Is kidnap insurance a good thing?

In some countries, kidnapping for ransom has become a common and profitable business. It does not strike as an added-value generating activity, but one has to live with it. One way in which markets have responded to this is that it is now possible to by kidnap insurance that pays ransoms. Is this a good thing? Indeed, kidnapping frequency may increase if there is a higher likelihood that a ransom is going to be paid. That is not unlike US colleges that charge higher tuitions because they can, as public funds for students grants and loans have been ramped up. But let us keep talking about criminal kidnapping.

Alexander Fink and Mark Pingle look into this issued. The first question one may ask is whether this kind on insurance is sustainable in the first place. Indeed, many insurance markets fail due to adverse selection or moral hazard issues. In this case, risk aversion on the insureds is high enough that they are willing to pay premiums sufficiently above what would be actuarially fair. Indeed, there is a risk of getting somebody killed, and optimal kidnappers would want to randomize over this just to make sure that they can extract the most. The presence of insurance will increase the number of kidnapings, but if it does not do this too much, one should see a reduction in killings. We can thus not unambiguously say that kidnap insurance should be allowed.

Dating Advice from Ed Glaeser

Believe it or not.

Are economists really uneasy about studying inequality?

Economists are often misunderstood. People do not understand what we do. They think we spend all our time forecasting the stock market. And the whole profession has been accused of not foreseeing the recent recession. Some economists have redirected this criticism and made a name for themselves by complaining that economic models do not take this or that into account. That is true, but this is often irrelevant, as models are abstractions and they cannot take everything into account. You want to build the right model for the particular question at hand. I have mentioned a few of those essays on this blog, in part because they frustrate me as they are ignoring the very literature they are calling for. There is a lot more to Economics than the principles with perfect markets we tend to teach as an introduction to the field.

The latest paper to frustrate me is by Brendan Markey‐Towler and John Foster. They claim the Economics profession is uncomfortable with issues about inequality to the point of ignoring them. To support this, they quote extensively from the introduction of the Handbook of Economic Inequality, which of course is going to try to make the case that inequality is underrepresented in the literature. Why so? Markey-Towler and Foster claim this has to do with the profession's adherence to Arrow-Debreu markets, welfare theorems, the Hicks-Kaldor efficiency-equity trade-off, and Arrow's impossibility theorem. Because the profession is so enamored in these theorems, it views the impact of inequality to be political only, but of no economic consequence. Never mind that you can still have inequality in such economies. Never mind that every issue of the top journals has papers with such properties and inequality. Never mind that many papers go through great lengths in trying to model observed inequality while studying many issues. I agree not every paper does this, far from this, but then not every answer hinges on inequality. Again, models are an abstraction, and one cannot include everything. One keeps what is most likely to matter. Occam's razor is still valid today.

Markey-Towler and Foster have this distorted and unfortunately common view that economists believe markets are always complete and perfect, and thus inequality cannot happen. This sounds a lot like those who criticize Economics after taking one class, where they learned that free markets and free trade are good. But economists have long realized that things are much more complicated than that, and the study of the departures from this perfect world dominates current research in Economics. In fact, read this blog and you should see that I hardly mention such perfect markets. The authors' solution? Complex systems theory, which I liken to modeling the actors of an economy being linked by a giant plumbing system with leaks, plugs and bottlenecks. That sounds much like the frictions, information asymmetries and imperfect competition we put in our models, except that complex systems theory is much more detailed, requires gigantic amounts of data to calibrate or estimate, and has gone nowhere so far. So researchers had to resort to heroic assumptions to show something could happen, without any ability to validate it empirically.

I do not think this is the way to go, and we can agree to disagree on that. But I take offense at the idea that economists are somehow uncomfortable, even scared of dealing with inequality. That is just not true.

Efficient raffling of public goods

How to provide for a public good is a classic problem, because of the free-rider problem. If you cannot compel users, say, by forced taxation, it is very difficult to recoup the cost of a public good, unless the cost is very low and the benefit to each user very large. That rarely happens. So how can you solve this conundrum when philanthropy is not available?

