human capital contracts could be a good diversifying addition to a conventional portfolio of stocks and bonds.

Education

Funding higher education is perhaps the best application for Human Capital Contracts.

Firstly, this is an extremely risky investment. There are countless stories of people who took out huge student loans to fund an arts degree and then have their lives dominated by the struggle to repay. Alternatively, if people could discharge education debts through bankruptcy, the risk to the lender would be too great, as the borrowers typically lack collateral, so loans would be available only at prohibitively high interest rates, if at all. Selling equity shares would avoid this problem; people who did badly after school would only have to repay a minimal amount, but lenders could afford to offer relatively generous terms because the average would be pulled up by the occasional very successful student.

The other appeal is the information such a market would provide students. It is fair to say that many students don’t really understand the long-term consequences of their choices. The information available on the future paths opened up by different majors is poor quality – at best, it tells you how well people who studied that major years ago have done, but the labor market has probably changed substantially over time. What students really want is forecasts of future returns to different colleges and majors, but this is very difficult! And many people are not even aware of the backwards-looking data. The situation isn’t improved by professors, who generally lack experience outside academia, and sometimes simply lie! I remember being told by a philosophy professor that philosophers were highly in demand due to the “transferable thinking skills” – despite the total lack of evidence for such an effect. Human Capital Contracts would largely solve this problem.

TIPs markets provide a forecast of future inflation. Population-linked bonds would provide similar forecasts of future population growth. Similarly, Human Capital Contracts could provide forecasts of the future returns to future degrees. Lenders would expect higher returns to some colleges and majors (Stanford Computer Science vs No-Name Communications Studies), and so would be willing to accept lower income shares for people who chose those majors. As such, being offered financing for a small percentage would indicate that the market expected this to be a profitable degree. Being offered financing only for a large percentage would be a sign that the degree would not be very profitable. Some people would still want to do it for love rather than money, but many would not – saving them from spending four years and a lot of money on a decision they’d subsequently regret.

What could make clearer the difference in expected outcomes than being offered the choice between Engineering for 1% or Fine Art for 3%?

Certainly I think I would have benefited from having this information available. Most people probably know that Computer Science pays better than English Literature, but that’s probably not a pair many people are choosing from. I was considering between Physics, Math, Economics or History for my major. I knew that History would probably pay less, but didn’t have a strong view on the relative earnings of the others. I probably would have guessed that math beat physics, for example, but in retrospect I think physics probably actually beats math.

Astute readers might object here that I am conflating the benefits of the type of financing (debt vs equity) with the mechanism for pricing the financing (free market or price fixed). If there was a free market in debt financing, lenders could charge different interest rates, and these would provide information to the students. This is true, except that 1) the interest rate would only tell you about the risk you’d end up super-poor, rather than providing information about the full distribution of outcomes, and 2) as student loans cannot be discharged through bankruptcy, there’s not really much reason for lenders to differentiate between candidates. If student loans could be discharged through bankruptcy, the interest rates charged would be informative but also probably very high. Perhaps this would be a good thing!

Education Funding – some illustrative examples.

Because it can be hard to think about these things in the abstract, I’ve tried to produce some worked-out examples. Suppose someone borrows $100,000, and then starts out earning $50,000 when they graduate. Their income grows over time, as they gain experience (maturity) and the economy grows (NGDP/capita). If we assume a 6% return for investors and a 20 year duration, they would have to give up just over 5% of their income of this time period. The repayments would be much more manageable – in year one, it would represent just 5% of their income, as opposed to 17% if they used debt.

Debt Equity Repayment Structures, equal r

Now, investors might demand a higher rate of return for equity investments, as they’re riskier than debt ( but then again maybe not . Here’s the same calculations, but assuming equity investors require a 10% return vs 6% on debt:

Debt Equity Repayment Structures, unequal r

What happens if the student runs into financial difficulty later in life? Here’s what happens if their income falls by 50% and never really recovers:

Debt Equity Repayment Structures, equal r, unexpected poverty

with equity, the hit is affordable, but with debt they have to pay 20% of their income in debt repayments – perhaps at the same time as having medical problems.

And what about the information value? Well, the investors would be willing to offer them $100,000 for just a 5.6% share, instead of 7.85%, if they took a major that would offer a $70,000 starting salary instead.

Debt Equity Repayment Structures, unequal r, higher initial

I hoped you enjoyed these tables. They are probably the closest you will ever get to a picture on this blog. I did add color to some of them though!

Mentors – Incentive Alignment

The modern world is very complicated, and we can’t expect people to understand all of it. Which is fine, except when it comes to understanding contracts, or credit cards, or multi-level-marketing schemes. At times the complexity of the modern world allows people to be taken advantage of, even in transactions which would be perfectly legitimate had the participants been better informed.

Equity investments have the potential to help a lot here. All of a sudden I have a third party who is genuinely concerned with maximizing my income. I could ask them for advise about looking for a job. Perhaps they could negotiate a raise for me. Indeed, they might even line up new jobs for me! Obviously their incentives are not totally aligned with me. Except insomuch-as happy workers are more productive, they might not put much weight on how pleasant the job is. But true incentive alignment is rare in general; even your parents or your spouse’s incentives aren’t perfectly aligned, and the government’s certainly aren’t. Even better, it’s very clear exactly how and to what degree my inventor’s incentives are aligned with mine: I don’t need to try and work out their angle. I can trust them on monetary affairs, and ignore their advice (if they offered any) with regards hobbies or friendships or whatever else.

Indeed, you could imagine schools that funded themselves entirely through equity investments in their students, and advertised this as a strength: their incentives are well aligned with their students. They would teach only the most useful skills, as efficiently as possible, and actively support your future career progression. This is basically the model App Academy uses:

App Academy is as low-risk as we can make it.

App Academy does not charge any tuition. Instead, you pay us a placement fee only if you find a job as a developer after the program. In that case, the fee is 18% of your first year salary, payable over the first 6 months after you start working.

source

Compare this to current universities, which actively push minority students out of STEM majors to maintain graduation rates.

Progressive

A clear implication of equity financing is that people who go on to earn more for ex ante unpredictable reasons will pay more than those who are ex post unlucky. As such, this system is mildly redistributive in a manner many people find attractive – like a sort of idealized social insurance that Luck Egalitarians like talking about. The lucky rich pay more and the unlucky poor pay less. Even better, it manages to do so in a voluntary way.

Taxation

The idea of human capital contracts may sound very strange. But we actually already have something similar in taxation. Governments invest in the education, health etc. of their citizens, and then levy taxes upon them. These taxes tend to be proportional to one’s ability to pay; they are some fraction of income, or expenditures (sales taxes). So Human Capital Contracts should feel familiar to socialists and the like.

There are of course a few differences between Human Capital Contracts and taxation. For example,

  • Human Capital Contracts are optional, whereas taxation is mandatory.
  • Human Capital Contracts give you more choice about what you spend the money on, whereas governments typically give you little choice.
  • Finally, Human Capital Contracts are customizable; you could negotiate different terms with the lender (like the % share you’re selling, or the income level at which you start repaying, or the timing of repayments), whereas individuals rarely get much choice about the taxes they will be made to pay.

Indeed, the advantages of human capital contracts suggest a new way of doing taxation: the state could simply claim a certain % ownership of its citizens. Perhaps it might demand a higher % for those who use public education or public healthcare.

The idea of the state literally owning (a stake in) its citizens, without their consent, might sound evil. But this is basically what the government already does with taxation – it claims a certain fraction of your income, leaving you no recourse. Even renouncing your citizenship will not persuade the IRS to let its property go. Human Capital Contracts just make it more explicit that the governments of most countries effectively own somewhere between 30% – 60% of their populations. Worse, if they want to they can increase their ownership stake without the consent of those affected. Compared to this, it is hard to make voluntary Human Capital Contracts sound problematic.

However, this suggests a danger with equity investments in people. At the moment you can escape most governments by fleeing abroad. The couple of exceptions are largely viewed as immoral aberrations, not the rightful state of affairs. This exit-right provides a vital check on their power, and forces them to compete to some degree. Without it they can descend to the most abusive tyranny. If equity investments became widely recognized, however, governments might start to recognize each other’s ownership of its population to a greater degree than now, which would make them harder to escape. Of course, virtually any innovation can be opposed by pointing out they make it easier for governments to oppress ‘their’ populace, from coinage to maps to cell phones. Perhaps a more powerful government would be a more benign one, as many different people have argued – though perhaps not.