Jörg Franke and Wolfgang Leininger propose an algorithm based on raffling the cost of the public good. This ideas is due to John Morgan: you create a lottery for the benefit of a socially beneficial public good. Then, people are willing to pay more for the public good. But this is not yet sufficient for the efficient amount of public good. To get there, Franke and Leininger propose an unfair raffle. The raffle tickets are sold at prices that look like Lindahl pricing, but unlike in the Lindahl model, there is no coercion. While there are already many charity raffles that would fit the Morgan model, I cannot think of an unfair public-good raffle in practice, though.

Five Lessons from the Financial Crisis

From Olivier Blanchard.

Obama's Anti-China Free Trade Area of Free People [sic]

Question: What do you get when you cross the EU-US FTA with the Trans-Pacific Partnership?
Answer: The Free Trade Area of Free People (FTAFP)[sic]

During the Cold War, older readers will remember that the United States began funding pro-democracy propaganda via Radio Free Europe, Radio Free Asia, and so forth. Now that the Cold War is over, we are, er...supposedly returning to that same sort of mentality from the Yanks. Or, at least news sources are telling as alike the Financial Times. Maybe it was a slow day at the world's premier financial newspaper, but it too has succumbed to this temptation of portraying US FTA initiatives as those meant to "bandwagon against" China in the economic realm.

I am honestly wary of this characterization since it, first of all, brings us back to the framing of trade as inherently conflictual when it's supposed to be mutually beneficial as per the theory of comparative advantage. Moreover, hasn't China pursued FTAs of its own especially in Asia that pointedly exclude the US and other Western nations? At any rate, an argument being marshaled is of China's exclusion helping to appease trade-phobic American lawmakers:

But much of the substance of the EU talks and of TPP points to China. The agenda includes state subsidies for business and protecting intellectual property – precisely the sorts of issues that are becoming huge bones of contention with Beijing. If the US can get enough important countries to sign up, it hopes to establish global trading standards that China would feel obliged to respect. On Capitol Hill, where free trade is not an easy sell in an era of unemployment of more than 7.5 per cent, the China angle is being used to rally support. “This is very much part of our China strategy,” an aide to a leading Republican senator puts it, talking of the discussions with the EU. 

And speaking of my admittedly, ah, tortured title, there is supposedly an emergent coalition of the WTO-plus trade willing to paraphrase a former American leader:

TPP and the US-EU trade talks represent an alternative strategy, an attempt to forge fresh rules by appealing to smaller groups of like-minded nations, in this case working around China rather than with Beijing. Supporters say this is not an abandonment of global institutions such as the World Trade Organisation but simply a realistic assessment of how to get things done.

You're either with us or against us in trade. Where have we heard something similar before? That said, I am doubtful whether joining up the TPP and US-EU FTA really is an American goal to isolate China in trade. After all, both American-led initiatives are hardly done deals and both face formidable obstacles to completion, so we cannot even begin to speculate about their merger.

That said, you must admit that Free Trade Area of Free People [sic] has a nice ring to it.

Overconfident NBA players are lead to a financial demise

Some professional athletes manage to amass amazing fortunes only to file for bankruptcy a few years after their retirement from sports. How can such large wealth go to waste so quickly? The typical explanation is that poor investments were made. Why does it happen so frequently to them? My take has been that either their wealth attracts swindlers, or the comparative advantage of these athletes is not human capital, or both.

Ruby Henry thinks this has to do with over-confidence. He builds a database of NBA players drafted in the 1990's and collects from various Internet source information about their personalities and their professional characteristics. The first sign of trouble is that most of those venturing into entrepreneurial undertakings do it in food services or real estate, two sectors were bankruptcies are particularly common. The second sign is that they do not seem to diversify much. One can interpret this as the consequence of over-confidence in one's ability and luck. Ruby measures the level of confidence of a player with the number of 3-point shots attempted per playing minute. And it appears that shooting for more 3-pointers later leads to more business ventures, and more bankruptcies. That would explain the variation across NBA players. But does that explain why NBA on average have more bankruptcies, and especially more spectacular ones?