Mechanics

Operationally this would be slightly more complicated than taking out a standard loan, because the amount owed to the lender would be variable. As such, they need to verify my income so they can check I’m repaying the correct amount. There are many ways this could be done, but an obvious one would be through the tax system; I would submit to the lender a copy of my tax return to show my annual income. Perhaps this could be automated through TurboTax. An even easier option would be if the payments were deducted from my paychecks – this is how English student loans work.

Possible Regulations

One option for regulating the system would be to impose a maximum amount of equity an individual could sell. This would prevent people from selling 100% of themselves, which might be a bad idea! Though for-profit investors would probably be uninterested in buying up to 100%, as the individual would lack any reason to actually work. Probably the only people interested in buying 100% ownership would be cults, communist co-ops and terrorist movements.

Another would be to regulate the contingencies that could be attached to such contracts.

A third would be to prohibit the investor from employing the investee, or vice versa.

Adverse Selection

One of the biggest impediments to such a system might be adverse selection. Students have ‘insider information’ about their future prospects – they know about their career plans. The less you expect to earn, the more attractive selling equity is over the fixed payments of debt. Conversely, the more you expect to earn, the less attractive equity is vs debt. As such, the students who opted for equity financing might be disproportionately the students with the lowest expected outcomes. This would increase the % investors would demand in return for funding, further deterring the higher-expectation students, until eventually only the very lowest-expectation students would remain in the pool.

We could imagine this being a big issue in some subjects, like physics, where there is a large variance in income for the different exit routes – grad school vs industry vs quant finance. For others it’s less of an issue; if you go to law school you’re probably aiming to become a lawyer, though even there you might choose between criminal or corporate law.

However, there are several factors which would mitigate against such an outcome. Firstly, the risk aversion we discussed earlier means students would probably be willing to pay a substantial amount to avoid the risk associated with debt. Adverse selection would mean it would be even more attractive to students pessimistic about their long-term earnings, but so long as it is attractive enough for the optimistic ones, it would still work.

Indeed, this is basically how it works for health insurance. In theory adverse selection is a problem for private health insurance; but in practice there is not much evidence this is actually a problem; healthy people still buy health insurance.

The effect would also be substantially reduced by students own lack of knowledge about their futures. Many students change their mind over the course of their studies about what they want to go on to do. So some low-expectation students might take out equity financing, thinking they were being cunning… and then change to a high paying career track! This seems to be the more common direction of travel in general; students go to college planning on becoming human rights lawyers, or engineers, or artists, but instead end up as corporate lawyers, investment bankers and advertisers.

So this is a problem I’d expect the bond/equity/insurance market to be more than capable of dealing with.

Addendum: Speculative Extensions

Here are some more ideas where equity investments in people could be useful. The idea could still be valuable even without these though; education is probably the best use-case.

Parents

Once upon a time the land was rich and fruitful, and the people were fecund with beautiful offspring.

… maybe that never happened, but fertility rates definitely have fallen over time, probably to our detriment. Future people matter, a lot! And even if they didn’t, we still need someone to fund social security.

One guess as to why fertility has dropped is once upon a time your children could be relied upon to live near you, following your customs, and supporting you in your old age, though its unclear if this ever made strictly economic sense. Now, however, children feel much less moved by filial piety, and frequently move far away. As such, parents seem much less value in having children, and only do so out of charity – raising a child takes a lot of effort, and the modern world is full of super-stimuli to distract you from productive procreation. Giving parents a small equity stake in their children would go some way towards recognizing the investment parents put into their children, and hopefully boost fertility rates.

It would also encourage parents to support their children and their careers; now the high-flying child is not merely a source of pride but also a source of retirement. A friend I discussed this with suggested that first-generation immigrants tended to give their children very practical advice about school, careers and relationships, whereas whites tend to be more wishy-washy; perhaps this would promote a return to reality-based parenting.

Divorce settlement

Another niche case where these could be useful would be divorce settlements. The classic feminist argument about divorce settlements was that the woman had invested in domestic and family labor, which was disrupted by the divorce, while the man had invested in his career, which he kept. Partly as a result of arguments like this, we now see divorce settlements where one party gets a claim to some of the resources of the other.

However, a fixed sum is not a very natural way of dealing with this. The woman, in entering marriage, assumed she would be benefiting from a certain share of the man’s output. If he were successful, this would be more; if he came upon poor fortune, this would be less – rather than taking a costly and messy court case to adjust the payments.  Human Capital Contracts would allow a divorce settlement to recognize this: in a divorce were the man were at fault, the woman might be granted a 1% equity share for each year of marriage.

Obviously if you thought permitting divorce was a mistake – “til death do us part” – then you’d have little interest in this application.

Further Reading

Further Reading: Risk-Based Student Loans

The War on Drugs as Make-Work

An argument for ending the War on Drugs is that it would undermine the drug gangs. At the moment we have a baptists and bootleggers situation, where the drug ban benefits illegal providers, because it raises the price of drugs a lot. If drugs were legal, supply would increase a lot, lowering prices. Criminal gangs don’t actually have a comparative advantage at running efficient supply chains – if they did they would be running WalMart instead – so they will be out-competed by new, legal entrants to the market. This would dramatically reduce their revenues, making joining them less attractive, and leave them with less money to spend on sinful things.

And all of this is probably true. But…

Here’s another way of looking at it. At the moment some argue the US has a zero-marginal-product-worker problem; there are people who aren’t worth hiring at any price, because you can’t trust them not to steal from you, or break things, or insult customers, or get you into legal trouble. But, like the army before them, criminal gangs can make use of such people – perhaps because criminal gangs can make use of extra-legal motivational techniques. Normally, this would be bad, if criminal gangs were hiring such people to do immoral things like theft. But at present many of them are usefully employed in the socially productive activity of consumer product distribution.

And another group of thugs, who lack skills beyond the ability to yell loudly and order people around, get make-work as DEA agents.

So actually the War on Drugs is job security for semi-criminal ZMP workers, providing them with employment and protecting them from competition. Maybe pretty rubbish protection – it leaves many of them dead or imprisoned – but other forms of ‘protection’ for low-skilled workers also have some pretty negative consequences.

2015/01/28 Shadow FOMC statement

The members of the Shadow FOMC would like to apologize for our extended absence; we were held under house arrest by the agents of Stanley Fisher.

Release Date: January 28, 2015

For immediate release

Information received since the Shadow Federal Open Market Committee met in September suggests that economic activity has been expanding at a pretty reasonable pace.  Labor market conditions have improved further, with strong job gains and a lower unemployment rate, and the employment to population ratio has improved, albeit off a low base. The end of extended unemployment insurance seems to have significantly boosted employment; we suggest that the federal government would benefit from privatizing and making optional the remaining unemployment insurance.  On balance, a range of labor market indicators suggests that underutilization of labor resources continues to diminish.  Household spending is rising moderately; recent declines in energy prices have boosted household purchasing power, though we worry they may have been caused by a fall in global aggregate demand.  Business fixed investment is advancing, though recent profitability among industrial companies has been disappointingly weak. The recovery in the housing sector remains slow. House prices remain well below the net present value of avoided future rent payments, probably due to regulation hindering the supply of mortgage financing, though recent data there has been encouraging.  Inflation has declined further below the Light Committee’s longer-run objective, as predicted by the Shadow FOMC, and they should not blame energy: while energy prices have fallen dramatically, inflation ex. shelter has been running below target for years, due to the unconsciously tight monetary policy the light committee has followed. Market-based measures of inflation expectations have declined substantially in recent months, and are now indicating that the Light Committee will miss its target for the next 10 years. We are highly disappointed that the Light Committee chose the Orwellian step of renaming them ‘inflation compensation’ instead of ‘inflation expectations’, ignoring the enormous predictive power the market gives us. Yes, survey-based measures of longer-term inflation expectations have remained stable, but who cares? These surveys have been awful forecasters in the past.

The recent rise in the value of the dollar against a trade-weighted basket of other currencies (or, indeed, virtually any other currency other than the Swiss Franc) shows the high level of global demand for the USD. Since this is a product that can be created at basically zero cost, the Shadow Committee would accommodate this demand and print some more USD.

Inconsistent with its statutory mandate, the Light FOMC is failing to foster maximum employment and price stability. Unemployment is low, so the Light Committee’s actions could be justified if it was targeting that… but it is ostensibly targeting employment instead. Employment is still pretty awful; both employment and inflation suggest the need for loser monetary policy. The Shadow Committee expects that, even with a lack of appropriate policy accommodation, economic activity will expand at a moderate pace, as free markets have a tendency to grow. As the economy is kind of like a martingale; risks to the outlook for economic activity and the labor market will always be nearly balanced.  Inflation is anticipated to decline further in the near term, and though the Committee expects inflation to rise gradually as energy is a one-time shock and the oil forward curve is very steep, we have no idea why the Lighties expect it to reach the target at any point in the foreseeable future.  The Shadow Committee continues to monitor inflation developments closely; evidently more closely than the Light FOMC!

To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that the current 0 to 1/4 percent target range for the federal funds rate remains appropriate. However, we wish to remind people that this by no means represents a lower bound on interest rates; in the event the economy deteriorates further, we would be willing to lower interest rates further, or to deploy an array of other policy tools. In determining how long to maintain this target range, the Committee will assess progress–both realized and expected–toward its objective of a certain NPGDP level, which increases by 6% a year.  This assessment will take into account a wide range of information, including market indicators, what people say on facebook, and the behaviour of our cats.

We regret that the Light Committee completed the taper of its bond holdings, though we believe that resuming the program now could be destabilizing and reduce the credibility of the Bed. The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction.  This policy, by keeping the Committee’s holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.

When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and NPGDP of 6 percent. The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Shadow Committee views as more consistent with the fundamental level of human time preference, which implies long-run real rates of around 3-4%. Over the longer term, the Shadow remains concerned about value drift resulting in a future devoid of moral significance.

Voting for the SFOMC monetary policy action were: everyone, because I rule with an Iron Fist.

What if Regulation was a Finite Resource?

Alternative Title: Conservation of Regulation

Think of the fuels that have provided the energy for human civilization so far – coal, oil, gas. They existed for thousands of years, largely inert. A small part of them (mainly coal) was used by humans for forges and the like. But then we discovered them during the industrial revolution. We put them to good use, but there’s only a limited supply.

What if regulation was the same? There’s only a finite amount available. For most of history, this existed in a largely inert fashion, regulating the atmosphere, evolution, and so on. A small part of it was used by humans to regulate their habits and bowl movements.

But then during the industrial revolution regulation was discovered by socialists and paternalists. They started using it on a massive scale, trying to regulate all of society.

Unfortunately, there’s only a finite amount of regulation available. We’ve been using so much over the last few hundred years that there’s not enough to regulate the climate – hence climate change. It caused a breakdown in virtue when people’s ability to regulate their habits was reduced. It also caused the obesity crisis because we can no longer regulate our bowl movements properly.

Now, leading scientists are warning about an even greater threat: we might be using up so much regulation that the earth’s orbit will cease to be regular. This will have dramatic consequences, ranging from disruptions to the seasons and day-and-night cycle, to the earth crashing into the sun.

Leading scientists say we need to rapidly reduce our regulation consumption if this is to be avoided. They recommend bring our regulation uses back down to 1990s levels by 2020, and 1900 levels by 2050, and 1700 levels by 2100. Unfortunately, it may already be too late to avoid changing the day-and-night cycle by 1-2 hours, in an effect scientists have dubbed ‘daylight savings time’.

Economists are divided on the best way to respond to the crisis. Some favor a regulation tax, where anyone who implemented or enforced a regulation would have to pay a tax equal to the negative externality they caused. Others suggest a cap-and-trade system, whereby rich countries would be able to buy regulation credits from poor countries. Some politicians prefer a command-and-control approach, where they would pass regulations limiting the use of regulations in industry.

Some progress has been made – most countries have signed up to the Hong Kong Protocol, promising to reduce their regulation levels. The US risks becoming an international pariah by refusing to sign; the Obama administration defended its intransigence:

Hong Kong is, in many ways, unrealistic. Many states do not want to meet their Hong Kong targets. The targets themselves were arbitrary and not based upon political science. For America, complying with those mandates would have a positive economic impact, with increased hiring by small businesses and price decreases for consumers. And when you evaluate all these flaws, most reasonable people will understand that it’s not sound public policy.

But you too can make a difference! There are many easy steps you can take. Maybe turn off your thermostat – doesn’t the earth need that regulation more than your central heating? Write to politicians expressing your concern. Join a local libertarian group.

Remember, preventing the world crashing into the sun is more important than regulating your heartbeat, so ask yourself: do I really need a pace-maker?